10-Q 1 gran-q3.txt FORM 10-Q FOR SEPTEMBER 30, 2001 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For quarterly period ended September 30, 2001 Commission File No. 0-14895 Granite State Bankshares, Inc. (Exact name of registrant as specified in its charter) New Hampshire 02-0399222 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 122 West Street, Keene, New Hampshire 03431 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (603) 352-1600 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) The number of shares outstanding of each of the issuer's classes of common stock, as of November 7, 2001 was 5,257,219, $1.00 par value per share. INDEX Granite State Bankshares, Inc. and Subsidiary Part I Financial Information Page Item 1. Financial Statements: Consolidated Statements of Financial Condition September 30, 2001 and December 31, 2000 3 Consolidated Statements of Earnings Three and Nine Months Ended September 30, 2001 and 2000 4 Consolidated Statements of Comprehensive Income Three and Nine Months Ended September 30, 2001 and 2000 5 Consolidated Statements of Cash Flows Three and Nine Months Ended September 30, 2001 and 2000 6 Notes to Unaudited Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 3. Quantitative and Qualitative Disclosures About Market Risk 22 Part II Other Information Item 1. Legal Proceedings 22 Item 2. Changes in Securities 22 Item 3. Defaults upon Senior Securities 22 Item 4. Submission of Matters to a Vote of Security Holders 22 Item 5. Other Information 22 Item 6. Exhibits and Reports on Form 8-K 22 Signatures 23 2 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 1 - Financial Statements Consolidated Statements of Financial Condition

See accompanying notes to unaudited consolidated financial statements. 3 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 1 - Financial Statements Consolidated Statements of Earnings

See accompanying notes to unaudited consolidated financial statements. 4 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 1 - Financial Statements Consolidated Statements of Comprehensive Income

See accompanying notes to unaudited consolidated financial statements. 5 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 1 - Financial Statements Consolidated Statements of Cash Flows

See accompanying notes to unaudited consolidated financial statements. 6 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 1. Financial Statements Notes to Unaudited Consolidated Financial Statements September 30, 2001 Note 1. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2001 are not necessarily indicative of the results that may be expected for the current fiscal year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2000. Note 2. Earnings Per Share Basic earnings per share is computed by dividing net earnings by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Information regarding the computation of earnings per share is as follows:

Weighted average options to purchase 6,980 and 2,352 shares of common stock were outstanding during the three and nine months ended September 30, 2001, respectively, and weighted average options to purchase 399,250 and 299,781 shares of common stock were outstanding during the three and nine months ended September 30, 2000, respectively, but were not included in the computation of weighted average common shares outstanding for purposes of computing diluted earnings per share, because the effect would have been antidilutive. 7 Note 3. Securities Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost; debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as trading and reported at fair value, with unrealized gains and losses included in earnings; and debt and equity securities not classified as either held-to-maturity or trading are classified as available-for-sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported as part of accumulated other comprehensive income (loss), net of related income tax effects. At September 30, 2001 and December 31, 2000, the Company had no securities classified as trading securities. The amortized cost, estimated market value and carrying value of securities at September 30, 2001 and December 31, 2000 were as follows:

Note 4. Loans Loans consist of the following at:

Real estate mortgage loans and other loans are stated at the amount of unpaid principal, less unearned income and the allowance for possible loan losses. Interest on loans is accrued and credited to operations based upon the principal amount outstanding. When management determines that significant doubt exists as to collectibility of principal or interest on a loan, the loan is placed on nonaccrual status. In addition, loans past due 90 days or more as to principal or interest are placed on nonaccrual status, except those loans which, in management's judgment, are fully secured and in the process of collection. Interest accrued but not received on loans placed on nonaccrual status is reversed and charged against current operations. Interest subsequently received on 9 nonaccrual loans is either applied against principal or recorded as income according to management's judgment as to the collectibility of principal. Loans considered to be uncollectible are charged against the allowance for possible loan losses. The allowance is increased by charges to current operations in amounts sufficient to maintain the adequacy of the allowance. The adequacy of the allowance is determined by management's evaluation of the extent of losses inherent in the loan portfolio and prevailing economic conditions. Changes in the allowance for possible loan losses are as follows:

Information with respect to impaired loans consisted of the following at:

The Company's policy for interest income recognition on impaired loans is to recognize income on impaired loans on the cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company; if these factors do not exist, the Company will not recognize income. The average recorded investment in impaired loans was $2,270,000 and $604,000 for the nine months ended September 30, 2001 and 2000, respectively. During the nine months ended September 30, 2001 and 2000, the Company recognized no income on impaired loans. 10 Note 5. Interest Bearing Deposits Interest bearing deposits consist of the following at:

Note 6. Supplemental Disclosures of Cash Flow Information

Note 7. Adoption of New Accounting Policy The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended, on January 1, 2001 as required by the Financial Accounting Standards Board. The cumulative effect on prior years of adopting SFAS No. 133 on January 1, 2001, was not significant and therefore has not been separately disclosed. The impact of accounting for derivative instruments under SFAS No. 133 during the three and nine months ended September 30, 2001 decreased net interest and dividend income by $7,000 and $170,000, respectively. The after tax impact on net earnings for the three and nine months ended September 30, 2001 was a decrease of $4,000 and $102,000, respectively. Note 8. Recent Accounting Developments On July 20, 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Intangible Assets". SFAS No. 141 is effective for all business combinations initiated after June 30, 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001; however, certain provisions of this Statement apply to goodwill and other intangible assets acquired between July 1, 2001 and the effective date of SFAS No. 142. Major provisions of these Statements and their effective dates for the Company are as follows: * All business combinations initiated after June 30, 2001 must use the purchase method of accounting. The pooling of interests method of accounting is prohibited except for transactions initiated before July 1, 2001. 11 * Intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability. * Goodwill, as well as intangible assets with indefinite lives, acquired after June 30, 2001, will not be amortized. Effective January 1, 2002, all previously recognized goodwill and intangible assets with indefinite lives will no longer be subject to amortization. * Effective January 1, 2002, goodwill and intangible assets with indefinite lives will be tested for impairment annually and whenever there is an impairment indicator. * All acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting. The Company will continue to amortize goodwill recognized prior to July 1, 2001, under its current method until January 1, 2002, at which time annual and quarterly goodwill amortization of $588,000 and $147,000 will no longer be recognized. By December 31, 2002, the Company will have completed a transitional fair value based impairment test of goodwill as of January 1, 2002. Impairment losses, if any, resulting from the transitional testing will be recognized retroactively in the quarter ending March 31, 2002, as a cumulative effect of a change in accounting principle. 12 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations September 30, 2001 General All information within this section should be read in conjunction with the consolidated financial statements and notes included elsewhere in this Form 10-Q. All references in the discussion to financial condition and results of operations are to the consolidated financial position of the Company and its subsidiary taken as a whole. The principal business of the Company is to serve as a financial intermediary attracting deposits from the general public and making both secured and unsecured loans. The operating results of the Company depend primarily on net interest and dividend income earned by the Company's subsidiary, Granite Bank ("the subsidiary bank"). Net interest and dividend income is the difference between interest and dividend income on interest earning assets, primarily loans and securities, and interest expense on interest bearing liabilities, which consist of deposits and borrowings. Operating results of the Company also depend upon the provision for possible loan losses, noninterest income, noninterest expense and income taxes. Certain statements contained herein are not based on historical facts and are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "estimate," "anticipate," "continue," or similar terms or variations on those terms, or the negative of those terms. Forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, those related to the economic environment, particularly in the market areas in which the company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset-liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors listed above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. The Company does not undertake and specifically declines any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Financial Condition Total assets increased by $78,468,000 or 8.22%, from $955,009,000 at December 31, 2000 to $1,033,477,000 at September 30, 2001. The increase in assets resulted primarily from increases in interest bearing deposits in other banks, securities available for sale, loans held for sale and portfolio loans, partially offset by decreases in cash and due from banks and securities held to maturity. Cash and due from banks decreased $2,286,000, from $26,434,000 at December 31, 2000 to $24,148,000 at September 30, 2001. The decrease related primarily to a decrease in the amount of items processed through the Company's depository bank accounts that settled subsequent to the end of the reporting period. 13 Interest bearing deposits in other banks, which primarily consist of deposits with the Federal Home Loan Bank of Boston, increased $21,700,000, from $8,872,000 at December 31, 2000 to $30,572,000 at September 30, 2001. Interest bearing deposits in other banks are short-term overnight investments and the level of the Company's investment in these instruments fluctuates as investments are made in other interest earning assets such as loans, securities held to maturity and securities available for sale, and as balances of interest bearing liabilities such as deposits, securities sold under agreements to repurchase and other borrowings fluctuate. These instruments are also used to fund cash and due from bank requirements. Securities available for sale increased $52,057,000, from $196,522,000 at December 31, 2000 to $248,579,000 at September 30, 2001, while securities held to maturity decreased $13,004,000, from $18,011,000 at December 31, 2000 to $5,007,000 at September 30, 2001. The increase in securities available for sale were funded by the reinvestment of proceeds received from calls of securities held to maturity and increases in deposits, securities sold under agreements to repurchase and other borrowings. Loans held for sale increased $7,498,000, from $657,000 at December 31, 2000 to $8,155,000 at September 30, 2001. The lower interest rate environment in 2001 compared with 2000 encouraged residential real estate borrowers into fixed rate loans which are primarily originated for sale in the secondary mortgage market. Net loans were $664,433,000 at September 30, 2001, an increase of $16,079,000, or 2.48%, from $648,354,000 at December 31, 2000. During the first nine months of 2001, the Federal Reserve Board lowered short term interest rates eight times totaling 350 basis points. The lower interest rate environment encouraged residential real estate borrowers into fixed rate loan products, which the Company sells into the secondary mortgage market. This was the primary reason that the net loan portfolio increased only 2.48% during the nine months ended September 30, 2001. Total deposits increased $37,785,000, or 5.53%, from $683,334,000 at December 31, 2000 to $721,119,000 at September 30, 2001. The significant changes in deposits related to increases in NOW accounts and time certificates of $25,091,000 and $8,080,000, respectively. The increase in NOW accounts relates primarily to the success the Company has had in targeting these accounts as growth accounts. Competitive rates offered by the subsidiary bank for time certificates resulted in the increase in balances of time certificates. Securities sold under agreements to repurchase increased $1,248,000, from $90,811,000 at December 31, 2000 to $92,059,000 at September 30, 2001. The increase related primarily to business investors investing additional cash in this product at September 30, 2001 compared to December 31, 2000. Other borrowings, which consist of borrowings from the Federal Home Loan Bank of Boston ("FHLB"), increased $34,962,000 to $135,477,000 at September 30, 2001 from $100,515,000 at December 31, 2000. Changes in other borrowings include FHLB callable advances borrowed during the nine months ended September 30, 2001 of $35,000,000, with a weighted average rate of 4.42%, $10,000,000 of which are callable March 26, 2002, $5,000,000 of which are callable February 5, 2003, $5,000,000 of which are callable May 8, 2003, $5,000,000 of which are callable February 5, 2004 and $10,000,000 of which are callable August 13, 2004. Additionally, repayments of amortizing FHLB debt were $38,000 during the nine months ended September 30, 2001. Stockholders' equity increased by $7,582,000 from $73,464,000 at December 31, 2000 to $81,046,000 at September 30, 2001. The increase related primarily to net earnings of $8,251,000 and an increase of $4,395,000 for the change in accumulated other comprehensive income (loss), partially offset by decreases of $2,719,000 for dividends declared and $2,580,000 for the purchase of treasury stock. 14 Results of Operations Net Earnings Net earnings for the three and nine months ended September 30, 2001 were $2,864,000 and $8,251,000, compared to $2,516,000 and $7,547,000 for the three and nine months ended September 30, 2000. Basic earnings per share were $.54 and $1.56 for the three and nine months ended September 30, 2001, compared to $.47 and $1.36 for the three and nine months ended September 30, 2000. Diluted earnings per share were $.53 and $1.52 for the three and nine months ended September 30, 2001 compared to $.46 and $1.35 for the three and nine months ended September 30, 2000. The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended, on January 1, 2001 as required by the Financial Accounting Standards Board. The cumulative effect on prior years of adopting SFAS No. 133 on January 1, 2001, was not significant and therefore has not been separately disclosed. The impact of accounting for derivative instruments under SFAS No. 133 during the three and nine months ended September 30, 2001 decreased net interest and dividend income by $7,000 and $170,000, respectively. The after tax impact on net earnings for the three and nine months ended September 30, 2001 was a decrease of $4,000 and $102,000, respectively. Interest and Dividend Income Interest and dividend income for the three and nine months ended September 30, 2001 was $17,519,000 and $51,980,000 compared to $16,042,000 and $46,935,000 for the corresponding periods in 2000. The increase in interest and dividend income for the three and nine months ended September 30, 2001 compared to the three and nine months ended September 30, 2000 is primarily attributable to an increase in the average balance of interest earning assets of $120,527,000 and $94,934,000, respectively, partially offset by a decrease in the overall yield on interest earning assets to 7.32% and 7.59% for the three and nine months ended September 30, 2001 compared to 7.70% and 7.63% for the same periods in 2000. The increase in the average balance of interest earning assets for the three and nine months ended September 30, 2001 is attributable to the Olde Port Bank branch acquisition from which approximately $43,200,000 of loans were acquired at year end 2000, as well as normal operational growth in average interest earning assets. The decrease in overall yield on interest earning assets for the three and nine months ended September 30, 2001 is attributable to the Federal Reserve Board easing interest rates eight times, totaling 350 basis points, during the first three quarters of 2001, which resulted in lower yields for loans and securities and interest earning assets for the three and nine months ended September 30, 2001 as compared to the same periods a year ago. The lower interest rate environment during 2001 as compared to 2000 resulted in a decrease in the yield on loans to 7.93% and 8.13% for the three and nine months ended September 30, 2001 compared to 8.26% and 8.21% for the three and nine months ended September 30, 2000 and a decrease in the yield on securities and interest earning investments from 6.28% and 6.25% for the three and nine months ended September 30, 2000 to 5.83% and 6.16% for the three and nine months ended September 30, 2001. As a result of the Federal Reserve Board decreasing short term interest rates during the first three quarters of 2001, management expects asset yields to continue to decrease during the remainder of 2001. Interest Expense Interest expense for the three and nine months ended September 30, 2001 was $8,126,000 and $24,965,000 compared to $7,926,000 and $22,807,000 for the corresponding periods in 2000. The increase in interest expense for the three and nine months ended September 30, 2001 compared to the same periods in 2000 is primarily due to an increase in the average balance of total interest bearing liabilities of $114,711,000 and $91,541,000, respectively, partially offset by a decrease in the cost of interest bearing liabilities to 3.84% and 4.12% for the three and nine months ended September 30, 2001 compared to 4.35% and 4.23% for the same periods a year earlier. The increase in the average balance of interest 15 bearing liabilities for the three and nine months ended September 30, 2001 is attributable to the Olde Port Bank branch acquisition effective at year end 2000, where approximately $31,500,000 of interest bearing deposits and securities sold under agreements to repurchase were assumed, as well as normal operational growth in average interest bearing liabilities. Average balances of savings deposits increased $32,601,000 and $22,716,000 for the three and nine months ended September 30, 2001 compared to the same periods in 2000. Average balances of time deposits increased $20,287,000 and $20,481,000 for the three and nine months ended September 30, 2001 compared to the same periods in 2000. The average cost of savings deposits decreased to 2.03% and 2.24% for the three and nine months ended September 30, 2001 compared to 2.59% and 2.56% for the three and nine months ended September 30, 2000. The decrease in the average cost of savings deposits was primarily related to the lower short term interest rates in 2001 compared to 2000, as a result of the Federal Reserve Board decreasing short term interest rates in the first three quarters of 2001. The average cost of time deposits decreased from 5.57% for the three months ended September 30, 2000 to 5.49% for the same period in 2001, while the average cost of time deposits increased from 5.41% for the nine months ended September 30, 2000 to 5.79% for the same period in 2001. The increase in the cost of time deposits for the nine months ended September 30, 2001 was primarily the result of time deposits which were opened or renewed by depositors during 2000 when interest rates were higher, generally for terms of twelve to fifteen months, some of which have matured and renewed at lower rates and some of which are still outstanding. As these time deposits mature in the current low rate environment, they will renew at lower rates and the average cost of time deposits will continue to decrease as it did in the second and third quarters of 2001. The average balance of securities sold under agreements to repurchase and other borrowed funds increased $61,823,000 and $48,344,000 for the three and nine months ended September 30, 2001 compared to the same periods in 2000. Average balances of securities sold under agreements to repurchase increased $13,141,000 and $12,505,000 and average balances of FHLB borrowings increased $48,682,000 and $35,839,000 during the three and nine months ended September 30, 2001 compared to the same periods in 2000. The average cost of securities sold under agreements to repurchase and other borrowed funds decreased to 4.53% and 4.84% for the three and nine months ended September 30, 2001 compared to 5.70% and 5.51% for the three and nine months ended September 30, 2000. The lower cost of securities sold under agreements to repurchase and other borrowed funds related primarily to the lower interest rate environment during 2001 compared to 2000, with short term rates on securities sold under agreements to repurchase being lower in 2001 than 2000. Additionally, callable advances from the FHLB totaling $35,000,000 were borrowed during 2001 at lower rates than previous advances, which also lowered the average cost of borrowings. As a result of the Federal Reserve Board decreasing short term interest rates during the first three quarters of 2001, management expects the costs of interest bearing liabilities to decrease during the remaining quarter of 2001, particularly with respect to time deposits. Net Interest and Dividend Income Net interest and dividend income increased by $1,277,000 and $2,887,000 for the three and nine months ended September 30, 2001 compared to the same periods in 2000. The increase for the three and nine months ended September 30, 2001 compared to the same periods in 2000 is primarily due to the changes in interest and dividend income and interest expense as discussed above. The interest rate spread increased from 3.35% and 3.40% for the three and nine months ended September 30, 2000 to 3.48% and 3.47% for the three and nine months ended September 30, 2001. The net yield on interest earning assets increased from 3.89% and 3.92% for the three and nine months ended September 30, 2000 to 3.92% and 3.94% for the same periods in 2001. Provision for Possible Loan Losses The provision for possible loan losses for the three and nine months ended September 30, 2001 was $180,000 and $360,000 compared to $150,000 and $230,000 for the three and nine months ended September 30, 2000. The increase for the three and nine months ended September 30, 2001, compared to the same periods in 2000, is primarily related to an increase in nonperforming loans and an increase in net charge offs. 16 The allowance for possible loan losses is maintained through provisions for possible loan losses based upon management's ongoing evaluation of the losses inherent in the loan portfolio. The methodology for determining the amount of the allowance for possible loan losses consists of several elements. Nonperforming, impaired and delinquent loans are reviewed individually and the value of any underlying collateral is considered in determining estimates of possible losses associated with those loans. Another element involves estimating losses inherent in categories of loans, based primarily on historical experience, industry trends and trends in the real estate market and the current economic environment in the Company's primary market areas. The last element is based on management's evaluation of various conditions, and involves a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with this element include the following: industry and regional conditions and/or concentrations; seasoning of the loan portfolio and changes in the composition of and growth in the loan portfolio; the strength and duration of the current business cycle; existing general economic and business conditions in the lending areas; credit quality trends, including trends in nonperforming loans expected to result from existing conditions; historical loan charge-off experience; and the results of bank regulatory examinations. Management uses currently available information in determining the adequacy of the allowance for possible loan losses. If economic conditions deteriorate, significant additional provisions for possible loan losses may be necessary. Noninterest Income Noninterest income for the three and nine months ended September 30, 2001 totaled $1,875,000 and $5,267,000, compared to $1,420,000 and $4,068,000 for the same periods in 2000. The increase of $455,000 and $1,199,000 for the three and nine months ended September 30, 2001 compared to the same periods in 2000, relates primarily to increases in net gains on sales of loans of $359,000 and $657,000, respectively, as well as an increase in net gains on sales of securities available for sale of $368,000 for the nine months ended September 30, 2001 compared to the same period in 2000. The increase in net gains on sales of loans in the secondary mortgage market was as a result of an increase in residential real estate loans originated for and sold into the secondary mortgage market in 2001 compared to 2000, due to a declining interest rate environment during the first three quarters of 2001, which encouraged refinancing activity and encouraged borrowers into fixed rate loan products which the Company sells in the secondary mortgage market. Additionally, customer account service fees and charges on deposits increased $74,000 and $175,000, respectively, for the three and nine months ended September 30, 2001, compared to the same periods in 2000. Noninterest Expense Noninterest expense for the three and nine months ended September 30, 2001 increased $1,041,000 and $2,683,000 compared to the same periods a year earlier. The increases for the three and nine months ended September 30, 2001, compared to the same periods in 2000 relates primarily to increased costs associated with the acquisition of two Olde Port Bank branches which became effective at year end 2000. Salaries and benefits increased by $570,000, to $3,631,000 for the three months ended September 30, 2001 as compared to $3,061,000 for the same period a year earlier and increased by $1,509,000 to $10,410,000 for the nine months ended September 30, 2001 as compared to $8,901,000 for the same period a year earlier. The increase in salaries and benefits was attributable to the acquisition of the two Olde Port Bank branches which contributed to an increase in full time equivalent employees from 266 at year end 2000 to 306 at September 30, 2001. Additionally, normal salary increases and an increase in commissions paid to mortgage loan originators as a result of the increased refinance activity which occurred for the three and nine months ended September 30, 2001 compared to the same periods in 2000, contributed to the increase. Other real estate owned expense increased by $120,000 and $137,000 for the three and nine months ended September 30, 2001 as compared to the same periods in 2000 as a result of an increase in expenses and writedowns related to foreclosed properties. Other expenses increased by $373,000 to $1,758,000 for the three months ended September 30, 2001 as compared with $1,385,000 for the same period a year earlier and increased by $1,158,000 to $5,179,000 for the nine months ended September 30, 2001 compared to $4,021,000 for the same period a year earlier. The increase in other expenses is partially attributable to an increase in amortization expense of $119,000 and $357,000, 17 respectively, for the three and nine months ended September 30, 2001, for goodwill and intangible assets associated with the Olde Port Bank branch acquisition. Additionally, for the three months ended September 30, 2001 compared to the same period in 2000, professional fees increased by $51,000, telephone expenses increased by $43,000, amortization expense of mortgage servicing rights increased by $35,000 and expenses for printing and supplies increased by $31,000. For the nine months ended September 30, 2001 compared to the same period in 2000, advertising and marketing costs increased by $198,000, professional fees increased by $193,000, printing and supplies increased by $102,000 and telephone expenses increased by $86,000. Income Taxes Income tax expense for the three and nine months ended September 30, 2001 was $1,735,000 and $4,786,000, compared with $1,422,000 and $4,217,000 for the same periods in 2000. Income tax expense as a percentage of earnings before income taxes was 37.73% and 36.71% for the three and nine months ended September 30, 2001 and 36.11% and 35.85% for the three and nine months ended September 30, 2000. Risk Elements Total nonperforming loans increased from $3,201,000 or 0.49% of total loans, at December 31, 2000, to $3,491,000 or 0.52% of total loans, at September 30, 2001. During the same period, other real estate owned, decreased from $416,000 to $165,000. The allowance for possible loan losses as a percent of total nonperforming loans was 225.81% at September 30, 2001, compared with 245.36% at December 31, 2000. As shown in the following table, nonperforming assets as a percentage of total assets were 0.35% and 0.38%, as of September 30, 2001 and December 31, 2000, respectively.

Liquidity The Company's primary sources of liquidity, through its subsidiary bank, are its borrowing capacity with the Federal Home Loan Bank of Boston, interest bearing deposits in other banks and securities available for sale, particularly short-term investments. At September 30, 2001, short-term and 18 long-term borrowings from the Federal Home Loan Bank of Boston were $135,477,000, with an additional available borrowing capacity of approximately $132,067,000; interest bearing deposits in other banks were $30,572,000 and securities available for sale were $248,579,000. Included in securities held to maturity and securities available for sale are debt securities with a carrying value of $247,374,000. The weighted average maturity for debt securities held to maturity and available for sale, excluding mortgage-backed securities with a carrying value of $8,567,000, is approximately 86 months. The weighted average interest rate sensitivity for these securities is approximately 58 months, when adjusting floating rate securities in the amount of $19,058,000 to next repricing date from maturity date. In addition to these liquidity sources, the Company has significant cash flow from the amortization of loans through its subsidiary bank. Capital Resources Under the Federal Reserve Board's guidelines, bank holding companies such as the Company currently are required to maintain a minimum ratio of qualifying total capital to total assets and off-balance sheet instruments, as adjusted to reflect their relative credit risks, of 8.0 percent. At least one-half of total capital must be comprised of common equity, retained earnings, non-cumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill ("Tier I capital"). The Federal Reserve Board also has established an additional capital adequacy guideline referred to as the Tier I leverage capital ratio, which measures the ratio of Tier I capital to total assets less goodwill. Although the most highly-rated bank holding companies will be required to maintain a minimum Tier I leverage capital ratio of 3.0 percent, most bank holding companies will be required to maintain Tier I leverage capital ratios of 4.0 percent to 5.0 percent or more. The actual required ratio will be based on the Federal Reserve Board's assessment of the individual bank holding company's asset quality, earnings performance, interest rate risk, and liquidity. The Company was in compliance with all regulatory capital requirements at September 30, 2001 and December 31, 2000. Substantially similar rules have been issued by the Federal Deposit Insurance Corporation ("FDIC"), with respect to state-chartered banks which are not members of the Federal Reserve System such as the subsidiary bank. At September 30, 2001 and December 31, 2000, the subsidiary bank was in compliance with all regulatory capital requirements. Additionally, at September 30, 2001, the subsidiary bank was considered "well capitalized" for purposes of the FDIC's prompt corrective action regulations. At September 30, 2001 the Company's and the subsidiary bank's regulatory capital ratios as a percentage of assets are as follows:

On May 3, 2000, the Company announced a Stock Repurchase Program ("Program"), whereby its Board of Directors authorized the repurchase of up to 10% (approximately 566,000 shares), of the Company's outstanding common shares from time to time. Shares repurchased under this Program may be held in treasury, retired, or used for general corporate purposes. As of September 30, 2001, the Company had repurchased 435,327 shares of common stock, with approximately 130,673 shares still available to be repurchased under this Program. 19 Recent Accounting Developments On July 20, 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Intangible Assets". SFAS No. 141 is effective for all business combinations initiated after June 30, 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001; however, certain provisions of this Statement apply to goodwill and other intangible assets acquired between July 1, 2001 and the effective date of SFAS No. 142. Major provisions of these Statements and their effective dates for the Company are as follows: * All business combinations initiated after June 30, 2001 must use the purchase method of accounting. The pooling of interests method of accounting is prohibited except for transactions initiated before July 1, 2001. * Intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability. * Goodwill, as well as intangible assets with indefinite lives, acquired after June 30, 2001, will not be amortized. Effective January 1, 2002, all previously recognized goodwill and intangible assets with indefinite lives will no longer be subject to amortization. * Effective January 1, 2002, goodwill and intangible assets with indefinite lives will be tested for impairment annually and whenever there is an impairment indicator. * All acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting. The Company will continue to amortize goodwill recognized prior to July 1, 2001, under its current method until January 1, 2002, at which time annual and quarterly goodwill amortization of $588,000 and $147,000 will no longer be recognized. By December 31, 2002, the Company will have completed a transitional fair value based impairment test of goodwill as of January 1, 2002. Impairment losses, if any, resulting from the transitional testing will be recognized retroactively in the quarter ending March 31, 2002, as a cumulative effect of a change in accounting principle. Consolidated Quarterly Average Balances and Interest Rates The table on the following page presents, for the periods indicated, average balances of assets and liabilities, as well as yields on interest earning assets and the cost of interest bearing liabilities. 20 Granite State Bankshares, Inc. and Subsidiary Consolidated Quarterly Average Balances and Interest Rates ($ in Thousands)

21 Granite State Bankshares, Inc. and Subsidiary Part I Item 3 and Part II - Other Information September 30, 2001 Item 3. Quantitative and Qualitative Disclosures About Market Risk There has been no material changes in the Company's assessment of its sensitivity to market risk since its presentation in the 2000 annual report filed with the SEC. Part II -Other Information Item 1. Legal Proceedings The Company is a defendant in ordinary and routine pending legal actions incident to its business, none of which is believed by management to be material to the financial condition of the Company. Item 2. Changes in Securities None. Item 3. Defaults upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K 1. Exhibits None. 2. Reports on Form 8-K None. 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant, has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. GRANITE STATE BANKSHARES, INC. /s/ Charles W. Smith ____________________________________ Dated: November 9, 2001 By: Charles W. Smith Chairman and Chief Executive Officer /s/ William G. Pike ____________________________________ Dated: November 9, 2001 By: William G. Pike Executive Vice President and Chief Financial Officer 23

GRANITE STATE BANKSHARES INC 10-Q