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New Hampshire Thrift Bancshares, Inc. is the parent company of Lake Sunapee Bank,_fsb,a federal stock savings bank providing financial services throughout central and western New Hampshire.

The Bank encourages and supports the personal and professional development of its employees, dedicates itself to consistent service of the highest level for all customers, and recognizes its responsibility to be an active participant in, and advocate for, community growth and prosperity.

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Selected Financial Highlights

⁽¹⁾ See Note 1 to Consolidated Financial Statements regarding earnings per share.

⁽²⁾ Includes available-for-sale securities shown at fair value, held-to-maturity securities at cost and Federal Home Loan Bank stock at cost.

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…the Company saw a significant repositioning of its balance sheet as total loans held in portfolio declined, loans sold and serviced for others increased, net deposit grew $6 million, and the investment in securities nearly doubled…

Letter to Shareholders

The Company continued to experience record levels of mortgage lending activity throughout the year 2002 as the refinance boom extended its multi-year run. At the same time, the Company worked to fully integrate the enhancements to our data processing capabilities made possible by our in-house conversion in late-2001. Economic conditions led to an ongoing decline in interest rates to historically low levels not seen for several decades that, when combined with the now seemingly embedded restlessness of the stock market, continued to foster a clear and obvious anxiousness as investors sought to find ‘safe harbors’ for their funds. As a primary result of these trends, the Company saw a significant repositioning of its balance sheet as total loans held in portfolio declined, loans sold and serviced for others increased, net deposit growth grew $6 million, and the investment in securities nearly doubled. The Company continued to build upon its primary role as a community-focused institution and sought ways to further enhance our customer relationships in ways that would strategically advantage our financial services franchise. An underlying premise of the Company lies in the progressive and steady growth of shareholder value through the application of ‘best practices’ policies throughout the institution.

Company Earnings

Earnings for the year, aided by the final maturity of higher-yielding certificates of deposit and an accounting change impacting the amortization of goodwill, set a new record for the Company, increasing by nearly 40% over the previous year. Consolidated net income for the year-ended December 31, 2002 was $4,299,988 or $2.20 per share of common stock. This compares to net income of $3,100,464, or $1.60 per share, that the Company reported for 2001. The many changes that continued to occur within the various asset allocations on the balance sheet are a direct result of the moderately weak economy and the ongoing trends in customer perceptions and needs. As interest rates continued to move lower over the course of the year, the liquidity position of the Company strengthened and, in so doing, shifted some of our attention from the retail delivery side of the business to the investment function. The benefits of developing advisory relationships were to ensure that the best possible pricing was always achieved when executing a trade or re-deploying resources for an optimum return on investment. Complete financial details for the year-ended December 31, 2002 are more fully covered in the Management’s Discussion and Analysis section immediately following this letter.

Shareholder Value

In general, financial institutions have continued to provide growth in shareholder value and have not fallen victim to the nervousness and pressure of the stock market. While the litany of corporate scandals have somewhat diminished, the after-shock has resulted in the Sarbanes-Oxley Act of 2002 and the demand for greater accountability within the universe of public companies. Financial institutions, interestingly enough, by their nature and charter, have always subscribed to, or been held to, a higher-standard of care that is inherent to the regulated environment of federally-insured depository institutions. The basic philosophy and oversight of the Company, then, finds itself in parallel with the public perception of stabilityinvesting in a company that provides needed services and does so profitably. The Company’s stock price ended the year 2002 at $18.60, having ranged from a low of $15.00 to a high of $19.77 over the course of year. The change from year-end 2001 resulted in a net stock price increase of nearly 20%. Shareholders’ equity ended the year at $33,765,996 as compared to $28,965,895 at December 31, 2001. The number of common shares outstanding at year-end was 1,958,924 and the book value per share stood at $17.24, an increase of $2.29 per share over the December 31, 2001 book value of $14.95 per share.

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Letter to Shareholders (continued)

Business Activity

The pace of our mortgage lending activities escalated beyond expectations during the second half of 2002 as interest rates continued their descent into territory not seen in nearly forty years. Almost universally the pressure was on to refinance one’s mortgage loan again and capture the lowest possible rate for the longest possible time. When coupled with our normal purchase and construction lending activity, the flow of applications, commitments and closings resulted in yet another record year for the Company. Maintaining our leadership role in this area requires a coordinated and dedicated effort within the underwriting, processing and servicing departments, to meet the daily challenges of documentation deadlines.

With interest rates at record lows and a significant number of higher-yielding certificates of deposits set to mature during the year, the Company prepared itself for a possible out-flow of funds to meet the demands of those customers seeking alternative investments that might return them more than a traditional deposit account. As the year progressed it became more and more evident that this movement of funds was not going to take place as the fundamental values of safety and security more than offset the desire for a slightly higher yield. The retention of those deposits, when married to the inflow of cash from the sale of previously held portfolio loans refinancing into the fixed-rate secondary market, resulted in a significant increase in liquidity and placed the Company in an unexpected position…that of being an investor of funds itself…and, in turn, the Company has moved to strengthen its asset and liability management resources. While the residential mortgage lending process transitions to more of a commodity-like business, commercial and small business lending continue to be seen as avenues with considerable potential for growth and profitability not only for the community banks…but also for the communities they serve. This, then, is one of the areas receiving greater emphasis within the Company as a way to build and maintain a healthy loan portfolio. In fact, the non-residential segments of our portfolio now make up a far larger percentage of our overall loans than ever before. With the growth in the sold loan portfolio and the corresponding reduction in adjustable rate loans held for investment, this is a trend that is now likely to continue.

Balance Sheet Fundamentals

Total assets of the Company stood at $496,644,923 at year-end December 31, 2002 as compared to $493,937,076 at December 31, 2001. This modest increase belies the level of activity that took place during the year, nor does the number itself reveal the shifts and repositioning in the structure of the asset and liability classifications themselves. The ‘flight to safety’ deposit increases of the prior year appear to have been replaced by a more moderate ‘leave it in the bank’ philosophy which will likely continue in the near term. The short-term rewards of the stock market were quickly eroded and, for many people, a full return to the world of investments will require a confidence level in the economy that will take some period of time to rebuild.

The most significant change during the year is evidenced by a decrease of $20,570,040 in our loans held in portfolio as many customers sought to refinance their home mortgages from adjustable-rate to fixed-rate loans. At December 31, 2002 the loan portfolio stood at $319,865,972 as compared to $340,436,012 at year-end 2001. Alternatively, the Company is an active seller of loans into the secondary market and the total of the sold loan portfolio was $260,774,730 at year-end 2002 as compared to $214,576,888 a year earlier. The Company retains the servicing rights on almost all of these loans in order to maintain the ‘relationship business’ aspect that customers of local community banks have come to expect and appreciate.

…the pace of our mortgage lending activities escalated beyond expectations during the second half of 2002 as interest rates continued their descent into territory not seen in nearly forty years…

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…the institution remains both well-capitalized and well-reserved, placing it securely in a position of financial strength…

Letter to Shareholders (continued)

Asset quality remains high across all segments of the loan portfolio. The Company maintains active internal loan review procedures that are further supported by the ongoing engagement of an external audit process that regularly reviews different segments of our banking franchise. Based upon the most recent Safety and Soundness Examination conducted by the Office of Thrift Supervision, we have again retained our quality rating and the institution remains both well-capitalized and well-reserved, placing it securely in a position of financial strength.

Challenges and Changes

As competitive pressures continue to change…both from in-market and out-of-market providers…the primary challenge will remain that of being customer-centric as the need to offer a broader array of more specific purpose products grows ever more important. Prevailing economic conditions result in a variety of mixed-signals for our customers and a larger part of our mission is to provide a banking environment for both customers and employees that keeps promises, delivers value and leads by example. The role of leadership in the community banking setting helps us to better understand and build upon the bond that can be created with each customer relationship. Recognizing and appreciating the fact that what we do and how we do it does make a difference is an important part of our business culture and, in turn, our business success.

Customer service…poor, fair, good, great or exceptional…has always been a defining factor in almost any business setting. We are now in the early implementation stages of an across-the-bank effort to reinforce those characteristics that customers inherently value and to make them an integral part of how the Company conducts itself on a day-to-day basis. Since not all customers are created alike, this re-dedication to focusing on each customer to better identify their needs and to find solutions to their problems will help enable the institution to set itself apart and maintain its leadership position within the relatively narrow economic, geographic and demographic corridor of our financial services franchise.

The Company and its employees remain committed to the standards of excellence and quality in all that we do and fully recognize that, while interest rates will rise and fall and net earnings can be impacted by things both in and out of our control, a bank cannot survive without an ongoing effort to develop, nurture and retain customer relationships.

In Closing

Dedication…teamwork…and a desire to assist others are the primary underpinnings to the continuing success of the Company as we progressively and strategically move to strengthen our marketplace positioning and presence. Our goal is to provide excellence in banking that will, in the end, be of lasting benefit to our communities, to our customers, to our employees and to our shareholders.

Stephen W. Ensign

Chairman of the Board,

President and Chief Executive Officer

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Management’s Discussion and Analysis

of Financial Condition and Results of Operation

General

New Hampshire Thrift Bancshares, Inc.’s (the “Company”) profitability is derived from its subsidiary, Lake Sunapee Bank, fsb (the “Bank”). The Bank’s earnings are primarily generated from the difference between the yield on its loans and investments and the cost of its deposit accounts and borrowings. Retail-banking service fees, and gains on security and loan transactions supplement these core earnings.

In 2002, the Company earned $4,299,988, or $2.19 per common share, assuming dilution, compared to $3,100,464, or $1.59 per common share, assuming dilution, in 2001. The increase in earnings for the year was driven by an increase in net interest income due to the falling rate environment and an increase in other income spurred by the gains generated from the sale of loans to the secondary market. During 2002, the Bank sold close to $95.0 million in loans to the secondary market, realizing gains on those sales of $2,203,260. In 2002, the Bank originated $231.5 million in loans, compared to $230.6 million in 2001. The low interest rate environment in 2001 carried over to 2002, continuing to create a high demand for fixed rate mortgage loans. Since the Bank sells fixed rate loans to the secondary market, the Bank’s servicing portfolio increased from $214.6 million at December 31, 2001 to $260.8 million at December 31, 2002, an increase of $46.2 million, or 21.53%. In addition, the Bank benefited from an accounting change regarding the treatment of Goodwill, which discontinued the requirement to amortize the unidentifiable intangible asset. This is discussed on pages through 17-19.

Forward-looking Statements

The preceding and following discussion may contain certain forward-looking statements, which are based on management’s current expectations regarding economic, legislative, and regulatory issues that may impact the Company’s earnings in future periods. Factors that could cause future results to vary materially from current management expectations include, but are not limited to: general economic conditions, changes in interest rates, deposit flows, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory and technological factors affecting the Company’s operations, pricing, products

and services. In particular, these issues may impact management’s estimates used in evaluating market risk and interest rate risk in its GAP and Net Portfolio Value (NPV) tables, loan loss provisions, classification of assets, accounting estimates and other estimates used throughout this discussion. The Company disclaims any obligation to subsequently revise any forward-looking statements, or to reflect the occurrence of anticipated or unanticipated events.

Critical Accounting Policies

The Company considers the following accounting policies to be most critical in their potential effect on its financial position or results of operations:

Allowance for Loan Losses

The allowance for loan losses is established through a charge to the provision for loan losses. Provisions are made to reserve for estimated losses in outstanding loan balances. The allowance for loan losses is a significant estimate and is regularly reviewed by the Company for adequacy by assessing such factors as changes in the mix and volume of the loan portfolio; trends in portfolio credit quality, including delinquency and charge-off rates; and current economic conditions that may affect a borrower’s ability to repay. The Company’s methodology with respect to the assessment of the adequacy of the allowance for loan losses is more fully discussed on pages 16-18 of this report.

Income Taxes

The Company must estimate income tax expense for each period for which a statement of operations is presented. This involves estimating the Company’s actual current tax exposure as well as assessing temporary differences resulting from differing treatment of items, such as timing of the deduction of expenses, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and to the extent that recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31, 2002, there was a valuation allowance set aside against deferred tax assets.

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Management’s Discussion and Analysis (continued)

Interest Income Recognition

Interest on loans is included in income as earned based upon interest rates applied to unpaid principal. Interest is not accrued on loans 90 days or more past due. Interest is not accrued on other loans when management believes collection is doubtful. All loans considered impaired are nonaccruing. Interest on nonaccruing loans is recognized as payments are received when the ultimate collectibility of interest is no longer considered doubtful. When a loan is placed on nonaccrual status, all interest previously accrued is reversed against current-period interest income.

Acquisition of Assets

On October 13, 1999, the Bank received regulatory approval to purchase three branches from New London Trust Company, fsb, (NLTC) located in New London, Andover, and Newbury, New Hampshire.

As of the close of business on October 29, 1999, the Bank completed its purchase of certain assets and assumption of certain liabilities of NLTC, including the three branches, pursuant to an agreement entered with PM Holdings, Inc., (“PM Holdings”), a wholly owned subsidiary of Phoenix Home Life Mutual Insurance Company (“Phoenix”), and PM Trust Holding Company, a wholly owned subsidiary of PM Holdings. The acquisition occurred immediately after PM Trust’s acquisition of all outstanding capital stock of New London Trust from Sun Life Assurance Company of Canada (U.S.). The Bank uses the property and equipment acquired in the same capacity as NLTC. The agreements among the parties relating to this transaction were filed as exhibits to the Form 10-QSB for the quarter ended March 31, 1999.

In connection with the acquisition, the Bank acquired the NLTC main office, Andover and Newbury branches of NLTC with deposits totaling approximately $100.0 million and gross loans totaling approximately $81.0 million. The consolidated assets of the Company upon consummation of the acquisition of the three branches were in excess of $450.0 million. The acquisition was consummated after satisfaction of certain conditions, including the receipt of all requisite regulatory approvals and was accounted for as a purchase under generally accepted accounting principles. The Bank paid a $10,576,000 deposit premium. Systems were successfully converted over the weekend of October 30, 1999.

On August 12, 1999, NHTB Capital Trust I (the “Trust”), a Delaware business trust formed by the Company, completed the sale of $16.4 million of 9.25% Capital Securities. The Trust also issued common securities to the Company and used the net proceeds from the offering to purchase a like amount of 9.25% Junior Subordinated Deferrable Interest Debentures (the “Debentures”) of the Company. The Debentures are the sole assets of the Trust and are eliminated, along with the related income statement effects, in the consolidated financial statements. The Company contributed $15.0 million from the sale of the Debentures to the Bank as Tier I Capital to support the acquisition of the three branches of NLTC. Total expenses associated with the offering approximating $900,000 are included in other assets and are being amortized on a straight-line basis over the life of the Debentures.

The Capital Securities accrue and pay distributions quarterly at an annual rate of 9.25% of the stated liquidation amount of $10 per Capital Security. The Company has fully and unconditionally guaranteed all of the obligations of the Trust. The guaranty covers the quarterly distributions and payments on liquidation or redemption of the Capital Securities, but only to the extent that the Trust has funds necessary to make these payments.

The Capital Securities are mandatorily redeemable upon the maturing of the Debentures on September 30, 2029 or upon earlier redemption as provided in the Indenture. The Company has the right to redeem the Debentures, in whole or in part on or after September 30, 2004 at the liquidation amount plus any accrued but unpaid interest to the redemption date.

Charter Holding Corporation

On October 2, 2000, the Bank and two other New Hampshire banks acquired Charter Holding Corporation (CHC) and Phoenix New England Trust Company (PNET) from Phoenix Home Life Mutual Insurance Company of Hartford, Connecticut. Contemporaneous with the acquisition, CHC and PNET merged under the continuing name of Charter Holding Corporation with assets of approximately $1.7 billion under management. As a result of the acquisitions and merger, at a cost of $3,033,337 each, the Bank and each of the other two banks own one-third of CHC. Headquartered in Concord, New Hampshire, CHC provides trust and investment services from more than a dozen offices across New Hampshire, as well as one in Norwich, Vermont. The Bank purchased CHC as a means to provide trust and investments services as well as insurance products to the Bank’s customers. By doing so, the Bank anticipates non-interest income to be enhanced. For the years ended December 31, 2002 and December 31, 2001, the Bank realized $113,424 and ($158,293), respectively in an undistributed gain and loss. The Bank has entered into an agreement with

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Management’s Discussion and Analysis (continued)

Charter New England Agency (CNEA), a subsidiary of CHC, which enables the Bank to sell brokerage, securities, and insurance products. For the years ended December 31, 2002 and December 31, 2001, the Bank generated commissions in the amount of $109,398 and $103,460, respectively.

Financial Condition

Total assets increased by $2,707,847 or 0.55%, from $493,937,076 at December 31, 2001 to $496,644,923 at December 31, 2002. Cash and cash equivalents decreased $2,917,533 while net loans receivable decreased $20,039,254 over the prior year-end.

Total gross loans, excluding loans held-for-sale, decreased $20,570,040 or 6.04%, from $340,436,012 at December 31, 2001 to $319,865,972 at December 31, 2002. The decrease was primarily attributed to an increase in loans sold to the secondary market. The Bank sold $95 million in loans during 2002. Sold loans totaled $260,774,730 at year-end 2002, compared to $214,576,888 for the same period in 2001. The Bank expects to continue to sell fixed rate loans to the secondary market, retaining the servicing, in order to manage interest rate risk and control growth.

Typically, the Bank holds adjustable rate loans in portfolio. Adjustable rate mortgages comprise approximately 80% of the Bank’s real estate mortgage loan portfolio. Real estate loans decreased $24,917,225 or 8.43%, from $295,455,068 at December 31, 2001 to $270,537,843 at December 31, 2002. This is consistent with recent years because of the Bank’s strategy of selling fixed-rate loans to the secondary market. Consumer loans increased $7,498,893, or 30.29%, to $32,255,636 due the Bank’s campaign in developing increased Home Equity Lines of Credit.

The amortized cost of investment securities increased $27,429,630, or 49.16%, from $55,793,535 at December 31, 2001 to $83,223,165 at December 31, 2002. The Bank took the proceeds of the sale of loans and invested these funds in short-term Commercial Paper, Mortgage-Backed Securities, U.S. Government Agencies, and Trust Cap Preferreds. Moreover, the Bank liquidated several long-term Corporate Bonds in order to shorten maturities and improve the risk profile of the investment portfolio. As a result, the Bank realized gains on the sale of securities in the amount of $146,473 during 2002, compared to $76,863 in 2001. At December 31, 2002, the Bank’s available-for-sale investment portfolio had a net unrealized gain of $233,331, compared to a net unrealized loss of $1,456,178 at December 31, 2001. This change of $1,689,509 in market value was significantly influenced by the decline in interest rates during 2002 which increased the market value of the investment portfolio.

Real estate owned and property acquired in settlement of loans decreased by a net $79,832, or 79.43%, to $20,668 at December 31, 2002.

Deposits increased by $6,591,426 or 1.56%, to $429,328,420 at December 31, 2002, from $422,736,994 at December 31, 2001. During 2000 and early 2001, the Bank offered time deposits with special rates in an effort to attract and retain deposits that had recently been acquired from NLTC and to meet the competitive environment. These time deposits carried a higher rate of interest than the current market and began to mature during 2002. Approximately $75 million of these “specials” matured in 2002 and were either re-deposited into other Bank deposit products or re-invested elsewhere. Many customers, uncertain about stock market stability, moved funds back into fully insured bank deposit accounts. At December 31, 2002, time deposits comprised 27.12% of total deposits versus 36.79% for the same period in 2001, reflecting customers’ appetite for short-term, liquid, and fully insured deposits.

Advances from the FHLB remained at zero during 2002.

Liquidity and Capital Resources

The Bank is required to maintain sufficient liquidity for safe and sound operations. At year-end 2002, the Bank’s liquidity ratio of 17.89% was sufficient to cover the Bank’s anticipated needs for funding loan and investment demands. The Bank’s source of funds comes primarily from net deposit inflows, loan amortizations, principal pay downs from loans, sold loan proceeds, and advances from the FHLB. At December 31, 2002, the Bank had approximately $145,000,000 in additional borrowing capacity from the FHLB.

At December 31, 2002, the Company’s shareholders’ equity totaled $33,765,996, compared to $28,965,895 at year-end 2001. The increase of $4,800,101 reflects net income of $4,299,988, the payment of $1,233,618 in common stock dividends, the exercise of 21,950 stock options in the amount of $38,272, a tax benefit on the exercise of stock options of $35,127, an increase in Paid-in Capital in the amount of $256,765 for the exercise of stock options, and an increase of $1,403,567 in accumulated other comprehensive income. The change in other comprehensive income reflects a decrease in interest

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Management’s Discussion and Analysis (continued)

rates during 2002 and the corresponding rise in investment security market values.

On February 22, 2001, the Company announced a stock repurchase program. Repurchases will be made from time to time at the discretion of management. The stock repurchase program will continue until the repurchase of 124,000 shares are repurchased. As of December 31, 2002, 59,500 shares of common stock had been repurchased. During 2002, no shares were repurchased. The Board of Directors of the Company has determined that a share buyback is appropriate to enhance shareholder value because such repurchases generally increase earnings per share, return on average assets and on average equity; three performing benchmarks against which bank and thrift holding companies are measured. The Company buys stock in the open market whenever the price of the stock is deemed reasonable and the Company has funds available for the purchase.

As of December 31, 2002, the Company had funds in the amount of $3,022,652 available, which it planned to use to continue its annual dividend payout of $.64 per share and pay interest on its capital securities. These payments are approximately $2.8 million per year. The Bank pays dividends to the Company as its sole stockholder, within guidelines set forth by the Office of Thrift Supervision (OTS). Since the Bank is well capitalized and has capital in excess of regulatory requirements, funds will be available to cover the Company’s future dividend, interest, and stock repurchase needs.

Net cash provided by (used in) operating activities increased $10,038,866 to $9,932,349 in 2002 from $(106,517) in 2001. The increase in net income and decrease in loans held-for-sale accounted for the majority of the change.

Net cash flows provided by (used in) investing activities totaled $(8,040,447) in 2002 compared to $4,690,378 in 2001, a change of $12,730,825. During 2002, the Bank utilized proceeds from both the sale and maturities of investment securities and loans to purchase $98,152,915 in investment securities. These purchases were either re-investments or additions to the investment portfolio.

In 2002, net cash flows used in financing activities totaled $4,809,435 compared to net cash provided by financing activities of $23,701,303 in 2001, a change of $28,510,738. During 2001, the Bank experienced a $28,625,069 increase in deposits and repurchase agreements which was somewhat offset by a

FHLB advance prepayment in the amount of $10,000,000. During 2002, the origination of fixed rate loans and sale to the secondary market dampened the need for funds. Thus, the need to attract deposits was tempered.

The Bank expects to be able to fund loan demand and other investing activities during 2003 by continuing to use funds provided by customer deposits, as well as the FHLB’s advance program. Management is not aware of any trends, events, or uncertainties that will have or that are reasonably likely to have a material effect in the Company’s liquidity, capital resources or results of operations.

The OTS requires that the Bank maintain tangible, core, and total risk-based capital ratios of 1.50%, 4.00%, and 8.00%, respectively. As of December 31, 2002, the Bank’s ratios were 7.02%, 7.02%, and 12.24%, respectively, well in excess of the regulators’ requirements.

At December 31, 2002, the Bank had loan commitments in the amount of approximately $25 million.

Book value per share was $17.24 at December 31, 2002 versus $14.95 per share at December 31, 2001.

Impact of Inflation

The financial statements and related data presented elsewhere herein are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) which require the measurement of the Company’s financial position and operating results generally in terms of historical dollars and current market value, for certain loans and investments, without considering changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations.

Unlike other companies, nearly all of the assets and liabilities of a bank are monetary in nature. As a result, interest rates have a far greater impact on a bank’s performance than the effects of the general level of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services, since such prices are affected by inflation. In the current interest rate environment, liquidity and the maturity structure of the Bank’s assets and liabilities are important to the maintenance of acceptable performance levels.

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Management’s Discussion and Analysis (continued)

Off-balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements within the meaning of SEC 33-8182.

Interest Rate Sensitivity

The principal objective of the Bank’s interest rate management function is to evaluate the interest rate risk inherent in certain balance sheet accounts and determine the appropriate level of risk given the Bank’s business strategies, operating environment, capital and liquidity requirements and performance objectives and to manage the risk consistent with the Board of Director’s approved guidelines. The Bank’s Board of Directors has established an Asset/Liability Committee (ALCO) to review its asset/liability policies and interest rate position. Trends and interest rate positions are reported to the Board of Directors monthly.

Gap analysis is used to examine the extent to which assets and liabilities are “rate sensitive”. An asset or liability is said to be interest rate sensitive within a specific time-period if it will mature or reprice within that time. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specified period of time and the amount of interest-bearing liabilities maturing or repricing within the same specified period of time. The strategy of matching rate sensitive assets with similar liabilities stabilizes profitability during periods of interest rate fluctuations.

The Bank’s one-year gap at December 31, 2002, was –6.02%, compared to the December 31, 2001 gap of –9.46%. The Bank continues to offer adjustable rate mortgages, which reprice at one, three, and five-year intervals. In addition, the Bank sells fixed-rate mortgages to the secondary market in order to minimize interest rate risk.

The Bank’s one-year gap, of approximately negative six percent at December 31, 2002, means net interest income would increase if interest rates trended downward. The opposite would occur if interest rates were to rise. Management feels that maintaining the gap within ten points of the parity line provides adequate protection against severe interest rate swings. In an effort to maintain the gap within ten points of parity, the Bank may utilize the FHLB advance program to control the repricing of a segment of liabilities.

As another part of its interest rate risk analysis, the Bank uses an interest rate sensitivity model, which generates estimates of the change in the Bank’s net portfolio value (NPV) over a range of interest rate scenarios. The OTS produces the data quarterly using its own model and data submitted by the Bank.

NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The NPV ratio, under any rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario. Modeling changes require making certain assumptions, which may or may not reflect the manner in which actual yields and costs respond to the changes in market interest rates. In this regard, the NPV model assumes that the composition of the Bank’s interest sensitive assets and liabilities existing at the beginning of a period remain constant over the period being measured and that a particular change in interest rates is reflected uniformly across the yield curve. Accordingly, although the NPV measurements and net interest income models provide an indication of the Bank’s interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market rates on the Bank’s net interest income and will likely differ from actual results.

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Management’s Discussion and Analysis (continued)

The following table shows the Bank’s interest rate sensitivity (gap) table at December 31, 2002:

Note: The Bank has used industry decay formulae in establishing repricing periods for savings and NOW accounts.

The following table sets forth the Bank’s NPV as of December 31, 2002 (the latest NPV analysis prepared by the OTS), as calculated by the OTS. For the December 31, 2002 reporting cycle, all output associated with the –200 and –300 bps scenarios has been suppressed due to the low prevailing interest rate environment.

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Management’s Discussion and Analysis (continued)

Results of Operations

Net Interest Income

Net interest income for the year ended December 31, 2002, increased by $796,196 or 5.05%, to $16,567,492. The increase was primarily due to a decrease in interest paid on deposits. The Bank offered time deposit specials during 2000 and 2001 in order to attract and retain customer deposits. These time deposits matured throughout 2002, and, with interest rates near historic lows, customers rolled these specials into lower costing deposits.

Total interest income decreased by $5,130,769, or 16.04%. Lower interest rates and fewer loans held in portfolio accounted for the majority of the decrease in interest and fees on loans. In 2002, the Bank originated $231.5 million in loans. Despite record production volume, total loans decreased from $340,436,012 at December 31, 2001 to $319,865,972 at December 31, 2002. The decrease was primarily attributed to an increase in loans sold into the secondary market. The Bank sold $95 million in loans during 2002. These sales of loans resulted in the Bank’s sold loan portfolio increasing by 21.53% to $260,774,730 at December 31, 2002.

Interest and dividends on investments decreased by $438,785 or 9.41% due to a drop in yield from 6.82% to 4.22%. The Bank repositioned its investment portfolio during 2002 in order to shorten maturities and, as a result, higher yielding, long-term bonds were liquidated and replaced by lower yielding, short-term investments.

Total interest expense decreased $5,926,965, or 36.54%. As mentioned above, interest on deposits decreased significantly due to the maturing of higher costing time deposits. Interest on deposits decreased by $5,518,846, or 39.35%. In addition, interest on FHLB advances was zero compared to $281,574 in 2001, because the Bank prepaid FHLB advances in 2001.

The Bank’s overall cost of funds decreased from 3.89% in 2001 to 2.45%, or 37.02%. The cost of deposits, including repurchase agreements, decreased from 3.63% in 2001 to 2.18% in 2002, or 39.94%. As mentioned above, the change was due to higher costing deposits rolling into a lower interest rate environment. In addition, the Bank was able to prepay all of its outstanding FHLB advances during 2001, thereby reducing interest on advances and other borrowed money.

The Bank’s interest rate spread, which represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities, increased to 3.63% in 2002 from 3.56% in 2001. The Bank’s net interest margin, representing net interest income as a percentage of average interest-earning assets, increased to 3.71% in 2002 from 3.60% in 2001. Both increases are the result of interest rates paid on deposits decreasing more quickly than interest and dividends earned on loans and investment securities.

The following table sets forth the average yield on loans and investments, the average interest rate paid on deposits and borrowings, the interest rate spread, and the net interest rate margin:

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Management’s Discussion and Analysis (continued)

The following table presents, for the periods indicated, the total dollar amount of interest income from interest earning assets and the resultant yields as well as the interest paid on interest bearing liabilities, and the resultant costs:

⁽¹⁾ Monthly average balances have been used for all periods. Management does not believe that the use of month-end balances instead of daily average balances caused any material difference in the information presented.

⁽²⁾ Loans include 90-day delinquent loans, which have been placed on a non-accruing status. Management does not believe that including the 90-day delinquent loans in loans caused any material difference in the information presented.

⁽³⁾ Loan fees are not included in interest on interest earning assets.

⁽⁴⁾ Other non-interest earning assets includes non-earning assets and real estate owned.

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Management’s Discussion and Analysis (continued)

The following table sets forth, for the periods indicated, a summary of the changes in interest earned and interest paid resulting from changes in volume and rates. The net change attributable to changes in both volume and rate, which cannot be segregated, has been allocated proportionately to the change due to volume and the change due to rate.

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Management’s Discussion and Analysis (continued)

Provision for Loan Losses

Lake Sunapee Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. Adjustments to the allowance for loan losses are charged to income through the provision for loan losses. The Bank considers many factors in determining the appropriate amount of the allowance and tests the adequacy at least quarterly. The valuation allowance consists of a specific allowance for identified problem loans and a general allowance for current performing loans. The amount of the specific allowance is based on loss estimates considering expected cash flows or fair value of the collateral. The amount of the general allowance is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. Fluctuations in the balances of impaired loans affect the specific allowance while fluctuations in volume, concentrations, and market conditions affect the general allowance. The allowance for loan losses is allocated across loan types.

The specific allowance incorporates the results of measuring impairment for specifically identified non-homogenous problem loans in accordance with SFAS No. 114 “Accounting by creditors for impairment of a loan,” and SFAS No. 118, “Accounting by creditors for impairment of a loan – income recognition and disclosures.” In accordance with SFAS No.’s 114 and 118 the specific allowance reduces the carrying amount of the impaired loans to their estimated fair value. A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the contractual terms of the loan. A loan is not deemed to be impaired if the Bank expects to collect all amounts due, including interest at the contractual rate. Measurement of impairment can be based on the present value of expected cash flows discounted at the loans effective interest rate, the market price of the loan, or the fair value of the collateral if the loan is collateral dependent. Measurement of impairment does not apply to large groups of smaller balance homogenous loans such as residential mortgage, home equity, or installment loans that are collectively evaluated for impairment. Please refer to Note 5 “Loans Receivable,” in the Consolidated Financial Statements for information regarding SFAS No. 114 and 118.

The Bank’s commercial loan officers review the financial condition of commercial loan customers on a regular basis and perform visual inspections of facilities and inventories. The Bank also has loan review, internal audit, and compliance programs. Results are reported directly to the Audit Committee of the Bank’s Board of Directors.

The Bank prepares a worksheet applying loss factors to outstanding loans by type. The worksheet stratifies the loan portfolio by loan type and assigns a loss factor to each type based on an assessment of the inherent risk associated with each type. In determining the loss factors to apply to each type of loan, the Bank considers historical losses, peer group comparisons, industry data, and market conditions. Loss factors may be adjusted for qualitative factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date. In the fourth quarter of 2002 the Bank expanded the number of loan categories used in the adequacy test to provide additional stratification of the loan portfolio. Expanding the number of types, with loss factors for each type, was recommended by regulatory examiners. The additional stratification for purposes of testing the adequacy of the allowance had no effect on the determination that the allowance was adequate on December 31, 2002.

The allowance for loan losses at December 31, 2002 was $3,875,708, compared to $4,405,385 at year-end 2001. The decline was primarily a result of $604,686 in loan write-downs incurred in the third quarter in anticipation of selling a $2.0 million pool of sub-performing and non-performing loans. The write-downs were taken to reduce the book value of the loans to their fair value. The decision to package and sell the loans considered factors such as anticipated collateral acquisition, holding, and liquidation costs. The loans were acquired from NLTC in 1999 along with an allowance for loan losses. The Bank improved the overall quality of the loan portfolio by selling those non-performing and sub-performing loans. At December 31, 2002 the allowance consisted of $3,847,395 in general reserves compared to $4,112,733 at the end of 2001. During 2002, the Bank had net charge-offs and write-downs of $649,677 compared to net charge-offs of $117,469 in 2001. Gross charge-offs and write-downs during 2002 amounted to 0.21% of average loans. The provision for loan losses was $120,000 compared to $90,000 in 2001. The allowance represented 1.21% of total loans at year-end 2002 compared to 1.29% at year-end 2001. The allowance for loan losses as a percentage of total non-performing loans was 584% at December 31, 2002 compared to 175% at December 31, 2001. The improvement came from the reduction in non-performing loans due to improved borrower performance and the sale of certain non-performing loans.

While the amount of the allowance declined, management determined the allowance remained at a level sufficient to cover inherent losses in the loan portfolio. The results of the adequacy test, reduction in both non-performing and classified loans, the increase in the allowance as a percentage of non-performing loans, and the generally favorable real estate market conditions in the Bank’s market area contributed to that determination. The $30,000 increase in the amount of the provision for loan loss in 2002 helped to maintain the allowance at an adequate level despite the charge-offs. During 2002 the loan portfolio declined by $20.6

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Management’s Discussion and Analysis (continued)

million, but consumer loans increased about $7.5 million. Historical losses from consumer loans have been low, but the volume increase resulted in a slightly higher allocation to that category. The allocation table below also reflects a shift in the allowance from commercial loans to conventional real estate loans.

Loans classified for regulatory purposes as loss, doubtful, substandard or special mention, do not result from trends or uncertainties that the Bank reasonably expects will materially impact future operating results, liquidity, or capital resources.

Total classified assets, excluding special mention loans, as of December 31, 2002 and 2001 were $3,333,767 and $7,092,289, respectively. Total non-performing assets amounted to $684,760 and $2,621,424 for the respective years. The decrease in non-performing loans is due to the sale of some and the repayment, liquidation or improved performance of others. Non-performing loans consist of loans 90 days or more past due and impaired loans. Impaired loans were $105,354 on December 31, 2002 and $1,267,037 on December 31, 2001. Loans 90 days or more past due were $558,738 at the end of 2002 and $1,254,387 at the end of 2001. Loans 30 to 89 days past due were $4,542,125 and $5,800,075, respectively at December 31, 2002 and 2001. If all nonaccruing loans had been current in accordance with their terms during the years ended December 31, 2002 and 2001, interest income on such loans would have amounted to approximately $66,000 and $123,000, respectively.

As of December 31, 2002 there were no other loans not included in the tables below or discussed above where known information about the possible credit problems of borrowers caused management to have doubts as to the ability of the borrower to comply with present loan repayment terms and which may result in disclosure of such loans in the future.

The following table sets forth the breakdown of nonperforming assets:

The following table sets forth nonaccrual ⁽¹⁾ loans by category: