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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

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Letter to Shareholders

…long-term value… is created through… a strong customer base, a highly motivated workforce, good asset quality, sustainable earnings and a strong capital position

The Company, once again, experienced record levels of mortgage lending activity during 2003 as interest rates flirted with 40 year lows and the increase in the number of people refinancing their mortgage loans continued unabated throughout the first three quarters of the year. While the unusually high level of mortgage lending placed significant pressures on all associated segments of our operations, we were pleased with the efficiencies created by the major data processing conversion of just a few years ago that further enhanced our capabilities in this particular area with the addition of new processing systems and software. The substantial increases in deposits seen over the last couple of years slowed considerably in 2003 as the stock market began to regain some of its credibility and investors, who had retreated to the safety of banks and stayed on the sidelines, ever so cautiously, started their re-entry into the world of balancing the desire for higher returns against the backdrop of higher risk. The Company continued to build upon the investment portfolio that had been developed over the last two years by deploying the funding made available from loan portfolio amortization or prepayments and combining that with the initiation of certain leveraging strategies by taking advantage of the yield curve and the historically low short-term interest rates.

Additionally, the Company endeavored to further develop the operational themes and underlying aspects of our proven customer service ‘relationship-centered’ business model in a continuing effort to expand upon our existing leadership position and to strengthen the value of our multi-office banking franchise. All aspects of the Company, from corporate governance at the board level to policy implementation at the branch level, find their roots in the ongoing recognition that long-term value for the institution is created through the integration and interdependence of a strong customer base, a highly motivated workforce, good asset quality, sustainable earnings and a strong capital position.

COMPANY EARNINGS

Earnings for 2003 increased by 34% over the previous year and established a new record for the Company. Consolidated net income for the year-ended December 31, 2003 was $5,771,453 or $2.92 per share of common stock. This compares to net income of $4,299,988, or $2.20 per share, that the Company reported for 2002. With interest rates continuing at their lowest levels in decades, the Company realized a more active position in the strategic re-balancing of the various asset allocations and a definite trend towards increasing our total investment portfolio through a variety of proactive measures. There is a clear need within the financial services sector to develop and expand durable sources of income to help offset the industry-wide margin compression pressures now evidencing themselves within the core dependence upon the balance between interest income and interest expense. The complete financial details for the year-ending December 31, 2003 are more fully covered in the Management’s Discussion and Analysis section immediately following this letter.

SHAREHOLDER VALUE

Growth in the shareholder value of financial institutions is, within the prevailing economic climate, becoming more closely aligned with the broader concepts of managing and mitigating risks. For our part, operating in a ‘best practices’ environment from the board room to the teller line, the Company seeks to measure and quantify the various levels of credit risk, interest rate risk, investment risk, technology risk, privacy risk and security risk…all under the umbrella of maintaining, enhancing and building sustainable long-term value. As a leading presence within the markets served, the Company looks to strengthen and expand upon our core operations, while, at the same time, maintaining a strong asset quality position and carefully managing expenses.

The Company’s stock price ended the year 2003 at $33.85, having ranged from a low of $18.30 to a high of $34.27 over the course of that twelve month period. The change from year-end 2002 resulted in a net stock price appreciation of nearly 80%. Shareholders’ equity ended the year at $39,124,596 as compared to $33,765,996 at December 31, 2002. The number of common shares outstanding at the end of the year totaled 2,008,690 and the book value per share stood at $19.48, an increase of $2.24 per share over the December 31, 2002 book value of $17.24 per share.

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Letter to Shareholders (continued)

Additionally, the Company, at the January 2004 board meeting, authorized an increase in the quarterly dividend pay-out from $0.18 per share to $0.225 per share, resulting in an annualized dividend of $.90 per share. This change is viewed as being indicative of our belief in the Company’s fundamental financial strength, capital position and ability to develop sustainable levels of net earnings going forward.

THE BUSINESS OF BANKING

While all areas of the Company experienced general increases in activity, it was in the mortgage lending area where, once again, the volume and pace of mortgage loan refinancings far exceeded all reasonable and predictable expectations. The operational pressures created by the on-rush for this perceived ‘once-in-a-lifetime’ opportunity to lock-in a long-term fixed-rate mortgage before rates might rise again were met by our processing and servicing departments with an incredible level of commitment and dedication to ‘get the job done’ and, in so doing, finding creative ways along the way to accomplish tasks and meet deadlines.

From the perspective of strategic positioning, the Company is looking for ways to further develop the asset base of the franchise. Internal and external growth both involve a coordinated approach centering on increasing the market penetration of the existing branch office network and expanding the network through de novo branching or branch acquisitions resulting from industry consolidations in attractive and complementary markets. With an eye towards delivering the fundamentals of wealth management as a business line, the Company continues to seek out and identify those areas where we can offer highly competitive products to customers at all stages in the wealth cycle…from creation…to preservation…to transfer.

The region’s continuing strong economy benefits the Company as it moves forward to both employ and deploy those resources necessary to ensure the effective implementation of strategies and plans for the accomplishment of our short-term and long-term goals. Further development of the base of commercial and municipal account relationships, as well as broadening the investment portfolio, are all part of an integrated asset diversification plan as key ingredients in helping to drive and sustain the institution’s growth in assets and earnings in the future. While building the sold loan portfolio has provided the Company with significant income over the last few years, it must be noted that the overall loan portfolio, particularly mortgage loans, have suffered varying degrees of attrition into a competitive marketplace where price rules and loyalty comes in a distant second.

BALANCE SHEET FUNDAMENTALS

Total assets of the Company stood at $526,246,231 at year-end December 31, 2003 as compared to $496,644,923 at year-end 2002. While this is a net increase of nearly $30,000,000 over the year, various balance sheet shifts occurred that saw asset increases of just over $27,000,000 in the loan portfolio and just over $40,000,000 in the investment portfolio, with a corresponding decrease in Federal Funds, an associated leveraging of $22,000,000 in advances from the Federal Home Loan Bank of Boston and very modest increases in total deposits and repurchase agreements. In general, depositors who took money out of stocks over the past few years now appear to be willing to cautiously re-enter the market when their anticipated returns are sufficient enough to outweigh the risks.

The fourth quarter introduction of a 10-year fixed-rate fully-amortizing mortgage loan originated for the Company’s own loan portfolio appeared to stem the tide of the secondary market refinance activity and, when combined with a recently renewed interest in adjustable rate mortgage loans and an active commercial lending department, resulted in real net growth in loans of $22,533,767 or 6.92%. At December 31, 2003 the loan portfolio stood at $347,956,158 as compared to $325,422,391 at year-end 2002. In addition, sold loans totaled $289,825,192 at year-end 2003 as compared to $260,774,730 a year earlier, for an increase of 11.14%. The Company continues to retain the servicing rights on substantially all of these loans in order to retain the direct relationships that are seen as one of the crucial aspects tying a community bank to its customer base.

Diversification, leveraging techniques and more complex asset allocation models do not in any way diminish our ongoing push for high asset quality in all that we do. The Company maintains active internal loan review

…the Company seeks to measure and quantify the various levels of credit risk, interest rate risk, investment risk, technology risk, privacy risk and security risk…

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Letter to Shareholders (continued)

…the development of a strategically-focused institution requires that all constituencies… board, management and staff alike…need to know and understand not just the Company’s goals and objectives, but why they are in place and why they are important…

and audit functions, as well as engaging external auditors to regularly and randomly review various segments of the Company. The annual Safety and Soundness Examination conducted by the Office of Thrift Supervision in late-2003, resulted in a continuation of our quality rating and served to reinforce the value of our banking franchise. It is important to note that, as part of the normal examination process, the ongoing threat of terrorism and the possibility of terrorist acts have placed additional burdens upon the financial services industry to help monitor, identify, document and report suspicious activity as defined by Federal and regulatory mandates.

CURRENT AND FUTURE CHALLENGES

As consolidations provide opportunities, branches become our points of contact and it is the people in the branches that make the difference. Beyond the two basic strategic issues of growth and profitability lies the realization that banking is not just another business, but a business that carries with it a high degree of public trust. There remains an expectation across the customer base that the character and content of who we are and what we do is an important factor in establishing and maintaining productive relationships.

The old business environment no longer exists as ‘bosses give way to leaders’ and ‘committees give way to teams’ in the daily activities of a bank… and marketing to the generations takes on even broader proportions in a world of longer and healthier lives, families with dual or multiple incomes and the upcoming transfer of both wealth and economic power as the baby boomers start their next lifestyle transition. The goal is to find ways to cement relationships…just knowing about a customer is not the same as knowing what it is that the customer actually needs and working in an almost advisory capacity to assist that person in reaching their individual goals.

Identifying and meeting customers’ needs is what we do day after day after day by matching them with a variety of products and services and advising them on the best possible solution for their situation…from car loans to mortgage loans, from checking accounts to jumbo CDs, from brokerage services to personal insurance products, from debit cards and ATMs to a host of online banking options…and…from general commercial retail services to municipal accounts and funding sources for either short-term or long-term needs.

We are committed to growing the Company, controlling the various risk aspects, maximizing reliable sources of sustainable revenues and working within a corporate culture that provides for quality reporting and clearly defined governance goals and objectives. While the Sarbanes-Oxley Act of 2002 has created greater pressures and expenses in the areas of audit, insurance and legal, it has not impeded our resolve to build upon the Company’s well-capitalized position and leverage the embedded capacity to profitably grow the franchise.

IN CLOSING

The development of a strategically-focused institution requires that all constituencies…board, management and staff alike…need to know and understand not just the Company’s goals and objectives, but why they are in place and why they are important. The creating and maintaining of a positive working environment is key to unifying the Company, sharing in a vision for the future and remaining flexible and open to change.

On behalf of all those involved in helping to ensure the continued success of our banking franchise, I want to take this opportunity to thank you…the shareholders…for the ongoing support and confidence that you have shown for the Company. It is also important to take this opportunity to acknowledge the untimely passing of Ralph B. Fifield, Jr., who, at the time of his death, had served the Company as a valuable member of our Board of Directors for nearly fifteen years. We pledge to continue to operate the Company in the best interests of our shareholders, customers and employees as we seek to meet the needs of the various communities we serve.

/s/  Stephen W. Ensign

Stephen W. Ensign

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. Loan origination fees, retail-banking service fees, and gains on security and loan transactions supplement these core earnings.

Overview

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.

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Management’s Discussion and Analysis (continued)

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 14-16 of Management’s Discussion and Analysis.

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, 2003, there were no valuation allowances set aside against any deferred tax assets.

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 NLT. 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.

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Management’s Discussion and Analysis (continued)

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 Corp.

On October 2, 2000, the Bank and two other New Hampshire banks acquired Charter Holding Corp. (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 Corp. with assets of approximately $1.7 billion under management. As a result of the acquisitions and merger, at a cost of $3,003,337 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, 2003 and December 31, 2002, the Bank realized $81,489 and $113,424, respectively in an undistributed gain. The Bank has entered into an agreement with 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, 2003 and December 31, 2002, the Bank generated commissions in the amount of $108,818 and $109,398, respectively.

Financial Condition

Total assets increased by $29,601,308 or 5.96%, from $496,644,923 at December 31, 2002 to $526,246,231 at December 31, 2003. Cash and federal funds sold decreased $34,861,180 as they were invested in loans and investment securities. Net loans receivable and loans held-for-sale increased $22,742,164 over the prior year-end.

Total gross loans, excluding loans held-for-sale, increased $27,220,646 or 8.51%, from $319,865,972 at December 31, 2002 to $347,086,618 at December 31, 2003. The increase was attributed to an increase of $18,665,369 or 10.05% in conventional real estate mortgage loans. The Bank’s promotion of a fixed rate, ten year amortizing and seven year hybrid loan products generated the majority of this increase. Consumer loans increased $11,625,347, or 36.04%, to $43,880,983 due to a demand for the Bank’s Home Equity Line of Credit product. The continued low interest rate environment made the above loan offerings very attractive. Sold loans totaled $289,825,192 at year-end 2003, compared to $260,774,730 for the same period in 2002. The Bank expects to continue to sell 30-year fixed rate loans into 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 79% of the Bank’s real estate mortgage loan portfolio, which is consistent with prior years.

The amortized cost of investment securities increased $40,665,238, or 48.86%, from $83,223,165 at December 31, 2002 to $123,888,403 at December 31, 2003. The Bank took the proceeds of the sale of loans, used Federal Funds Sold, and advances in the amount of $22,000,000 from the Federal Home Loan Bank (FHLB) and invested these funds in Mortgage Backed Securities and U.S. Government Agencies. The Bank took advantage of the favorable interest rates on the FHLB advances and invested the proceeds of the advances in higher yielding securities.

The Bank realized gains on the sales of securities in the amount of $227,687 during 2003, compared to $146,473 in 2002. At December 31, 2003, the Bank’s investment portfolio had an unrealized gain of $122,494, compared to a net unrealized gain of $233,331 at December 31, 2002. The relatively small unrealized gain for 2003 reflects the short-term duration of the Bank’s investment portfolio. The majority of holdings carry final or callable maturities of less than five years which tends to reduce market price volatility.

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Management’s Discussion and Analysis (continued)

Real estate owned and property acquired in settlement of loans decreased by a net of $20,668 at December 31, 2003 to $0 at December 31, 2003.

Deposits decreased slightly by $851,873 or 0.20%, to $428,476,547 at December 31, 2003, from $429,328,420 at December 31, 2002. Time deposits and Money market accounts decreased by $15,323,871, or 7.77%, to $181,836,545 as customers sought higher returns in non-bank alternatives. These decreases were offset by increases in the Bank’s core deposits of checking (non-interest-bearing) and savings accounts in the amount of $14,171,999, or 6.23% to $246,640,003, or 57.56% of total deposits. A marketing campaign conducted by the Bank to attract core accounts contributed in the increase. At December 31, 2003, time deposits comprised 25.39% of total deposits versus 26.59% for the same period in 2002.

Advances from the FHLB increased by $22,000,000 at December 31, 2003 from zero at December 31, 2002. The Bank employed a leverage strategy and took advantage of the favorable interest rates on the FHLB advances by investing the proceeds of the advances in higher yielding securities. The Bank expects to earn a spread of approximately 3%, or $660,000 (before tax) from this strategy.

Liquidity and Capital Resources

The Bank is required to maintain sufficient liquidity for safe and sound operations. At year-end 2003 the Bank’s liquidity was sufficient to cover the Bank’s anticipated needs for funding loan commitments of approximately $22 million. 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, 2003 the Bank had approximately $145,000,000 in additional borrowing capacity from the FHLB.

At December 31, 2003, the Company’s shareholders’ equity totaled $39,124,596, compared to $33,765,996 at year-end 2002. The increase of $5,358,600 reflects net income of $5,771,453, the payment of $1,419,736 in common stock dividends, the exercise of 52,950 stock options in the amount of $895,183, a tax benefit on the exercise of stock options of $139,921, and an decrease of $28,221 in accumulated other comprehensive income.

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, 2003, 59,500 shares of common stock had been repurchased. During 2003, 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, 2003, the Company had funds in the amount of $3,512,669 available, which it planned to use to continue its annual dividend payout of $.90 per share and pay interest on its capital securities. The Company increased the quarterly dividend by $.225 or 25% effective with the January 30, 2004 payment. The dividend and capital securities payments are approximately $3.4 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 operating activities increased by $23,812 to $9,956,161 in 2003 from $9,932,349 in 2002. The increase in net income and decrease in loans held-for-sale accounted for the majority of the change.

Net cash flows used in investing activities totaled $69,212,941 in 2003 compared to $8,040,447 in 2002, a change of $61,172,494. During 2003, the Bank utilized proceeds from both the sale and maturities of investment securities of $161,539,228 to purchase $202,664,999 in investment securities and $26,879,732 in net new loans. These purchases were either re-investments or additions to the investment portfolio. Cash was provided from financing activities in the amount of $24,395,600, primarily from FHLB advances in the amount of $22,000,000, and the use of beginning cash and cash equivalents in the amount of $53,387,195.

In 2003, net cash flows from financing activities totaled $24,395,600 compared to net cash used in financing activities of $4,809,435 in 2002, a change of $29,205,035.

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Management’s Discussion and Analysis (continued)

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. On December 31, 2003, approximately $22 million in commitments to fund loans had been made. 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 following table represents the Company’s contractual obligations at December 31, 2003:

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, 2003, the Bank’s ratios were 7.56%, 7.56%, and 11.88%, respectively, well in excess of the OTS requirements.

Book value per share was $19.48 at December 31, 2003 versus $17.24 per share at December 31, 2002.

Impact of Inflation

The financial statements and related data presented elsewhere herein are prepared in accordance with generally accepted accounting principles (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.

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 monthly. 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, 2003, was –25.59%, compared to the December 31, 2002 gap of –5.86%. During 2003, the Bank took advantage of the low interest rate environment and borrowed short-term advances from the FHLB. The proceeds of these advances were subsequently invested in intermediate term government bonds. This leverage strategy created an interest rate mismatch causing the Bank’s gap to become more negative. If interest rates were to rise, the

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Management’s Discussion and Analysis (continued)

Bank’s spread would be reduced because the cost to re-finance the FHLB advances would increase. 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 twenty six percent at December 31, 2003, means net interest income would increase if interest rates trended downward. The opposite would occur if interest rates were to rise.

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 Office of Thrift Supervision (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 requires 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.

The following table shows the Bank’s interest rate sensitivity (gap) table at December 31, 2003:

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

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Management’s Discussion and Analysis (continued)

The following table sets forth the Bank’s NPV as of December 31, 2003, as calculated by the OTS. For the December 31, 2003 reporting cycle, all output associated with the –200 bps scenario 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, 2003, increased by $947,719 or 6.39%, to $15,788,171. The increase was primarily due to the continuing low interest rate environment and the Bank’s negative gap position. As interest rates have fallen, more liabilities (deposits) have re-priced into falling rates, thus reducing the Bank’s cost of funds at a faster pace than its income on earning assets. The Bank’s interest rate spread increased by 9 basis points to 3.44% and the Bank’s interest margin increased by 2.63%. These increases were driven by a sharp decrease of 53.64% in the Bank’s cost of deposits. The Bank’s overall cost of funds decreased by 45.31% compared to a decrease of 17.59% in the Bank’s yield on loans and investments.

Total interest income decreased by $3,639,644 or 14.48%. Lower interest rates accounted for the majority of the decrease in interest and fees on loans. Interest and fees on loans decreased $3,115,175, or 14.90%, to $17,794,613 in 2003, due to a decrease in yield from 6.27% at December 31, 2002 to 5.33% at December 31, 2003. The Bank originated $380.1 million in loans in 2003.

Interest and dividends on investments decreased by $524,469, or 12.42%, due to a drop in yield from 4.22% to 3.20%, or 24.17%. This decrease was partially offset by a significant increase in the average balance of securities. Several higher-yielding callable agency bonds were called and the proceeds were re-invested in lower yielding securities. Also during 2002, the Bank repositioned its investment portfolio 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 $4,587,363, or 44.57%, for the year ended December 31, 2003 compared to 2002. Interest on deposits decreased by $4,467,581, or 52.52% because the Bank’s deposits re-priced into lower rates. Interest on FHLB advances increased by $53,115 at December 31, 2003 compared to $0 in 2002 as the Bank took advantage of favorable interest rates on the advances and invested the proceeds of the advances in higher yielding securities.

The Bank’s overall cost of funds decreased from 2.45% in 2002 to 1.34%, or 45.31%. The cost of deposits, including repurchase agreements, decreased 53.21% from 2.18% in 2002 to 1.02% in 2003. The Bank’s certificates of deposit, in particular, rolled into lower rates or transferred into more liquid savings or checking accounts.

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 3.44% at December 31, 2003 from 3.35% at December 31, 2002. The Bank’s net interest margin, representing net interest income as a percentage of average interest-earning assets, increased to 3.51% from 3.42%. Both increases are the result of falling interest rates.

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:

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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 Statement of Financial Accounting Standards (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. No changes were made to the Bank’s procedures with respect to maintaining the loan loss allowances as a result of any regulatory examinations.

The allowance for loan losses at December 31, 2003 was $3,898,650, compared to $3,875,708 at year-end 2002. The increase resulted from provisions and recoveries exceeding charge-offs during 2003. At December 31, 2003 the allowance consisted of $3,891,010 in general reserves compared to $3,847,395 at the end of 2002. During 2003, the Bank had net charge-offs of $77,054 compared to net charge-offs and write-downs of $649,677 in 2002. The provision for loan losses was $99,996 compared to $120,000 in 2002. The allowance represented 1.12% of total loans at year-end 2003 compared to 1.21% at year-end 2002. The allowance for loan losses as a percentage of total non-performing loans was 337% at December 31, 2003 compared to 584% at December 31, 2002. The lower amount of charge-offs and write-downs in 2003 is primarily due to $604,686 in write-downs taken prior to the sale of sub-performing and non-performing loans in the third quarter of 2002. The decline in the allowance as a percentage of loans results from the increase in total loans. The decline in the allowance as a percentage of non-performing loans comes from an increase in loans over 90 days past due. That increase is primarily attributable to one residential mortgage loan that is not expected to affect the allowance.

The provisions made during 2003 resulted in a slight increase to the allowance for loan losses. The results of the adequacy test led to the determination that, as of December 31, 2003, the allowance remained at an adequate level to cover losses inherent in the loan portfolio. The strong real estate market conditions in the Lake Sunapee and Upper Valley regions of New Hampshire contributed to that determination.

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Management’s Discussion and Analysis (continued)

The allocation table below reflects a decline in the allocation for impaired loans, despite the increase in the impaired loan balance. The increase in impaired loans comes from $726,698 of restructured loans that remain on accrual status and continue to be performing. No specific valuation allowance has been established for those loans, because the Bank expects no losses from those loans. The table shows a shift in the allowance allocation from other categories to commercial loans. That shift reflects the increase in commercial loan classifications.

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, 2003 and 2002 were $4,046,955 and $3,333,767, respectively. Total non-performing loans and real estate owned amounted to $1,157,957 and $684,760 for the respective years. Non-performing loans consist of loans 90 days or more past due and non-accrual impaired loans. Non-accrual impaired loans were $50,934 on December 31, 2003 and $105,354 on December 31, 2002. As of December 31, 2003 the Bank also held $726,698 in restructured loans on accrual status and performing, included in impaired loans. Loans 90 days or more past due were $1,107,023 at the end of 2003 and $558,738 at the end of 2002. Loans 30 to 89 days past due were $3,397,736 and $4,542,125, respectively at December 31, 2003 and 2002. If all non-accruing loans had been current in accordance with their terms during the years ended December 31, 2003 and 2002, interest income on such loans would have amounted to approximately $54,000 and $66,000 respectively.

As of December 31, 2003 there were no other loans not included in the tables below or discussed above where known information about possible credit problems of the 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 non-performing assets:

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

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Management’s Discussion and Analysis (continued)

The following is a summary of activity in the allowance for loan losses account for the periods ended December 31: