UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ______________ FORM 10-K (Mark One) X Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee Required) For the Fiscal Year Ended December 31, 1996 or _____Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (No Fee Required) for the transition period from _______to_______ Commission File Number 0-7974 CHITTENDEN CORPORATION (Exact name of Registrant as specified in its charter) Vermont 03-0228404 (State of Incorporation) (IRS Employer Identification No.) Two Burlington Square Burlington, Vermont 05401 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number: 802-658-4000 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: $1.00 Par Value Common Stock (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports 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 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the Registrant's common stock held by non- affiliates of the Registrant, on February 28, 1997 as reported on NASDAQ, was $337,430,170. At February 28, 1997, there were 12,270,188 shares of the Registrant's common stock issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE The following documents, in whole or in part, are specifically incorporated by reference in the indicated Part of this Annual Report on Form 10-K: 1. Proxy Statement for 1997 Annual Meeting of Registrant's Stockholders: Part III, Items 10, 11, 12, 13. This Form 10-K contains certain statements that may be considered forward- looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company s actual results could differ materially from those projected in the forward-looking statements as a result, among other factors, of changes in general, national or regional economic conditions, changes in loan default and charge-off rates, reductions in deposit levels necessitating increased borrowing to fund loans and investments, changes in interest rates, and changes in the assumptions used in making such forward-looking statements. PART I ITEM 1 BUSINESS Chittenden Corporation (the "Company" or "CC"), a Vermont corporation organized in 1971, is a registered bank holding company under the Bank Holding Company Act of 1956, as amended. Assets of the Company were $1,988,746,000 at December 31, 1996. The Company is the holding company parent of Chittenden Trust Company ("CTC"), Flagship Bank and Trust Company ("FBT") and The Bank of Western Massachusetts ("BWM") and, as of December 31, 1996, owned 100% of the outstanding common stock of those banks. During 1996 the Company created and became the holding company parent of Chittenden Connecticut Corporation ("CCC"), a non-bank mortgage company, and owns 100% of its outstanding common stock of that non-bank mortgage company. The Company's principal executive offices are located at Two Burlington Square, Burlington, Vermont 05401; telephone number: 802-658-4000. CHITTENDEN TRUST COMPANY CTC was chartered by the Vermont Legislature as a commercial bank in 1904. It is the largest bank in Vermont, based on total assets of $1,425,044,000 and total deposits of $1,258,189,000 at December 31, 1996. CTC's principal offices are in Burlington, Vermont and it has 35 additional locations in Vermont, of which three are free standing automated teller machines ("ATM's"). (See Item 2, "Properties"). All of these offices use the trade name "Chittenden Bank". CTC offers a variety of lending services, with loans and leases totaling $919,805,000 at December 31, 1996. The largest loan category is commercial loans, including those secured by commercial real estate, and others made to a variety of businesses, including retail concerns, small manufacturing businesses, larger corporations, other commercial banks, and to political sub- divisions in the U.S. These loans amounted to 37% of the total loans outstanding at December 31, 1996. Loans secured by residential properties, including closed-ended home equity loans, are also substantial, and amounted to 34% of total loans outstanding at December 31, 1996. CTC underwrites substantially all of its residential mortgages to secondary market standards and sells substantially all of its fixed-rate residential mortgage production on a servicing-retained basis. Variable-rate mortgage loans are typically held in portfolio. The remaining real estate loans mortgage loans, which are 1% of total loans outstanding at December 31, 1996, are construction loans secured by residential and commercial land under development. Consumer loans outstanding at December 31, 1996 were 20% of total loans. These include direct and indirect installment loans, auto leases and revolving credit. Revolving home equity loans as a separate group amounted to 8% of loans at December 31, 1996. These loans are generally underwritten to the same standards as first mortgages. CTC's lending activities are conducted primarily in Vermont, with additional activity related to nearby market areas in Quebec, New York, New Hampshire, Massachusetts, Maine and Connecticut. In addition to the portfolio diversifi- cation described above, the loans are widely diversified by borrowers and indus- try groups. In making commercial loans, CTC occasionally solicits the participation of other Vermont banks or correspondent banks and other financial investors outside the State. CTC also occasionally participates in loans originated by other banks. Certain of CTC's commercial loans are made under programs administered by the Vermont Industrial Development Authority, the U.S. Small Business Administration, or the U.S. Farmers Home Administration. These loans contain repayment guarantees by the agency involved in varying amounts up to 90% of the original loan. CTC offers a wide range of banking services, including the acceptance of demand, savings, and time deposits. As of December 31, 1996, total interest-bearing deposits amounted to $1,065,084,000 or 85% of total deposits. CTC also provides personal trust services, including services as executor, trustee, administrator, custodian and guardian. Corporate trust services are also provided, including services as trustee for pension and profit sharing plans. Asset management services are provided with both the personal and corporate trust services. CTC offers data processing services consisting primarily of payroll and automated clearing house for several outside clients. Financial and investment counseling is provided to municipalities and school districts within CTC's service area, as well as, central depository, lending, payroll, and other banking services for such customers. CTC offers a variety of other services including safe deposit facilities, Mastercard, and VISA credit card services, the processing of merchant credit card services, and certain non-bank, investment products through a dual-employee contractual relationship with Link Investment Services, Inc. THE BANK OF WESTERN MASSACHUSETTS BWM was chartered by the Commonwealth of Massachusetts as a commercial bank in 1986. BWM had total assets of $259,485,000 and total deposits of $225,225,000 at December 31, 1996. BWM's principal offices are in Springfield, Massachusetts and it has 4 additional locations in the greater Springfield,Massachusetts area. (See Item 2, "Properties"). BWM offers a variety of lending services, with loans totaling $185,849,000 at December 31, 1996. The largest loan category is commercial loans, including those secured by commercial real estate, and others made to a variety of businesses, including retail concerns and small manufacturing businesses. These loans amounted to 73% of total loans outstanding at December 31, 1996. Loans secured by residential properties, including closed-ended home equity loans, amounted to 19% of total loans outstanding at December 31, 1996. The remaining real estate mortgage loans, which are 2% of total loans outstanding at December 31, 1996, are primarily construction loans. Consumer loans outstanding at December 31, 1996 were 3% of total loans. These include direct and indirect installment loans, and revolving credit. Revolving home equity loans as a separate group amounted to 3% of loans at December 31, 1996. These loans are generally underwritten to the same standards as first mortgages. BWM's lending activities are conducted primarily in the greater Springfield, Massachusetts area. In making commercial loans, BWM occasionally solicits the participation of other banks, including its affiliates, CTC and FBT. BWM also occasionally participates in loans originated by other banks. Certain of BWM's commercial loans are made under programs administered by the U.S. Small Business Administration, or the U.S. Farmers Home Administration. These loans have repayment guarantees by the agency involved in varying amounts up to 90% of the original loan. BWM offers a wide range of banking services, including the acceptance of demand, savings, and time deposits. As of December 31, 1996, total interest-bearing deposits amounted to $188,773,000 or 84% of total deposits. BWM provides personal trust services, through CTC, including services as executor, trustee, administrator, custodian and guardian. Also through CTC, BWM provides corporate trust services, including services as trustee for pension and profit sharing plans. FLAGSHIP BANK AND TRUST COMPANY FBT was chartered by the Commonwealth of Massachusetts as a commercial bank in 1986. FBT had total assets of $312,375,000 and total deposits of $287,973,000 at December 31, 1996. FBT's principal offices are in Worcester, Massachusetts and it has 5 additional locations in the greater Worcester, Massachusetts area. (See Item 2, "Properties"). FBT offers a variety of lending services, with loans totaling $190,914,000 at December 31, 1996. The largest loan category is commercial loans, including those secured by commercial real estate, and others made to a variety of businesses, including retail concerns and small manufacturing businesses. These loans amounted to 53% of total loans outstanding at December 31, 1996. Loans secured by residential properties, including closed-ended home equity loans, amounted to 33% of total loans outstanding at December 31, 1996. The remaining real estate mortgage loans, which are 6% of total loans outstanding at December 31, 1996, are primarily construction loans. Consumer loans outstanding at December 31, 1996 were 5% of total loans. These include direct and indirect installment loans, and revolving credit. Revolving home equity loans as a separate group amounted to 3% of loans at December 31, 1996. These loans are generally underwritten to the same standards as first mortgages. FBT's lending activities are conducted primarily in the greater Worcester, Massachusetts area. In making commercial loans, FBT occasionally solicits the participation of other banks, including its affiliates, CTC and BWM. FBT also occasionally participates in loans originated by other banks. Certain of FBT's commercial loans are made under programs administered by the U.S. Small Business Administration, or the U.S. Farmers Home Administration. These loans contain repayment guarantees by the agency involved in varying amounts up to 90% of the original loan. FBT offers a wide range of banking services, including the acceptance of demand, savings, and time deposits. As of December 31, 1996, total interest-bearing deposits amounted to $230,424,000 or 80% of total deposits. FBT provides personal trust services, through CTC, including services as executor, trustee, administrator, custodian and guardian. Also through CTC, FBT provides corporate trust services, including services as trustee for pension and profit sharing plans. CHITTENDEN CONNECTICUT CORPORATION CCC was chartered by the State of Vermont as a mortgage company in 1996 and its principal offices are in Burlington, Vermont. CCC has additional offices in Brattleboro, Vermont, and in Glastonbury and Southbury, Connecticut (See Item 2, "Properties"). CCC's primary business is the origination of conforming residential real estate mortgage loans for resale to the secondary market. CCC originates these loans for resale through correspondent relationships with credit unions and through other mortgage brokers in the state of Connecticut who receive loan applications. These applications are underwritten by CTC in Vermont to secondary market standards and then sold. In addition, CCC uses brokers that are directly employed by and working through various financial institutions in Connecticut. ECONOMY The New England economy showed signs of continued improvement in 1996. Retail sales improved along with increases in both housing permits and new construction contracts. New England unemployment levels also continued to decrease. The ability and willingness of the Company's borrowers to honor their repayment commitments are impacted by many factors, including prevailing market interest rates and the level of overall economic activity within the borrowers' geographic area. COMPETITION There is vigorous competition in the Company's marketplace for all aspects of the banking and related financial services activities presently engaged in by the Company and its subsidiaries. CTC competes with Vermont banks and metropolitan banks based in southern New England and New York City to provide commercial banking services to businesses. Many of these out-of-state banks have greater financial resources than those of Vermont banks and are actively seeking financial relationships with promising Vermont enterprises. Two out-of-state banks own in-state banks or operate in- state branches; Allbank acquired Marble Bank early in 1996 and Key Bank operates branches throughout Vermont. In the retail financial services market, competitors include other banks, credit unions, finance companies, thrift institutions and, increasingly, brokerage firms, insurance companies, and mortgage loan companies. Money market deposit accounts and short term flexible-maturity certificates of deposit offered by CTC compete with investment account offerings of brokerage firms and, more recently, with new products offered by insurance companies. CTC also competes for personal and commercial trust business with investment advisory firms, mutual funds, and insurance companies. BWM and FBT also operate in areas in which competition among financial institutions is continuously increasing. BWM has focused on meeting the needs of the smaller and medium-sized businesses and professionals in its market area, while FBT has taken a balanced approach in serving the needs of both smaller and medium-sized businesses, as well as retail consumers in its market. SUPERVISION AND REGULATION The Company and its banking subsidiaries (CTC, BWM and FBT) are subject to extensive regulation under federal and state banking laws and regulations. The following discussion of certain of the material elements of the regulatory framework applicable to banks and bank holding companies is not intended to be complete and is qualified in its entirety by the text of the relevant state and federal statutes and regulations. A change in the applicable laws or regulations may have a material effect on the business of the Company and/or its banking subsidiaries. Regulation of the Company GENERAL. As a bank holding company, the Company is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") under the Bank Holding Company Act of 1956, as amended (the "BHC Act"). Under the BHC Act, bank holding companies generally may not acquire ownership or control of more than 5% of any class of voting shares or substantially all of the assets of any company, including a bank, without the prior approval of the Federal Reserve Board. In addition, bank holding companies are generally prohibited under the BHC Act from engaging in non- banking activities, subject to certain exceptions. As a bank holding company, the Company's activities are limited generally to the business of banking and activities determined by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto. The Federal Reserve Board has authority to issue cease and desist orders and assess civil money penalties against bank holding companies and their non-bank subsidiaries, officers, directors and other institution-affiliated parties, and to remove officers, directors and other institution-affiliated parties to terminate or prevent unsafe or unsound banking practices or violations of laws or regulations. INTERSTATE ACQUISITIONS. Prior to September 29, 1995, under the BHC Act a bank holding company was permitted to acquire a bank in another state only if the law of the state in which the bank to be acquired was located specifically authorized such acquisition of an in-state bank by an out-of-state bank holding company. As described below under "Capital Requirements and FDICIA - Interstate Banking and Branching", the BHC Act was amended, effective September 29, 1995, to remove this prohibition. Even prior to this amendment to the BHC Act, state legislation enacted in recent years substantially lessened prior legislative restrictions on geographic expansion by bank holding companies from and into Massachusetts and Vermont. For example, under nationwide reciprocal interstate banking legislation adopted by both states which became effective in 1990, bank holding companies whose subsidiaries' banking operations were principally conducted in any state outside Massachusetts or Vermont were authorized to acquire Massachusetts or Vermont banking organizations, provided that such companies' home states afforded Massachusetts or Vermont banking organizations reciprocal rights to acquire banks in such states. DIVIDENDS. The Federal Reserve Board has authority to prohibit bank holding companies from paying dividends if such payment is deemed to be an unsafe or unsound practice. The Federal Reserve Board has indicated generally that it may be an unsound practice for bank holding companies to pay dividends unless the bank holding company's net income over the preceding year is sufficient to fund the dividends and the expected rate of earnings retention is consistent with the organization's capital needs, asset quality, and overall financial condition. The Company's ability to pay dividends is dependent upon the flow of dividend income to it from its banking subsidiaries, which may be affected or limited by regulatory restrictions imposed by federal or state bank regulatory agencies. See "- Regulation of CTC, BWM and FBT - Dividends." CERTAIN TRANSACTIONS BY BANK HOLDING COMPANIES WITH THEIR AFFILIATES. There are various legal restrictions on the extent to which bank holding companies and their non-bank subsidiaries may borrow, obtain credit from or otherwise engage in "covered transactions" with their insured depository institution sub- sidiaries. Such borrowings and other covered transactions by an insured depository institution subsidiary (and its subsidiaries) with its non-depository institution affiliates are limited to the following amounts: (a) in the case of any one such affiliate, the aggregate amount of covered transactions of the insured depository institution and its subsidiaries cannot exceed 10% of the capital stock and surplus of the insured depository institution; and (b) in the case of all affiliates, the aggregate amount of covered transactions of the insured depository institution and its subsidiaries cannot exceed 20% of the capital stock and surplus of the insured depository institution. "Covered transactions" are defined by statute for these purposes to include a loan or extension of credit to an affiliate, a purchase of or investment in securities issued by an affiliate, a purchase of assets from an affiliate unless exempted by the Federal Reserve Board, the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any person or company, or the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. Covered transactions are also subject to certain collateral security requirements. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property of any kind, or furnishing of any service. HOLDING COMPANY SUPPORT OF SUBSIDIARY BANKS. Under Federal Reserve Board policy, the Company is expected to act as a source of financial strength to its subsidiary banks and to commit resources to support such subsidiaries. This support of its subsidiary banks may be required at times when, absent such Federal Reserve Board policy, the Company might not otherwise be inclined to provide it. In addition, any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and certain other indebtedness of such subsidiary banks. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. LIABILITY OF COMMONLY CONTROLLED DEPOSITORY INSTITUTIONS. Under the Federal Deposit Insurance Act, as amended ("FDI Act"), an FDIC-insured depository institution, such as CTC, BWM or FBT, can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989 in connection with (i) the "default" of a commonly controlled FDIC-insured depository institution, or (ii) any assistance provided by the FDIC to any commonly controlled depository institution in "danger of default." For these purposes, the term "default" is defined generally as the appointment of a conservator or receiver and "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur without Federal regulatory assistance. Regulation of CTC, BWM and FBT GENERAL. As FDIC-insured state-chartered banks, CTC, BWM and FBT are subject to supervision of and regulation by the Commissioner of Banking, Insurance, Securities and Heath Care Administration of the State of Vermont, in connection with CTC, and the Commissioner of Banks of the Commonwealth of Massachusetts in connection with BWM and FBT (collectively, the "Commissioners") and, for all three banks, by the FDIC. This supervision and regulation is for the protection of depositors, the BIF (as hereinafter defined), and consumers, and is not for the protection of the Company's stockholders. The prior approval of the FDIC and the Commissioners is required for CTC, BWM or FBT to establish or relocate an additional branch office, assume deposits, or engage in any merger, consolidation or purchase or sale of all or substantially all of the assets of any bank or savings association. EXAMINATIONS AND SUPERVISION. The FDIC and the Commissioners regularly examine the operations of CTC, BWM and FBT, including (but not limited to) their capital adequacy, reserves, loans, investments, earnings, liquidity, compliance with laws and regulations, record of performance under the Community Reinvestment Act and management practices. In addition, CTC, BWM and FBT are required to furnish quarterly and annual reports of income and condition to the FDIC and periodic reports to the Commissioners. The enforcement authority of the FDIC includes the power to impose civil money penalties, terminate insurance coverage, remove officers and directors and issue cease-and-desist orders to prevent unsafe or unsound practices or violations of laws or regulations. In addition, under recent federal banking legislation, the FDIC has authority to impose additional restrictions and requirements with respect to banks that do not satisfy applicable regulatory capital requirements. See "- Capital Requirements and FDICIA - Prompt Corrective Action" below. DIVIDENDS. The principal source of the Company's revenue is dividends from CTC, one of its bank subsidiaries. Payment of dividends by CTC, BWM and FBT are subject to certain Vermont and Massachusetts banking law restrictions. Payment of dividends by CTC is subject to Vermont banking law restrictions which require that, except when surplus and paid-in capital together amount to 10% or more of deposits and other liabilities (not including surplus, paid-in capital, capital notes and debentures, and funds held in a fiduciary capacity), at least one- tenth of its net profits must be set aside annually and added to surplus. The FDIC has authority to prevent CTC, BWM and FBT from paying dividends if such payment would constitute an unsafe or unsound banking practice or reduce the respective bank's capital below safe and sound levels. In addition, federal legislation prohibits FDIC-insured depository institutions from paying dividends or making capital distributions that would cause the institution to fail to meet minimum capital requirements. See "Capital Requirements and FDICIA - Prompt Corrective Action" below. AFFILIATE TRANSACTIONS. As noted above, banks are subject to restrictions imposed by federal law on extensions of credit to, purchases of assets from, and certain other transactions with, affiliates, and on investments in stock or other securities issued by affiliates. Such restrictions prevent CTC, BWM and FBT from making loans to affiliates unless the loans are secured by collateral in specified amounts and have terms at least as favorable to the bank as the terms of comparable transactions between the bank and non-affiliates. Further, federal and applicable state laws significantly restrict extensions of credit by CTC, BWM and FBT to directors, executive officers and principal stockholders and related interests of such persons. DEPOSIT INSURANCE. CTC's, BWM's and FBT's deposits are insured by the Bank Insurance Fund ("BIF") of the FDIC to the legal maximum of $100,000 for each insured depositor. The FDI Act provides that the FDIC shall set deposit insurance assessment rates on a semi-annual basis at a level sufficient to increase the ratio of BIF reserves to BIF-insured deposits to at least 1.25% over a 15-year period commencing in 1991, and to maintain that ratio. Although the established framework of risk-based insurance assessments accomplished this increase in May 1995, and the FDIC has made a substantial reduction in the assessment rate schedule, the BIF insurance assessments may be increased in the future if necessary to maintain BIF reserves at the required level. In addition, legislation enacted in 1996 to recapitalize the Savings Association Insurance Fund ("SAIF"), which insures the deposits of savings associations and certain savings banks, will result in increased BIF assessments. See "Capital Requirements and FDICIA - Risk-Based Deposit Insurance and FICO Assessments" below. FEDERAL RESERVE BOARD POLICIES. The monetary policies and regulations of the Federal Reserve Board have had a significant effect on the operating results of banks in the past and are expected to continue to do so in the future. Federal Reserve Board Policies affect the levels of bank earnings on loans and investments and the levels of interest paid on bank deposits through the Federal Reserve System's open-market operations in United States government securities, regulation of the discount rate on bank borrowings from Federal Reserve Banks and regulation of non-earning reserve requirements applicable to bank deposit account balances. CONSUMER PROTECTION REGULATION; BANK SECRECY ACT. Other aspects of the lending and deposit business of CTC, BWM and FBT that are subject to regulation by the FDIC and the Commissioners include disclosure requirements with respect to interest, payment and other terms of consumer and residential mortgage loans and disclosure of interest and fees and other terms of, and the availability of, funds for withdrawal from consumer deposit accounts. In addition, CTC, BWM and FBT are subject to federal and state laws and regulations prohibiting certain forms of discrimination in credit transactions, and imposing certain record keeping, reporting and disclosure requirements with respect to residential mortgage loan applications. In addition, CTC, BWM and FBT are subject to federal laws establishing certain record keeping, customer identification, and reporting requirements with respect to certain large cash transactions, sales of travelers checks or other monetary instruments and the international transpor- tation of cash or monetary instruments. CRA Regulations The Community Reinvestment Act ("CRA") requires lenders to identify the communities served by the institution's offices and to identify the types of credit the institution is prepared to extend within such communities. The FDIC conducts examinations of insured institutions' CRA compliance and rates such institutions as "Outstanding", "Satisfactory", "Needs to Improve" and "Substantial Noncompliance". As of their last CRA examinations, CTC and FBT received a rating of "Outstanding" and BWM received a rating of "Satisfactory." Failure of an institution to receive at least a "Satisfactory" rating could inhibit such institution's undertaking certain activities, including acquisitions of other financial institutions, which require regulatory approval based, in part, on CRA compliance considerations. The Federal Reserve Board must take into account the record of performance of banks in meeting the credit needs of the entire community served, including low and moderate income neighborhoods. The federal bank regulatory agencies have jointly issued amendments to the regulations implementing the CRA that revised the CRA framework effective January 1, 1996. These amended CRA regulations rely more than the former CRA regulations upon objective criteria of the performance of institutions under three key assessment tests: a lending test, a service test and an investment test. CTC, BWM and FBT are committed to meeting the existing or anticipated credit needs of their entire communities, including low and moderate income neighborhoods, consistent with safe and sound operations. Capital Requirements and FDICIA GENERAL. The FDIC has established guidelines with respect to the maintenance of appropriate levels of capital by FDIC-insured banks. The Federal Reserve Board has established substantially identical guidelines with respect to the maintenance of appropriate levels of capital, on a consolidated basis, by bank holding companies. If a banking organization's capital levels fall below the minimum requirements established by such guidelines, a bank or bank holding company will be expected to develop and implement a plan acceptable to the FDIC or the Federal Reserve Board, respectively, to achieve adequate levels of capital within a reasonable period, and may be denied approval to acquire or establish additional banks or non-bank businesses, merge with other institutions or open branch facilities until such capital levels are achieved. Federal legislation requires federal bank regulators to take "prompt corrective action" with respect to insured depository institutions that fail to satisfy minimum capital requirements and imposes significant restrictions on such institutions. See "Prompt Corrective Action" below. LEVERAGE CAPITAL RATIO. The regulations of the FDIC require FDIC-insured banks to maintain a minimum "Leverage Capital Ratio" or "Tier 1 Capital" (as defined in the Risk-Based Capital Guidelines discussed in the following paragraphs) to Total Assets of 3.0%. The regulations of the FDIC state that only banks with the highest federal bank regulatory examination rating will be permitted to operate at or near such minimum level of capital. All other banks are expected to maintain an additional margin of capital, equal to at least 1% to 2% of Total Assets, above the minimum ratio. Any bank experiencing or anticipating significant growth is expected to maintain capital well above the minimum levels. The Federal Reserve Board's guidelines impose substantially similar leverage capital requirements on bank holding companies on a consolidated basis. RISK-BASED CAPITAL REQUIREMENTS. The regulations of the FDIC also require FDIC- insured banks to maintain minimum capital levels measured as a percentage of such banks' risk-adjusted assets. A bank's qualifying total capital ("Total Capital") for this purpose may include two components - "Core" (Tier 1) Capital and "Supplementary" (Tier 2) Capital. Core Capital consists primarily of common stockholders' equity, which generally includes common stock, related surplus and retained earnings, certain non-cumulative perpetual preferred stock and related surplus, and minority interests in the equity accounts of consolidated subsidiaries, and (subject to certain limitations) mortgage servicing rights and purchased credit card relationships, less all other intangible assets (primarily goodwill). Supplementary Capital elements include, subject to certain limitations, a portion of the allowance for losses on loans and leases, perpetual preferred stock that does not qualify for inclusion in Tier 1 capital, long-term preferred stock with an original maturity of at least 20 years and related surplus, certain forms of perpetual debt and mandatory convertible securities, and certain forms of subordinated debt and intermediate-term preferred stock. The risk-based capital rules of the FDIC and the Federal Reserve Board assign a bank's balance sheet assets and the credit equivalent amounts of the bank's off- balance sheet obligations to one of four risk categories, weighted at 0%, 20%, 50% or 100%, respectively. Applying these risk-weights to each category of the bank's balance sheet assets and to credit the equivalent amounts of the bank's off-balance sheet obligations and summing the totals results in the amount of the bank's total Risk-Adjusted Assets for purposes of the risk-based capital requirements. Risk-Adjusted Assets can either exceed or be less than reported balance sheet assets, depending on the risk profile of the banking organization. Risk-Adjusted Assets for institutions such as CTC, BWM and FBT will generally be less than reported balance sheet assets because its retail banking activities include proportionally more residential mortgage loans with a lower risk weighing and relatively smaller off-balance sheet obligations. The risk-based capital regulations require all banks to maintain a minimum ratio of Total Capital to Risk-Adjusted Assets of 8.0%, of which at least one-half (4.0%) must be Core (Tier 1) Capital. For the purpose of calculating these ratios: (i) a banking organization's Supplementary Capital eligible for inclusion in Total Capital is limited to no more than 100% of Core Capital; and (ii) the aggregate amount of certain types of Supplementary Capital eligible for inclusion in Total Capital is further limited. For example, the regulations limit the portion of the allowance for loan losses eligible for inclusion in Total Capital to 1.25% of Risk-Adjusted Assets. The Federal Reserve Board has established substantially identical risk-based capital requirements which are applied to bank holding companies on a consolidated basis. The risk-based capital regulations provide explicitly for consideration of interest rate risk in the FDIC's overall evaluation of a bank's capital adequacy to ensure that banks effectively measure and monitor their interest rate risk, and that they maintain capital adequate for that risk. A bank deemed by the FDIC to have excessive interest rate risk exposure may be required by the FDIC to maintain additional capital (that is, capital in excess of the minimum ratios discussed above). CTC, BWM and FBT believe that this provision will not have a material adverse effect on them. At December 31, 1996, the Company's consolidated Total and Tier 1 Risk-Based Capital Ratios were 13.06% and 11.71%, respectively, and its Leverage Capital Ratio was 8.58%. Based on the above figures and accompanying discussion, CC exceeds all regulatory capital requirements. PROMPT CORRECTIVE ACTION. Among other things, the Federal Deposit Insurance Corporation Improvement Act ("FDICIA") requires the federal banking regulators to take "prompt corrective action" with respect to, and imposes significant restrictions on, any bank that fails to satisfy its applicable minimum capital requirements. FDICIA establishes five capital categories consisting of "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." Under applicable regulations, a bank that has a Total Risk-Based Capital Ratio of 10.0% or greater, a Tier 1 Risk-Based Capital Ratio of 6.0% or greater and a Leverage Capital Ratio of 5.0% or greater, and is not subject to any written agreement, order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure is deemed to be "well capitalized." A bank that has a Total Risk-Based Capital Ratio of 8.0% or greater, a Tier 1 Risk-Based Capital Ratio of 4.0% or greater and a Leverage Capital Ratio of 4.0% or greater and does not meet the definition of a well capitalized bank is considered to be "adequately capitalized." A bank that has a Total Risk-Based Capital Ratio of less than 8.0% or has a Tier 1 Risk-Based Capital Ratio that is less than 4.0% or generally a Leverage Capital Ratio of less than 4.0% is considered "undercapitalized." A bank that has a Total Risk- Based Capital Ratio of less than 6.0%, or a Tier 1 Risk-Based Capital Ratio that is less than 3.0% or a Leverage Capital Ratio that is less than 3.0% is considered to be "significantly undercapitalized," and a bank that has a ratio of tangible equity to total assets equal to or less than 2% is deemed to be "critically undercapitalized." A bank may be deemed to be in a capital category lower than is indicated by its actual capital position if it is determined to be in an unsafe or unsound condition or receives an unsatisfactory examination rating. FDICIA generally prohibits a bank from making capital distributions (including payment of dividends) or paying management fees to controlling stockholders or their affiliates if, after such payment, the bank would be undercapitalized. Under FDICIA and the applicable implementing regulations, an undercapitalized bank will be (i) subject to increased monitoring by the FDIC; (ii) required to submit to the FDIC an acceptable capital restoration plan (guaranteed, subject to certain limits, by the bank's holding company) within 45 days; (iii) subject to strict asset growth limitations; and (iv) required to obtain prior regulatory approval for certain acquisitions, transactions not in the ordinary course of business, and entry into new lines of business. In addition to the foregoing, the FDIC may issue a "prompt corrective action directive" to any undercapital- ized institution. Such a directive may require sale or re-capitalization of the bank, impose additional restrictions on transactions between the bank and its affiliates, limit interest rates paid by the bank on deposits, limit asset growth and other activities, require divestiture of subsidiaries, require replacement of directors and officers, and restrict capital distributions by the bank's parent holding company. In addition to the foregoing, a significantly undercapitalized institution may not award bonuses or increases in compensation to its senior executive officers until it has submitted an acceptable capital restoration plan and received approval from the FDIC. Not later than 90 days after an institution becomes critically undercapitalized, the appropriate federal banking agency for the institution must appoint a receiver or, with the concurrence of the FDIC, a conservator, unless the agency, with the concurrence of the FDIC, determines that the purposes of the prompt corrective action provisions would be better served by another course of action. FDICIA requires that any alternative determination be "documented" and re- assessed on a periodic basis. Notwithstanding the foregoing, a receiver must be appointed after 270 days unless the appropriate federal banking agency and the FDIC certify that the institution is viable and not expected to fail. RISK-BASED DEPOSIT INSURANCE AND FICO ASSESSMENTS. The FDIC has adopted a rule establishing a risk-based system which assigns an institution to one of three capital categories consisting of (1) well capitalized, (2) adequately capital- ized, or (3) undercapitalized, and one of three supervisory categories. An institution's assessment rate depends on the capital category and supervisory category to which it is assigned. Under this rule there are nine assessment risk classifications (i.e. combinations of capital categories and supervisory subgroups within each capital group). An institution's deposit insurance assessment rate is determined by assigning the institution to a capital category and a supervisory subgroup to determine which one of the nine risk classification categories is applicable. The FDIC is authorized to raise the assessment rates in certain circumstances. If the FDIC determines to increase the assessment rates for all institutions, institutions in all risk categories could be affected. The FDIC has exercised this authority several times in the past and may raise BIF insurance premiums again in the future. If such action is taken by the FDIC, it could have an adverse effect on the earnings of CTC, BWM and FBT, the extent of which is not currently quantifiable. The risk classification to which an institution is assigned by the FDIC is confidential and may not be disclosed. Current assessment rates range from 0% of domestic deposits for an institution in the lowest risk category (i.e., well-capitalized and healthy from a supervisory standpoint) to 0.27% of domestic deposits for institutions in the highest risk category (i.e., undercapitalized and unhealthy from a supervisory standpoint), for the first semiannual period of 1997. During 1996 assessment rates also included a minimum annual assessment of $2,000 per institution. CTC, BWM and FBT qualified for, and paid in 1996, the minimum annual assessment under this rate schedule. The Deposit Insurance Funds Act of 1996 eliminates the minimum assessment and authorizes the Financing Corporation (FICO) to levy assessments on BIF- assessable deposits and stipulates that the rate must equal one-fifth the FICO assessment rate that is applied to deposits assessable by the SAIF. The actual assessment rates for FICO were determined by deposit data from the September 30, 1996, Call Reports. Based on the 1996 Act, the Company anticipates that the Banks will pay assessments of 1.3 cents per $100 of deposits in 1997, which would amount to approximately $275,000 of expense for that year. BROKERED DEPOSITS AND PASS-THROUGH DEPOSIT INSURANCE LIMITATIONS. Under FDICIA, a bank cannot accept brokered deposits unless it either (i) is "Well Capitalized" or (ii) is "Adequately Capitalized" and has received a written waiver from the FDIC. For this purpose, "Well Capitalized" and "Adequately Capitalized" have the same definitions as in the Prompt Corrective Action regulations. See"- Prompt Corrective Action" above. Banks that are not in the "Well Capitalized" category are subject to certain limits on the rates of interest they may offer on any deposits (whether or not obtained through a third-party deposit broker). Pass-through insurance coverage is not available for deposits of certain employee benefit plans in banks that do not satisfy the requirements for acceptance of brokered deposits, except that pass-through insurance coverage will be provided for employee benefit plan deposits in institutions which at the time of acceptance of the deposit meet all applicable regulatory capital requirements and send written notice to their depositors that their funds are eligible for pass-through deposit insurance. Although eligible to do so, CTC, BWM and FBT do not accept brokered deposits. CONSERVATORSHIP AND RECEIVERSHIP AMENDMENTS. FDICIA authorizes the FDIC to appoint itself conservator or receiver for a state-chartered bank under certain circumstances and expands the grounds for appointment of a conservator or receiver for an insured depository institution to include (i) consent to such action by the board of directors of the institution; (ii) cessation of the institution's status as an insured depository institution; (iii) the institution is undercapitalized and has no reasonable prospect of becoming adequately capitalized, or fails to become adequately capitalized when required to do so, or fails to timely submit an acceptable capital plan, or materially fails to implement an acceptable capital plan; and (iv) the institution is critically undercapitalized or otherwise has substantially insufficient capital. FDICIA provides that an institution's directors shall not be liable to its stockholders or creditors for acquiescing in or consenting to the appointment of the FDIC as receiver or conservator for, or as a supervisor in the acquisition of, the institution. REAL ESTATE LENDING STANDARDS. FDICIA requires the federal bank regulatory agencies to adopt uniform real estate lending standards. The FDIC has adopted implementing regulations which establish supervisory limitations on Loan-to- Value ("LTV") ratios in real estate loans by FDIC-insured banks. The regulations require FDIC-insured banks to establish LTV ratio limitations within or below the prescribed uniform range of supervisory limits. STANDARDS FOR SAFETY AND SOUNDNESS. FDICIA requires the federal bank regulatory agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; and (vi) compensation, fees and benefits. The compensation standards would prohibit employment contracts, compensation or benefit arrangements, stock option plans, fee arrangements or other compensatory arrangements that would provide "excessive" compensation, fees or benefits, or that could lead to material financial loss. In addition, the federal bank regulatory agencies are required by FDICIA to prescribe standards specifying; (i) maximum classified assets to capital ratios; (ii) minimum earnings sufficient to absorb losses without impairing capital; and (iii) to the extent feasible, a minimum ratio of market value to book value for publicly-traded shares of depository institutions and depository institution holding companies. The FDIC has issued regulations implementing certain of these provisions. ACTIVITIES AND INVESTMENTS OF INSURED STATE BANKS. FDICIA provides that FDIC- insured state banks such as CTC, BWM and FBT may not engage as a principal, directly or through a subsidiary, in any activity that is not permissible for a national bank unless the FDIC determines that the activity does not pose a significant risk to the BIF, and the bank is in compliance with its applicable capital standards. In addition, an insured state bank may not acquire or retain, directly or through a subsidiary, any equity investment of a type, or in an amount, that is not permissible for a national bank. Subject to certain limited exceptions, the foregoing provisions of FDICIA prohibit insured state banks such as CTC, BWM and FBT or any subsidiary of such insured state banks from retaining or acquiring equity investments. However, under an exception in the statute, an insured state bank that (i) is located in a state such as Vermont or Massachusetts which authorized, as of September 30, 1991, state banks to invest in common or preferred stock listed on a national securities exchange ("listed stock") or shares of an investment company registered under the Investment Company Act of 1940 ("registered shares") and (ii) during the period beginning September 30, 1990 and ending on November 26, 1991 made or maintained investments in listed stocks and registered shares, may retain whatever listed stock or registered shares it lawfully acquired or held prior to December 19, 1991 and may continue to acquire listed stock or registered shares which may not exceed, taken together in the aggregate, 100% of the bank's Tier 1 Capital. In order to acquire or retain any listed stock or registered shares under this exception, the bank must file a one-time notice with the FDIC containing specified information, and the FDIC must determine that acquiring or retaining the listed stock or registered shares will not pose a significant risk to the BIF. Any such approval may be subject to whatever conditions or restrictions the FDIC determines to be necessary or appropriate and will terminate with respect to further acquisitions of listed stock or registered shares if the bank or its holding company experiences a change in control and in certain other circumstances. CTC filed the one-time notice with the FDIC and the FDIC did not object. CONSUMER PROTECTION PROVISIONS. FDICIA also includes provisions requiring advance notice to regulators and customers for any proposed branch closing and authorizing (subject to future appropriation of the necessary funds) reduced insurance assessments for institutions offering "lifeline" banking accounts or engaged in lending in distressed communities. FDICIA also includes provisions requiring depository institutions to make additional and uniform disclosures to depositors with respect to the rates of interest, fees and other terms applicable to consumer deposit accounts. DEPOSITOR PRIORITY STATUTE. The FDI Act provides that, in the liquidation or other resolution by any receiver of a bank insured by the FDIC, the claims of depositors have priority over the general claims of other creditors. Hence, in the event of the liquidation or other resolution of a banking subsidiary of the Company, the general claims of the Company as creditor of such banking subsidiary would be subordinate to the claims of the depositors of such banking subsidiary, even if the claims of CC were not by their terms so subordinated. In addition, this statute may, in certain circumstances, increase the costs to banks of obtaining funds through non-deposit liabilities. INTERSTATE BANKING AND BRANCHING. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Riegle-Neal Act") provides that an adequately capitalized and managed bank holding company may (with Federal Reserve Board approval) acquire control of banks outside its principal state of operations, without regard to whether such acquisitions are permissible under state law. States may, however, limit the eligibility of banks to be acquired by an out-of- state bank holding company to banks in existence for a minimum period of time (not in excess of five years). No bank holding company may make an acquisition outside its principal state of operations which would result in it controlling more than 10% of the total amount of deposits of all insured depository institutions in the United States, or 30% or more of the total deposits of insured depository institutions in any state (unless such limit is waived, or a more restrictive or permissible limit is established, by a particular state). In addition, beginning June 1, 1997, banks may branch across state lines either by merging with banks in other states or by establishing new branches in other states. The date relating to interstate branching through mergers may be accelerated by any state. The provision relating to establishing new branches in another state requires a state's specific approval. Effective in 1996, the Vermont and Massachusetts legislatures adopted legislation to accelerate the effective date of interstate branching through mergers (that is, to "opt-in early"). Since 1990, Massachusetts has had nationwide reciprocal interstate banking legislation permitting out-of-state banks to conduct banking operations in that state both by mergers and by establishing new banks, subject to the reciprocity requirements that banks from another state may acquire banks in Massachusetts only if Massachusetts banks may conduct banking operations in that state. CC is unable to predict the ultimate impact of this interstate banking legislation on it or its competitors. The United States Congress has periodically considered and adopted legislation which has resulted in and could result in further regulation or deregulation of both banks and other financial institutions. Such legislation could place the Company, CTC, BWM, FBT or CCC in more direct competition with other financial institutions, including mutual funds, securities brokerage firms and investment banking firms. No assurance can be given as to whether any additional legislation will be enacted or as to the effect of such legislation on the business of the Company, CTC, BWM, FBT or CCC. EMPLOYEES The Company and its subsidiaries on December 31, 1996 employed 944 persons, with a full-time equivalency of 877 employees. The Company enjoys good relations with its employees. A variety of employee benefits, including health, group life and disability income replacement insurance, a funded, non-contributory pension plan, and an incentive savings and profit sharing plan, are available to qualifying officers and employees. SELECTED STATISTICAL INFORMATION Certain consolidated financial data about the business of the Company is contained on pages 13 to 53 of the Company's 1996 Annual Report to Stockholders which is attached hereto as Exhibit 13. ITEM 2 PROPERTIES The Company's principal banking subsidiary, CTC, operates banking facilities in 36 locations in Vermont. The offices of the Company are located in the main office of the CTC, which occupied all of the five-floor Chittenden Building at Two Burlington Square in Burlington as of December 31, 1996. The Chittenden Building is owned by CTC. BWM and FBT both operate banking facilities in Massachusetts; BWM operating 6 locations and FBT operating 6 locations. CCC operates 2 mortgage company facilities in Connecticut. The offices of CTC, BWM, FBT and CCC are in good physical condition with modern equipment and facilities considered adequate to meet the banking needs of customers in the communities serviced. ITEM 3 LEGAL PROCEEDINGS A number of legal claims against the Company arising in the normal course of business were outstanding at December 31, 1996. Management, after reviewing these claims with legal counsel, is of the opinion that these matters, when resolved, will not have a material effect on the consolidated financial statements. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters. PART II ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Information regarding the market in which the Company's common stock is traded, and the quarterly high and low bid quotations for the Company's common stock during the past five years are included in the Company's 1996 Annual Report to Stockholders on page 57, and is attached hereto as Exhibit 13. The approximate number of stockholders at February 28, 1997 was 3,147. Note 8 of the Consolidated Financial Statements appearing on page 28 of the Company's 1996 Annual Report to Stockholders contains a discussion of restrictions on dividends and is attached hereto as Exhibit 13. Beginning October 17, 1996 through December 30, 1996, there were eight transactions in which 27,171 shares of the Company's common stock were issued pursuant to the 1993 Stock Option Plan (The SOP ). The SOP provides an opportunity for key employees of the Company to purchase the Company's common stock at stated exercise prices. Options exercised during the fourth quarter had exercise prices ranging from $3.97 to $14.80 per share, with a weighted average price of $9.20 per share. The Company received cash in the amount of $249,952 from these transactions. The Company relies on Section 4 (2) of the Securities Act of 1933 for exemption from registration. The Company anticipates filing a Registration Statement on Form S-8 in the second quarter of 1997 covering the shares of the Company's common stock issued and issuable pursuant to the SOP. ITEM 6 SELECTED FINANCIAL DATA A five-year summary of selected consolidated financial data for the Company and its subsidiaries is included on page 40 of the Company's 1996 Annual Report to Stockholders and is attached hereto as Exhibit 13. ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of Financial Condition and Results of Operations is included on pages 41 to 53 of the Company's 1996 Annual Report to Stockholders and is attached hereto as Exhibit 13. ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following consolidated financial statements of the Company and its subsidiaries appear in the Company's 1996 Annual Report to Stockholders at the pages indicated and are attached hereto as Exhibit 13: Report of Independent Public Accountants Page 39 Consolidated Balance Sheets at December 31, 1996 and 1995 Page 13 Consolidated Statements of Income for the Years Ended December 31, 1996, 1995, and 1994 Page 14 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1996, 1995, and 1994 Page 15 Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995, and 1994 Page 16 Notes to Consolidated Financial Statements Pages 17-38 ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable PART III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding the directors and director-nominees of the Registrant is included in the Company's definitive Proxy Statement for the 1997 Annual Meeting of Stockholders at pages 5-10, and is specifically incorporated herein by reference. At December 31, 1996, the principal officers of the Company and its principal subsidiary, CTC, with their ages, positions, and years of appointment, were as follows: YEAR NAME AND AGE APPOINTED POSITIONS - -------------------------------------------------------------------------------- Barbara W. Snelling, 69 1990 Chair of the Company and CTC Paul A. Perrault, 45 1990 President and Chief Executive Officer of the Company and CTC Lawrence W. DeShaw, 50 1990 Executive Vice President of the Company and CTC John W. Kelly, 47 1990 Executive Vice President of the Company and CTC Kirk W. Walters, 41 1996 Executive Vice President, Chief Financial Officer, and Treasurer of the Company and CTC F. Sheldon Prentice, 46 1985 Senior Vice President, General Counsel, and Secretary of the Company and CTC John P. Barnes, 41 1990 Senior Vice President of the Company and CTC Danny H. O'Brien, 46 1990 Senior Vice President of the Company and CTC Howard L. Atkinson, 52 1996 Chief Auditor, CTC - ------------------------------------------------------------------------------- All of the current officers, except Mr. Walters and Mr. Atkinson, have been principally employed in executive positions with CTC for more than five years. In accordance with the provisions of the Company's By-Laws, the officers, with the exception of the Secretary, hold office at the pleasure of the Board of Directors. The Secretary is elected annually by the Board of Directors. ITEM 11 EXECUTIVE COMPENSATION Information regarding remuneration of the directors and officers of the Company is included in the Company's definitive Proxy Statement for the 1997 Annual Meeting of Stockholders at pages 11-19 and is specifically incorporated herein by reference. ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information regarding the security ownership of directors and director-nominees of the Company, all directors and officers of the Company as a group, and certain beneficial owners of the Company's common stock, as of January 31, 1997, is included in the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders, at pages 4-10, and is specifically incorporated herein by reference. There are no arrangements known to the registrant which may, at a subsequent date, result in a change of control of the registrant. ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information regarding certain relationships and transactions between the Company and its Directors, Director-Nominees, Executive Officers, and family members of these individuals, is included in the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders at page 20, and is specifically incorporated herein by reference. PART IV ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) FINANCIAL STATEMENTS The financial statements of the Company and its subsidiaries appear in the Company's 1996 Annual Report to Stockholders at the pages indicated in Item 8, and are attached hereto as Exhibit 13. (2) FINANCIAL STATEMENT SCHEDULES There are no financial statement schedules required to be included in this report. (3) EXHIBITS The following are included as exhibits to this report: 3. By-Laws of the Company, as amended, incorporated herein by reference to Exhibit 3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1985. 3.01 Amendment to the By-Laws of the Company, dated February 16, 1988, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1987. 3.02 Amendment to the By-Laws of the Company, dated January 17, 1990, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989. 3.03 Amendment to the By-Laws of the Company, dated June 19, 1991, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991. 3.04 Amendment to the By-Laws of the Company, dated November 15, 1995, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. 3.1 Articles of Association of the Company, as amended, incorporated herein by reference to the Proxy Statement for the 1994 Annual Meeting of Stockholders. 4. Statement of the Company regarding its Dividend Reinvestment Plan is incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993. 10.1 Directors' Deferred Compensation Plan, dated April 1972, as amended May 20, 1992, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992. 10.2 Pension Plan of CTC, incorporated herein by reference to the Company's Annual Report on form 10-K for the year ended December 31, 1994, as amended on March 15, 1995 and December 20, 1995, and incorporated herein by reference to the Company's Annual Report on form 10-K for the year ended December 31, 1995, and December 20, 1996 attached to the Company's Annual Report on Form 10-K for the year ended December 31, 1996. 10.3 Incentive Savings and Profit Sharing Plan, attached to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, as amended for the year ended December 31, 1995. 10.4 Letter from the Company to Paul A. Perrault, dated July 26, 1990, regarding terms of employment, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990. 10.5 The Company's 1988 Stock Option Plan, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1987. 10.6 The Company's Restricted Stock Plan, incorporated herein by reference to the Company's Proxy Statement in connection with the 1986 Annual Meeting of Stockholders. 10.7 Registration Statement under The Securities Act of 1933 on form S-8 dated February 27, 1996, incorporated herein by reference. 10.8 Executive Management Incentive Compensation Plan ("EMICP"), incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1994. 10.9 Amendment to EMICP to increase cap on awards from 60% to 100% of base salary. 10.10 The Company's Stock Incentive Plan, dated January 1, 1993, incorporated herein by reference to the Company's Proxy Statement for the 1993 Annual Meeting of Stockholders. 10.11 Compensation plan of Paul A. Perrault. 10.12 Supplemental Executive Retirement Plan of Paul A. Perrault. 13. The Company's 1996 Annual Report to Stockholders. 21. List of subsidiaries of the Registrant. 23. Consent of Arthur Andersen LLP 27. Financial Data Schedule (b) REPORTS ON FORM 8-K A report was filed by the Company on Form 8-K December 20, 1996 in connection with the Company's hiring of Kirk W. Walters as Executive Vice President, Chief Financial Officer and Treasurer. EXHIBITS (c) EXHIBIT 10.2 BOARD OF DIRECTORS RESOLUTION RENAMING THE PENSION PLAN FOR EMPLOYEES OF THE CHITTENDEN CORPORATION TO THE "CHITTENDEN PENSION ACCOUNT PLAN" AND AMENDING THE PLAN TO A CASH BALANCE ACCOUNT TYPE PLAN. EXHIBIT 10.9 AMENDMENT TO EMICP TO INCREASE CAP ON AWARDS FROM 60% TO 100% OF BASE SALARY. EXHIBIT 10.11 COMPENSATION PLAN OF PAUL A. PERRAULT EXHIBIT 10.12 SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN OF PAUL A. PERRAULT EXHIBIT 13 CHITTENDEN'S 1996 ANNUAL REPORT HAS BEEN FILED AS AN EXHIBIT EXHIBIT 21 LIST OF SUBSIDIARIES OF CHITTENDEN CORPORATION Chittenden Trust Company, Vermont, d/b/a Chittenden Bank, Mortgage Service Center of New England and CUMEX Mortgage Service Center The Bank of Western Massachusetts, Massachusetts Flagship Bank and Trust Company, Massachusetts Chittenden Connecticut Corporation, Vermont, d/b/a Mortgage Service Center of New England and CUMEX Mortgage Service Center EXHIBIT 23 CONSENT OF ARTHUR ANDERSEN LLP HAS BEEN FILED AS AN EXHIBIT EXHIBIT 27 FINAICIAL DATA SCHEDULE HAS BEEN FILED AS AN EXHIBIT EXHIBIT 10.2 CHITTENDEN CORPORATION BOARD OF DIRECTORS RESOLUTION AUTHORIZING THE ADOPTION OF THE CHITTENDEN PENSION ACCOUNT PLAN EFFECTIVE JANUARY 1, 1996 WHEREAS, Chittenden Corporation (the "Principal Employer") heretofore adopted the Pension Plan for Employees of the Chittenden Corporation (the "Plan"); and WHEREAS, the Principal Employer desires to amend and restate the plan to reflect changing employee retirement objectives; and WHEREAS, the Principal Employer is permitted to amend the Plan at any time by means of a resolution of the Board of Directors; NOW, THEREFORE, the Board of Directors, at a meeting held on September 20, 1995 and at which a quorum was present and acting throughout, hereby authorizes the Principal Employer to rename the Plan and to amend and restate the Plan as follows: Effective January 1, 1996, the Plan shall be renamed the "Chittenden Pension Account Plan". The Plan shall be amended to a cash balance account type plan. All benefits that accrued under the Plan as in effect immediately prior to January 1, 1996, shall be converted to an actuarial equivalent opening account balance under the Plan and shall further serve as the minimum retirement benefit for an individual covered under the Plan as of January 1, 1996. The Plan shall be further amended to recognize the incorporation of a previously eligible employee group. Effective as of October 7, 1996, the Chittenden Connecticut Corporation shall become an "Employer" as defined under the terms of the Plan. Employees of such corporation shall continue to be eligible to participate in and accrue benefits under the terms of the Plan without interruption. The Principal Employer is further authorized to take whatever action is necessary and appropriate to effect the amendment and restatement of the Plan. A summary of the principal provision of the amended Plan are documented in the attached summary. IN WITNESS WHEREOF, the Board of Directors has caused this instrument to be executed by its officer duly authorized and its corporate seal to be hereunto affixed as of the 20th day of December, 1996. CHITTENDEN CORPORATION By: /s/F. Sheldon Prentice F. Sheldon Prentice SVP, General Counsel & Secretary ATTEST: /s/Eugenie J. Fortin (CORPORATE SEAL) EXHIBIT 10.9 FIRST AMENDMENT This Amendment effective March 20, 1996 shall amend the Chittenden Corporation Executive Management Incentive Compensation Plan (the "Plan") as follows: 1. Paragraph "a" of Section II of the Plan is hereby deleted in its entirety and is replaced by the following paragraph: a. Adjusted Earnings means the earnings per share or return on equity, as the case may be, calculated based on the actual after tax profit of the Company as published, recognizing amounts awarded under this Plan, but excluding (i) gains or losses from sales of assets not in the normal course of business and exceeding $50,000 per year in the aggregate, and (ii) gains or losses as a result of securities transactions. 2. The reference to 60% in Paragraph "h" of Section II of the Plan shall be changed to 100% and said Paragraph "h" of Section II shall now read as follows: h. Incentive Award means bonuses ranging from 0% to 100% in such percentages as shall be designated annually by the President of the Company, with approval of the Board. 3. Paragraph "l" of Section II of the Plan is hereby deleted in its entirety and is replaced by the following paragraph: l. Profit Goal means the performance target of the Company established each year by the Board for the then current Plan Year as measured by the level of earnings per share and return on equity of the Company. Each year the Board shall establish for the then current Plan Year the targeted level of earnings per share and the targeted level of return on equity. To the extent that either of these targets is met, the performance target will be achieved. The calculation of earnings per share and return on equity shall be based on after-tax profit of the Company, computed according to generally accepted accounting principles, consistently applied, recognizing amounts awarded under this Plan but excluding (i) gains or losses from sales of assets not in the normal course of business and exceeding $50,000 per year in the aggregate, and (ii) gains or losses as a result of securities transactions. 4. All terms of the Plan not expressly amended herein shall remain in full force and effect. This Amendment shall be effective as of March 20, 1996. ATTEST: CHITTENDEN CORPORATION By: S/F. SHELDON PRENTICE S/SARAH P. MERRITT Witness Title: SVP, GENERAL COUNSEL AND SECRETARY EXHIBIT 10.11 PAUL A. PERRAULT COMPENSATION PLAN June 19, 1996 1. Base Salary: Increase in 1996 to $250,000 and in 1997 to $300,000, effective one and two years, respectively, from date of last increase. 2. EMCIP: The following changes have already been implemented: - Increase cap to 100% of salary - Payments all in cash - Flexibility in payment of deferred portion of award 3. Cash Bonus Plan: If (i) the Corporation's net income (calculated after making an accrual for the amount payable pursuant to this plan) exceeds a specified ROE and (ii) the year-to-year increase in EPS is at least 10 percent, a cash bonus (subject to a cap of 100% of base salary) will be paid based upon a percentage of earnings in excess of such earnings as equate to the specific ROE, as follows: Bonus % on earnings is If ROE is: excess of 15% ROE: ------------ ------------------- 15 - 17% 2% 17% + 5% For example, assume average equity of $170 million (est.) and 12.5 million (est.) shares outstanding: Earnings in Earnings EPS ROE excess of 15% % Amount ----------------------------------------------------------------------- $25 million $2.00 14.70% $ ------- 2% $ ------ $26 million $2.08 15.29% $ 500,000 2% $ 10,000 $27 million $2.16 15.88% $1,500,000 2% $ 30,000 $28 million $2.24 16.47% $2,500,000 2% $ 50,000 $30 million $2.40 17.64% $4,500,000 5% $225,000 This plan is subject to annual review. 4. Stock Options: Options will be granted to purchase 150,000 shares, 50,000 vesting annually June 19, 1997, June 19, 1998 and June 19, 1999. The option price will be as follows: Date of Vesting Price --------------- ------------------- June 1, 1997 June 19, 1996 price June 1, 1998 20% in excess of June 19, 1996 price June 1, 1999 30% in excess of June 19, 1996 price Options must be exercised within five years of date of vesting, or, if employment is terminated, within 60 days of termination. In the event of a "change in control," all options will vest immediately. Example based upon a current price of $22 per share, 10% per year increase in market price of stock and exercise of options five years after vesting: Option Price at Gain per Total Price exercise share gain ------------------------------------------------------- $22.00 $38.97 $16.97 $ 848,500 $26.40 $42.52 $16.12 $ 806,000 $28.60 $46.06 $17.46 $ 873,000 --------------- $2,527,500 Market capitalization, June 19, 1996 to June 19, 2004: 12.5 million shares @ $22/share $275,000,000 12.5 million shares @ $47/share $587,500,000 Increase $312,500,000 Paul's gain $ 2,527,500 Gain as percentage of increase .81% 5. LTD: In the event of permanent disability resulting in termination of employment, a monthly benefit will be paid through age 60 based upon 60 percent of base salary at the time of disability. By: /s/ James C. Pizzagalli ------------------------ James C. Pizzagalli EXHIBIT 10.12 SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN OF PAUL A. PERRAULT SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN I. Purpose Chittenden finds it desirable to create a non-qualified supplemental retirement plan for it Chief Executive Officer to: (1) offset the effect of certain regulatory restrictions on contributions to a qualified pension plan, and (2) recognize that the Chief Executive Officer may have an insufficient working career at Chittenden to realize a pension benefit that is an acceptable portion of the Chief Executive's working salary and benefits. To compensate for these factors and to reward a Chief Executive's performance, Chittenden will create a Supplemental Pension for the Chief Executive under the terms and conditions contained herein. II. Definitions (a) Accrued Benefit shall mean all sums allocated in prior years including interest credited thereon pursuant to Section IV. (b) Board shall mean the Board of Directors of the Chittenden Corporation. (c) Chief Executive Officer shall mean Paul Perrault. (d) Chittenden shall mean Chittenden Corporation. (e) Code shall mean the Internal Revenue Code of 1986, as amended from time to time. (f) Disability shall mean a total or permanent condition which qualifies the Chief executive Officer to receive full Social Security Benefits. (g) ERISA shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time. (h) Gross Salary shall mean the total of all salary, benefits, and bonuses paid to the CEO by the Corporation or its subsidiaries and reported in box 1 ("wages, tips, other compensation") of form W-2 together with that portion of compensation not reported in box 1 of the form W-2 (i.e. Flexible Medical/Dental premiums, Health Care/Dependent Care Flexible spending accounts and 401k contributions). (i) Plan shall mean this Supplement Executive Retirement Plan. (j) ROE shall mean return on average common shareholders' equity calculated on an annual basis as of 12/31. III. Plan Construction This is a defined contribution, non-qualified retirement plan. This means that Chittenden will allocate a specific amount to a notional account calculated in accordance with Paragraph IV below but the Plan will not pay a specific benefit. Further, this Plan is intended to be a Top Hat Plan under ERISA and benefits under the plan are not protected by the Pension Benefit Guaranty Corporation. Any assets funding the Plan are subject to the claims of the general creditors of Chittenden. IV. Allocations Allocations to the Plan shall be made on an annual basis each January. The amount of the allocation shall be a certain percentage of gross salary based on the ROE of Chittenden as of December 31st of each year determined in accordance with the following schedule: ROE % % Of Gross Salary -------- ------------------- 10 6.68 11 10.68 12 14.69 13 18.69 14 22.70 15 26.70 16 29.37 17 32.04 18 34.71 19 37.38 20 40.05 Should attained ROE in any given year be a partial percentage, it shall be rounded to the nearest .5% and the annual contribution shall be interpolated accordingly. An allocation shall be made each year that the minimum ROE is met and the Chief Executive remains employed with Chittenden in a full time capacity. The Board, at its sole discretion, may amend the above schedule at any time. V. Interest Calculation Accrued balances shall earn interest based upon Chittenden's average yield on earning assets. Such earnings shall be computed on an annual basis based upon the preceding year's average yield on earning assets and calculated on the December 31st balance plus any award for the current year. For example, interest earned for 1995 would be calculated by multiplying the December 31st, 1994 balance, plus any award granted based upon 1994 performance, times the 1994 average yield on earning assets. VI. Distributions Distributions from the Plan shall begin when the Chief Executive retires directly from active employment at or after reaching the age of 55. Distributions of the accrued benefit shall be made on a schedule of monthly, annual or lump sum payments. Such selection must be made at least 12 months prior to the actual separation. All accrued contributions shall be forfeited if the Chief Executive ceases employment prior to age 55. Not withstanding the foregoing, accrued contributions shall be distributed to the Chief Executive or his designated beneficiary in the event of his death or disability or at the discretion of the Board. Distributions to a designated beneficiary or beneficiaries upon the Chief Executive's death shall be as a lump sum. VII. Successor Obligations Not withstanding the provisions of section VIII, in the event of a merger or acquisition in which Chittenden shall cease to exist as a distinct entity or a change of control as defined in a certain agreement between Chittenden Bank and Paul Perrault dated July 26, 1990, the surviving organization shall have no obligation or requirement to make continuing contributions under the terms of this Plan; provided however, such surviving Corporation shall remain liable to the Chief Executive for all sums accrued prior to the merger or acquisition regardless of his age at the time of this event. Interest as defined in Section V shall continue to accrue on the undistributed balance. Such sums shall be payable at the time of termination or retirement, whether prior or subsequent to the attainment of age 55. VIII. Plan Amendment and Termination Chittenden or its successors and assigns may amend or terminate this plan at any time at its discretion. All sums accrued for the benefit of the Chief Executive to the date of plan termination shall remain due and payable in accordance with this Plan. In the event that the Plan is amended or terminated all sums accrued as of such date shall not be reduced and shall remain due and payable under the terms of the Plan. Interest as defined in Section V shall continue to accrue on the undistributed balance. IX. Effective Date This plan shall be effective on January 1, 1993. IN WITNESS WHEREOF, this Supplemental Executive Retirement Plan has been adopted and approved by the Board of Directors of the Chittenden Corporation and is executed on behalf of the Corporation this 15th day of June, 1994 by Barbara Snelling, Chair and Sarah Merritt, Senior Vice President and Human Resources Director. CHITTENDEN CORPORATION By: /s/ Barbara W. Snelling Barbara W. Snelling Chair By: /s/ Sarah P. Merritt Sarah P. Merritt Senior Vice President And Duly Authorized Agent IN THE PRESENCE OF: /s/ F. Sheldon Prentice F. Sheldon Prentice Corporate Secretary SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) 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. Date: March 19, 1997 CHITTENDEN CORPORATION BY: /S/ PAUL A. PERRAULT Paul A. Perrault President, Chief Executive Officer and Director SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. NAME TITLE DATE - ------------------------------------------------------------------------------- /s/ Barbara W. Snelling Chair of the Board of Directors 03-22-97 /s/ Paul A. Perrault President, Chief Executive Officer and Director 03-19-97 /s/ Kirk W. Walters Executive Vice President, Chief Financial Officer and Treasurer (principal accounting officer) 03-19-97 /s/ Frederic H. Bertrand Director 03-19-97 /s/ David M. Boardman Director 03-19-97 /s/ Paul J. Carrara Director 03-19-97 /s/ Lyn Hutton Director 03-19-97 /s/ Philip A. Kolvoord Director 03-19-97 /s/ James C. Pizzagalli Director 03-19-97 /s/ Pall D. Spera Director 03-19-97 Martel D. Wilson, Jr. Director </TEXT> </DOCUMENT> <DOCUMENT> <TYPE>EX-13 <SEQUENCE>2 <DESCRIPTION>96 ANNUAL REPORT <TEXT> <PAGE 1> Successful growth needs to start from a solid foundation. At Chittenden Corporation, our strength and foundation comes from the business we know best - traditional, local banking. From that core strength, we have made strategic changes which have transformed Chittenden from a local Vermont institution into a regional financial services company. Our growth has been through targeted acquisition of other banks and continued expansion of our specialized businesses. These three areas - traditional banking, targeted acquisitions and specialized businesses - give us a broad foundation aimed at sustained growth and balance. With this strategy in place, Chittenden is poised to handle the changes and challenges ahead, while remaining a secure and dynamic financial institution well into the future. <PAGE 2> TABLE OF CONTENTS 3 Financial Highlights 4 Letter to Stockholders 6 Chittenden - Plotting Progress 8 Chittenden - A Strategic Approach to Banking 13 Consolidated Financial Statements 39 Report of Independent Public Accountants 41 Management's Discussion and Analysis of Financial Condition and Results of Operation 54 Directors and Officers 57 Stockholder Information <PAGE 3> FINANCIAL HIGHLIGHTS 1996 1995 --------------------------- (dollars in thousands except per share amounts) FOR THE YEAR Net Interest income $ 83,993 $ 78,331 Provision for possible loan losses 4,183 5,000 Noninterest income 24,920 22,040 Noninterest expense 64,557 61,584 Net income 26,721 22,131 Cash dividends declared 8,747 4,803 ---------------------------- AT YEAR END Investment securities $ 397,092 $ 321,486 Net loans 1,268,472 1,179,788 Deposits 1,761,579 1,587,723 Stockholders' equity 174,401 153,949 Total assets 1,988,746 1,794,704 Number of stockholder 3,167 3,073 Number of employees 944 920 ------------------------------- PER SHARE OF COMMON STOCK Fully diluted earnings $ 2.14 $ 1.83 Cash dividends declared 0.71 0.40 Book value at end of year 14.21 12.85 Weighted average shares outstanding 12,486,200 12,084,731 during year -------------------------------- <PAGE 4> LETTER TO STOCKHOLDERS Since our last annual report, several things at Chittenden Corporation have changed; however, some things haven't changed at all. One constant is our commitment to execution - carrying out well-planned strategies that are beneficial to our shareholders and customers in a workmanlike fashion, insuring their effectiveness and sustainability. We are pleased to report that these strategies are providing continued earnings momentum. At $2.14 per share, earnings are up 17% from 1995, once again a new record for the Corporation. I am particularly pleased that these results were achieved while maintaining our core value of "balance" in all of our activities. On the revenue side, net interest income increased 7%, and non-interest income increased 13%, both numbers exhibiting gains across a broad array of activities. Recognizing that even high-quality providers need to be low-cost producers, expense growth has been contained to 5% during 1996 and, despite the obvious strength of our loan loss reserves we provided for losses at a rate of $4.1 million, continuing to provide sufficient resources to maintain and even grow our outstanding balance sheet strength. One of the greatest challenges we continue to face, along with all financial services providers, is offering the right mix of products and services at the right time in ways that are beneficial for, and expected by, the marketplace. Across the company, efforts are continuous on all these fronts, with customers first in mind. Encouraging customers to utilize readily available technology, expanding the availability of many services outside the branch environment, and locating and staffing community offices to be complementary with our overall effort reflects the reasons why customers of Chittenden's banks are loyal. They expect more from Chittenden, and they get it. The choices of Who, What, When, and Where, remain with the customer. Much has been written in recent years about financial services, particularly the impact that mergers and unregulated providers will have on traditional, local banking. Some pundits take the view that, like Canada and parts of Europe and Asia, the United States will soon consolidate to a handful of national banks. We agree with the notion that we will have a few national banking companies, but we do not believe that they will dominate the financial services industry nor make obsolete the successful participation of other players. <PAGE 5> Historically, Americans have not tended to behave in a way that would suggest following patterns of other countries. Our nation's entrepreneurial spirit, natural apprehension about size, and the advance of technology will ensure that our citizens will continue to have a diverse array of options. To remain viable, however, we at Chittenden believe it is crucial to be price competitive, product competitive and personnel competitive. This means being cost efficient, able to manage and integrate a number of diverse businesses, and be the "employer of choice" up and down the line. Each of our major constituencies has many choices. Investors, customers, employees and communities are constantly presented with choices. It is our job to present the right combination of our attributes to each member of these constituencies, to deepen our relationships, and to continue our established "pattern of progress." I can assure you that we are taking steps every day to keep Chittenden and the consumer out in front by not becoming complacent, and by focusing on our role in the future. As I have said before, I am very proud of our results in 1996. But more that anything else, I believe they show that our course is a good one. Our "steady hand at the helm" philosophy doesn't mean we are inflexible, nor do we wait to see what happens. It does mean we focus on execution today, and focus on what's ahead. We look to be successful now, and in the future. By properly taking care of business today we will be positioned to take care of business tomorrow. That is the Chittenden of today, and of the future. Our shareholders and customers deserve nothing less. In closing, I want to publicly express my admiration and appreciation to the Chittenden people, your employees and Board of Directors, who continue to be the inspiration for our results. Thank you. <PAGE 6> CHITTENDEN - PLOTTING PROGRESS The following graphs are provided to give you a brief, visual review of Chittenden's progress over the past six years. The graphs indicate that Chittenden has achieved consistent and steady improvement in a number of measurements. This performance is a reflection of Chittenden's commitment to a balanced, efficient, and sound approach to banking. Return on Average Equity (as a percent) - --------------------------------------- 91 92 93 94 95 96 5.5 8.9 12.2 15.6 15.9 16.4 Return on Average Assets (as a percent) - ---------------------------------------- 91 92 93 94 95 96 0.37 0.62 0.94 1.2 1.3 1.4 Earnings per Share (in dollars) - --------------------------------------- 91 92 93 94 95 96 0.4 0.7 1.1 1.6 1.8 2.1 Book Value per Share (in dollars) - --------------------------------------- 91 92 93 94 95 96 8.0 8.8 10.0 10.4 12.8 14.2 Closing Price per Share (in dollars) - --------------------------------------- 91 92 93 94 95 96 4.5 8.2 11.8 13.3 25.6 23.9 Efficiency Ratio (as a percent) - --------------------------------------- 91 92 93 94 95 96 71 65 64 60 61 58 <PAGE 8> CHITTENDEN - A STRATEGIC APPROACH TO BANKING TRADITIONAL BANKING At Chittenden Corporation, our success as a whole is largely a reflection of the success of our core business - traditional, local banking. For over 90 years, we have constantly evolved to meet our customers' changing needs while remaining focused on growth and efficiency. Rather than pursuing growth by just adding more branches, the nature of Vermont banking demands a creative approach. With a limited number of customers to be found in-state, we have focused on expanding the products and services we can offer our existing customers. At a basic banking level, these efforts translate into innovative products that create new ways and more reasons to bank with Chittenden. This year, we debuted our Internet website, which can be found at www.chittenden.com. This handy tool gives customers instant access to useful financial information and investment advice. With other new service enhancements, customers can access specific information about their accounts. Our newly expanded Automated Banking Line lets customers use their phone to do much of their banking, such as account transfers and loan payments. Chittenden's Loan-by-Phone program offers our customers the convenience of applying for a consumer loan from their home or office. With Chittenden Electronic Banking, businesses can keep an eye on finances and bank from the convenience of their office PC. On a consumer product level, one of our latest introductions is the Chittenden ATM & Check Card which works like a check, but offers the convenience of a credit card. When a customer makes a purchase using the card wherever Visa is accepted, the money is simply deducted from their account electronically. New products often come about from customer input. With the help of small business owners, we put together our new "Chittenden Small Business Advantage" package, combining valuable services with discounts and incentives. Our new branch on Shelburne Road was designed with the customer in mind. An excellent location, easy access, a separate commercial area, an information kiosk and specialized service representatives will make this branch service-oriented for commercial and retail customers alike. Chittenden Bank also continues to grow beyond the traditional realm of deposits and withdrawals. In a variety of areas, we provide products and services designed to meet the unique, individual needs of our clients. We provide these services through many different venues, including traditional branches and high- tech connections. Because of this, Chittenden is becoming more and more a one- stop shop for banking and financial services. Small businesses have long been a major part of the Vermont economy. From "mom and pop" operations to nationally known companies, their needs are very diverse. One of the biggest differences between Chittenden and other banks is our willingness to work with the smallest of these businesses, often ones that are just getting started. Beyond providing loans, our Business Bankers provide the <PAGE 9> advice and information needed to start a business. If we can't initially provide financing, we work with the company and refer them to technical service programs or financial access programs. Much of our success in Business Banking comes from our knowledge of local markets. Many offices have their own Business Banking specialists in-house who have the authority to make decisions on loans. Through their knowledge of the local market, these people are in a better position to evaluate the loan. While Business Banking does not typically produce loans with enormous individual dollar amounts, the volume of loans adds up to a significant piece of business for the bank and establishes a strong relationship with each business. With this focus on providing complete, custom services, Business Banking will continue to benefit Chittenden and Vermont businesses. Our skill in small business lending is also reflected in the volume of SBA lending through the Low Doc program. In 1996, our Branch Managers and Business Bankers helped earn Chittenden special recognition for the highest volume of Low Doc loans in Vermont. Our Commercial Finance Group gives businesses a helping hand by providing asset- based lending. By lending against a company's inventory and receivables, we provide new or expanding businesses the financing they need to keep growing. We work closely with these customers, staying in contact with them on an almost daily basis. This close contact, combined with aggressive sales efforts, has paid off. Unique among Vermont banks and only three years old, our Commercial Finance division has performed beyond expectations and will continue to succeed in the future. Another area of Chittenden which continues to grow is Correspondent Banking. Working closely with smaller community banks around New England, we help furnish their customers with mortgage services, automotive financing, and merchant credit card services, all of which they would otherwise be unable to provide. We also help these banks with commercial loans they are unable to approve because of lending limitations. These programs consistently prove to be "win/win" relationships. Chittenden gets the benefit of additional business and the community bank can satisfy their customers' needs without losing out to a larger competitor. Chittenden has always offered investment products and investment management. Over this past year, however, Chittenden Investment Services has begun to expand and take on its own identity through distinctive marketing that gives more significance to the brand. Investment Services has also grown by working closely with other areas of the bank. One example of such cooperation is seen with Private Banking. In this partnership, Private Banking can offer its professional clients investments as well as loans and other bank services. Similarly, our Investment Services area gets to strengthen their client base. These links between departments will continue to expand, providing more business for the bank and giving our customers more services under one roof. <PAGE 10> Through a strong client base and close customer contact, Chittenden's Government Banking group continues to be an extremely valuable part of the bank's core business. This area provides almost 10% of the bank's deposits. By providing state and local organizations with financial services, Government Banking gives the bank a steady and relatively secure level of business. With the addition of new technology, such as providing taxpayers the option of having their property taxes automatically withdrawn from their account, Government Banking will continue its steady position well into the future. SPECIALIZED BUSINESSES At Chittenden, Specialized Businesses continue to play an increasing role in our growth. Specialized Businesses are services that were already in place at Chittenden and have been expanded to a much wider market. By working closely with outside banks and businesses, we can aggressively seek out new customers for these existing services. While we have long provided merchant services (the electronic processing of credit card transactions) in Vermont, the field has changed dramatically. Working with outside organizations, such as consultants, service providers and other banks, 80% of our Merchant Services business is now located out of state. In just the last two years, Merchant Services' volume has more than tripled, going from $265 million in 1994 to $801 million in 1996. Chittenden's Automotive Finance operation has also seen tremendous growth. Not long ago, most people went directly to a bank to obtain auto financing. Now, direct lending accounts for only a fraction of all auto loans. More and more, people secure their financing right at the dealership. As a consequence, Chittenden works with dealers across New England to provide loans. And with the introduction of our TAMMAC Leasing operation, we now offer a full range of auto financing products. In just two years, total loan and lease originations have increased 80%, going from just under $50 million to almost $90 million, and year-end outstandings have more than doubled. This growth also provides more security for the bank. Rather than having a number of loans concentrated in one geographic area, Chittenden can diversify and spread loans over a wider client and geographic base. Because of favorable tax laws in Vermont, many captive insurance companies are based here. Captive insurers offer companies an alternative to traditional insurance methods by providing the ability to insure themselves. We have carved out a niche business for ourselves by catering to the specific needs of these companies. Through a high level of service and an aggressive sales effort, our customer base has grown from 30 companies in 1990 to almost 100 today in a market of only 300. Captive insurers now have more reasons to do business with Chittenden. Many of them are on-line so they can better monitor their financial operations, and we have given them more options by providing <PAGE 11> other services such as trust and investments. With these advancements and our commitment to customer service, our business with the captive insurance industry will continue to expand and contribute to Chittenden's success. Chittenden has provided Payroll Services since 1969, but through sales efforts and improvements in technology, the business has grown rapidly, tripling the customer base in just four years. With a new software system, we can now provide customers with more options and quicker processing. Through aggressive marketing and new technology, Payroll Services will continue to be another growth- oriented, Specialized Business for the bank. Mortgage Service Center of New England, our wholesale mortgage business, has grown significantly to give Chittenden the ability to offer residential mortgage services to other financial institutions across New England. This ability was further augmented by the 1995 acquisition of CUMEX, which specializes in offering residential mortgage services to credit unions in the northeast region. Mortgage Service Center can offer all or any portion of the mortgage operation to its clients. For example, this year we entered into an agreement with a local community bank in Connecticut to provide the entire mortgage operation to the bank, complete with loan officers in local branches and servicing of originated mortgages. Chittenden's Specialized Businesses owe their growth to a basic change in philosophy. Gone are the days when we could wait for customers to come to us. We now have the ability to form unique alliances with a variety of organizations across the country who can bring us new customers. With our experience, technology, and consistent approach to business, along with a proven ability to venture into new areas, Specialized Businesses will contribute to Chittenden's success for years to come. TARGETED ACQUISITIONS Chittenden Corporation has also expanded beyond Vermont through targeted acquisitions of other institutions. This strategy is not one based on geographic proximity, but rather on selecting acquisitions of quality that can grow and succeed with Chittenden's input, expertise and product offerings. Both of our recent acquisitions fit this profile. Flagship Bank and Trust Company, based in Worcester, Massachusetts, is a relatively new bank that has a strong management team in place and is located in a market where there is plenty of room to grow. The Worcester market is dominated by two large banks, but Flagship Bank and Trust Company, with the ability to offer new products and services that Chittenden provides, will be a viable and attractive, local alternative to the larger competitors. <PAGE 12> The Bank of Western Massachusetts is in a similar position. Based in Springfield, Massachusetts, The Bank of Western Massachusetts is poised to capture more market share from its larger competitors with an increased product line. This year, we successfully introduced our Automotive Finance operation in the Springfield area through The Bank of Western Massachusetts. To start this operation from scratch would have been an expensive proposition, taking years to become profitable. With the platform already in place at Chittenden, the start- up was quicker, had less overhead, and became profitable in a shorter period of time. Both of these banks were managed successfully before we came along and that success continues to grow today. With Chittenden's ability to bring in new products, this success will be magnified and expanded much faster than would have been possible before the mergers. Chittenden will continue to be active in the acquisitions market. We have looked at many different merger possibilities, but often walk away without taking action because the match wasn't right. Future transactions will likely fall into two areas: we will continue to look for banks in new markets that fit well with Chittenden's business culture and philosophy, and we will look for opportunities in markets where we already have a presence. Only when the situation makes sense and when there is a real opportunity for cooperative growth and profitable expansion, will future acquisitions be made. Chittenden's dynamic, sustained success over the past six years is attributable in part to our concentration on delivering the best in traditional, local banking. In addition, strategic moves to augment growth and earnings have resulted in developing two additional elements: targeted acquisitions and expanded specialized businesses. With these three key components in place, the result has been a balanced performance based on contributions from all of Chittenden's business areas. This strategy will continue to keep Chittenden ahead of the competition well into the 21st century. <PAGE 13> CHITTENDEN CORPORATION CONSOLIDATED BALANCE SHEETS December 31, 1996 1995 (in thousands) ASSETS Restated Cash and cash equivalents $ 230,259 $ 197,140 Securities available for sale 358,536 278,322 Securities held for investment (market value $38,381,000 in 1996 and $42,634,000 in 1995) 38,556 43,164 Federal Home Loan Bank stock 5,591 5,591 Mortgage loans held for sale 9,870 14,692 Loans 1,296,568 1,207,606 Allowance for possible loan losses (28,096) (27,818) ------------------------- Net loans 1,268,472 1,179,788 Accrued interest receivable 14,179 12,880 Other real estate owned 2,251 2,652 Net deferred tax asset 10,647 10,159 Other assets 15,797 13,855 Premises and equipment, net 24,297 24,947 Intangible assets 10,291 11,514 -------------------------- Total assets $1,988,746 $1,794,704 ========================== LIABILITIES AND STOCKHOLDERS EQUITY LIABILITIES: Deposits: Demand $ 286,932 $ 252,421 Certificates of deposit $100,000 and over 104,295 105,604 Savings and other time 1,370,352 1,229,698 -------------------------- Total deposits 1,761,579 1,587,723 Short-term borrowings 23,992 25,025 Accrued expenses and other liabilities 26,234 25,523 Long-term debt 2,540 2,484 -------------------------- Total liabilities 1,814,345 1,640,755 ========================== Commitments and contingencies STOCKHOLDERS EQUITY: Preferred stock - $100 par value authorized - 200,000 shares issued and outstanding - none Common stock - $1 par value authorized - 30,000,000 shares issued - 12,678,625 in 1996 and 12,345,304 in 1995 12,679 12,345 Surplus 74,706 70,806 Retained earnings 92,040 74,066 Treasury stock, at cost - 402,413 shares in 1996 and 367,417 shares in 1995 (4,770) (3,967) Net unrealized gain (loss) on securities available for sale, net of taxes of ($102,000) in 1996 and $533,000 in 1995 (208) 768 Unearned portion of employee restricted stock (46) (69) ------------------------ Total stockholders equity 174,401 153,949 ------------------------ Total liabilities and stockholders equity $1,988,746 $1,794,704 =========================== The accompanying notes are an integral part of these consolidated financial statements. <PAGE 14> CHITTENDEN CORPORATION CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1996 1995 1994 (in thousands, except per share amounts) INTEREST INCOME: Restated Interest on loans $116,563 $111,087 $ 82,396 Investment securities: Mortgage-backed securities 6,062 5,666 1,058 Taxable 14,528 12,972 14,728 Tax-favored debt 2,950 2,687 1,678 Tax-favored equity 962 700 529 Short-term investments 1,527 1,991 994 ------------------------------------------- Total interest income 142,592 135,103 101,383 ------------------------------------------- INTEREST EXPENSE: Deposits: Savings 27,268 26,211 18,351 Time 29,247 27,560 15,492 ------------------------------------------- Total interest on deposits 56,515 53,771 33,843 Short-term borrowings 1,887 2,858 2,118 Long-term debt 197 143 127 ------------------------------------------- Total interest expense 58,599 56,772 36,088 ------------------------------------------- Net interest income 83,993 78,331 65,295 Provision for possible loan losses 4,183 5,000 5,500 ------------------------------------------- Net interest income after provision for possible loan losses 79,810 73,331 59,795 ------------------------------------------- NONINTEREST INCOME: Trust income 4,876 4,456 4,038 Service charges on deposit accounts 6,260 5,860 5,266 Gains (losses) on sales of securities, net (98) 205 (362) Mortgage servicing income 2,454 2,427 2,288 Gains on sales of mortgage 2,720 1,282 1,208 loans, net Credit card income, net 4,212 3,634 2,739 Other 4,496 4,176 4,175 ------------------------------------------ Total noninterest income 24,920 22,040 19,352 ------------------------------------------ Noninterest expense: Salaries 25,517 23,372 19,884 Employee benefits 7,509 8,160 6,916 Net occupancy expense 9,475 8,449 7,093 FDIC deposit insurance 27 1,580 2,769 Other real estate owned, income and expense, net 153 (243) (215) Other 21,876 20,266 14,946 ------------------------------------------- Total noninterest expense 64,557 61,584 51,393 ------------------------------------------- Income before income taxes 40,173 33,787 27,754 ------------------------------------------- Provision for income taxes 13,452 11,656 9,717 ------------------------------------------- Net income $ 26,721 $ 22,131 $ 18,037 =========================================== Earnings per share $2.14 $1.83 $1.57 Dividends declared per share $0.71 $0.40 $0.27 Weighted average shares outstanding 12,468,200 12,084,731 11,472,933 The accompanying notes are an integral part of these consolidated financial statements. <PAGE 15> CHITTENDEN CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY Years ended December 31, 1996, 1995, and 1994 Common Retained Treasury Stock Surplus Earnings Stock ----------------------------------------------------- (in thousands) Balance at December 31, 1993, restated $11,714 $61,145 $41,837 $(2,982) Cumulative effect of adoption of SFAS 115 Net income 18,037 Cash dividends declared ($0.27 per share) (3,136) Shares issued/forfeited under various stock plans, net 39 331 Amortization of deferred compensation for restricted stock earned Repurchase of common stock (6,685) Issuance of treasury stock (15) - 81 Change in net unrealized loss on securities available for sale ------------------------------------------------- Balance at December 31, 1994, restated 11,753 61,461 56,738 (9,586) Net income 22,131 Cash dividends declared ($0.40 per share) (4,803) Shares issued in conjunction with acquisition of The Bank of Western Massachusetts 470 8,292 5,514 Shares issued/forfeited under various stock plans, net 122 1,071 Amortization of deferred compensation for restricted stock earned Issuance of treasury stock (18) 105 Change in net unrealized gain on securities available for sale -------------------------------------------------- Balance at December 31, 1995, restated 12,345 70,806 74,066 (3,967) Net income 26,721 Cash dividends declared ($0.71 per share) (8,747) Shares issued/forfeited under various stock plans, net 334 3,917 (853) Amortization of deferred compensation for restricted stock earned Issuance of treasury stock (17) 50 Change in net unrealized gain/loss on securities available for sale ------------------------------------------------ Balance at December 31, 1996 $12,679 $74,706 $92,040 $(4,770) ================================================ Valuation Net Allowance for Unrealized Net Unrealized Gain (Loss) Unearned Loss on Portion of Total Securities on Marketable Available Employee Stock- Equity for Sale, Restricted holders Securities Net of Taxes Stock Equity --------------------------------------------------------- (in thousands) Balance at December 31, 1993, restated $(21) $ $(31) $111,662 Cumulative effect of adoption of SFAS 115 21 1,357 1,378 Net income 18,037 Cash dividends declared ($0.27 per share) (3,136) Shares issued/forfeited under various stock plans, net (116) 254 Amortization of deferred 43 43 compensation for restricted stock earned Repurchase of common stock (6,685) Issuance of treasury stock 66 Change in net unrealized loss on securities available for sale (8,298) (8,298) ---------------------------------------------- Balance at December 31, 1994, restated (6,941) (104) 113,321 Net income 22,131 Cash dividends declared ($0.40 per share) (4,803) Shares issued in conjunction with acquisition of The Bank of Western Massachusetts - 14,276 Shares issued/forfeited under various stock plans, net 1,193 Amortization of deferred compensation for restricted stock earned 35 35 Issuance of treasury stock 87 Change in net unrealized gain on securities available for sale 7,709 7,709 ------------------------------------------------ Balance at December 31, 1995, restated 768 (69) 153,949 Net income 26,721 Cash dividends declared ($0.71 per share) (8,747) Shares issued/forfeited under various stock plans, net 3,398 Amortization of deferred compensation for restricted stock earned 23 23 Issuance of treasury stock 33 Change in net unrealized gain/loss on securities available for sale (976) (976) ----------------------------------------------- Balance at December 31, 1996 $- $(208) $(46) $174,401 =============================================== The accompanying notes are an integral part of these consolidated financial statements. <PAGE 16> CHITTENDEN CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1996 1995 1994 (in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Restated Net income $ 26,721 $ 22,131 $ 18,037 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses 4,183 5,000 5,500 Depreciation and amortization 3,551 2,840 2,560 Amortization of intangible assets 1,223 1,031 Amortization of premiums, fees, and discounts, net 2,854 1,449 1,721 Investment securities (gains) losses 98 (205) 362 Deferred (prepaid) income taxes (133) (43) 257 Loans originated and purchased for (193,833) (159,895) (123,626) sale Proceeds from sales of loans 201,375 150,771 133,610 Gains on sales of loans (2,720) (1,282) (1,208) Increase in Federal Home Loan Bank stock (374) Gains on sales of premises and equipment (225) (425) Changes in assets and liabilities, net of effect from purchase of The Bank of Western Massachusetts: Accrued interest receivable (1,299) (108) (3,764) Other assets (2,721) 1474 (1,865) Accrued expenses and other liabilities 896 (1,042) 3,728 ------------------------------------- Net cash provided by operating activities 40,195 21,522 34,887 ------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of The Bank of Western Massachusetts, net of cash acquired (3,455) Proceeds from sales of securities available for sale 9,291 9,473 46,083 Proceeds from maturing securities and principal payments on securities available for sale 490,591 325,985 155,357 Purchases of securities available for sale (581,842) (317,340) (278,622) Proceeds from principal payments on securities held for investment 9,578 6,054 11,178 Purchases of securities held for investment (5,047) (6,034) (12,772) Loans originated, net of principal repayments (94,106) (37,235) (45,508) Purchases of premises and equipment (2,901) (4,254) (4,933) Proceeds from sales of premises and equipment 488 496 --------------------------------------- Net cash used in investing activities (174,436) (26,318) (128,721) --------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 173,653 115,637 48,116 Net decrease in short-term borrowings (1,033) (24,884) (58,428) Net increase in long-term borrowings 56 54 53 Proceeds from issuance of treasury and 3,431 1,280 320 common stock Dividends on common stock (8,747) (4,803) (3,136) Repurchase of common stock (6,685) --------------------------------------- Net cash provided by (used in) financing activities 167,360 87,284 (19,760) --------------------------------------- Net increase (decrease) in cash and cash equivalents 33,119 82,488 (113,594) Cash and cash equivalents at beginning of year 197,140 114,652 228,246 --------------------------------------- Cash and cash equivalents at end of year $230,259 $197,140 $114,652 ======================================= Supplemental disclosure of cash flow information: Cash paid during the year for: Interest $58,201 $56,410 $35,269 Income taxes 9,950 11,668 7,996 Noncash investing and financing activities: Loans transferred to other real estate owned 2,444 5,152 2,511 Mortgage loans securitized 3,665 9,228 Acquisition of The Bank of Western Massachusetts: Fair value of assets acquired 229,971 Liabilities assumed (203,518) Common stock issued (14,276) Cash paid 12,177 The accompanying notes are an integral part of these consolidated financial statements. <PAGE 17> CHITTENDEN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION the accompanying consolidated financial statements include the accounts of Chittenden Corporation (the Company ) and its subsidiaries, Chittenden Trust Company (CTC), The Bank of Western Massachusetts (BWM), Flagship Bank and Trust Company (FBT), and Chittenden Connecticut Corporation (CCC). (CTC, BWM, and FBT are collectively referred to as the Banks. ) All material intercompany accounts and transactions have been eliminated in consolidation. All 1995 and 1994 information presented has been restated to include FBT, which was acquired on February 29, 1996 (see note 2). This transaction was accounted for as a pooling of interests. NATURE OF OPERATIONS CTC operates thirty-six branches throughout the state of Vermont, BWM operates five branches in the greater Springfield, Massachusetts area and FBT operates six branches in the greater Worcester, Massachusetts area. The Banks primary business is providing loans, deposits, and other banking services to commercial, individual, and public sector customers. CCC is a mortgage banking operation with offices in Southbury and Glastonbury, Connecticut. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. SECURITIES Under Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS 115), investments in debt securities may be classified as held for investment and measured at amortized cost only if the Company has the positive intent and ability to hold such securities to maturity. Investments in debt securities that are not classified as held for investment and equity securities that have readily determinable fair values are classified as either trading securities or securities available for sale. Trading securities are investments purchased and held principally for the purpose of selling in the near term; securities available for sale are investments not classified as trading or held for investment. Unrealized holding gains and losses on trading securities are included in earnings; unrealized holding gains and losses on securities available for sale are reported as a separate component of stockholders equity, net of applicable income taxes. The Company adopted SFAS 115 on January 1, 1994. The majority of the Company's investment portfolio was classified as available for sale and the cumulative net unrealized holding gain of $1,357,000, net of applicable taxes, was recorded in stockholders equity. All other debt securities held are classified as held for investment as the Company has the positive intent and ability to hold such securities to maturity. Dividend and interest income, including amortization of premiums and discounts, is included in earnings for all categories of investment securities. Discounts and premiums related to debt securities are amortized using a method which approximates the level-yield method, adjusted for estimated prepayments in the case of mortgage-backed securities. Unrealized losses which are considered other than temporary in nature are recognized in earnings. LOANS Loans are stated at the amount of unpaid principal, net of unearned discounts and unearned net loan origination fees. Such fees and discounts are accreted using methods that approximate the effective-interest method. 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 unless they are adequately secured and in the process of collection, or on other loans when management believes collection is doubtful. All loans considered impaired under SFAS 114 (except troubled debt restructurings), as defined below, are nonaccruing. Interest on nonaccruing loans is recognized when 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. <PAGE 18> ALLOWANCE FOR POSSIBLE LOAN LOSSES The allowance for possible loan losses is based on management s estimate of the amount required to reflect the risks in the loan portfolio, based on circum- stances and conditions known or anticipated at each reporting date. There are inherent uncertainties with respect to the final outcome of the Banks loans. Because of these inherent uncertainties, it is reasonably possible that actual losses experienced in the near term may differ from the amounts reflected in these consolidated financial statements. The inherent uncertainties in the assumptions relative to projected sales prices or rental rates may result in the ultimate realization of amounts on certain loans that are significantly different from the amounts reflected in these consolidated financial statements. Factors considered in evaluating the adequacy of the allowance for possible loan losses include previous loss experience, current economic conditions and their effect on borrowers, the performance of individual loans in relation to contract terms, and estimated fair values of underlying collateral. Losses are charged against the allowance for possible loan losses when management believes that the collectibility of principal is doubtful. Key elements of the above estimates, including assumptions used in developing independent appraisals, are dependent on the economic conditions prevailing at the time such estimates are made. Accordingly, uncertainty exists as to the final outcome of certain valuation judgments as a result of changes in economic conditions in the Banks' lending areas. As of January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118 (hereafter collectively referred to as SFAS 114). A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. SFAS 114 requires that impaired loans be measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate. In the case of collateral dependent loans, impairment may be measured based on the fair value of the collateral. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance. This change in accounting policy, as prescribed by SFAS 114, did not result in a cumulative adjustment of the Company s reported financial condition. Further, adoption of SFAS 114 did not affect the Company's provision for possible loan losses for the year ended December 31, 1995. The adoption of SFAS 114 had no impact on the Company s income recognition policy for nonaccrual loans. LOAN ORIGINATION AND COMMITMENT FEES Loan origination and commitment fees, and certain loan origination costs, are deferred and amortized over the contractual terms of the related loans as yield adjustments using primarily the level-yield method. When loans are sold or paid off, the unamortized net fees and costs are recognized in income. Net deferred loan fees amounted to $1,121,000 and $1,964,000 at December 31, 1996 and 1995, respectively. PURCHASED MORTGAGE SERVICING RIGHTS Purchased mortgage servicing rights (PMSRs) are initially recorded at the lower of cost or the present value of the estimated future net servicing income. Such amounts are amortized in proportion to and over the period of the estimated net servicing income. The Company periodically evaluates the carrying value of PMSRs for individual servicing acquisitions, compared with the present value of estimated future net servicing income. Amortization is adjusted to reflect changes in prepayment experience. PMSRs included in Other Assets amounted to $1,836,000 and $2,126,000 at December 31, 1996 and 1995, respectively. ORIGINATED MORTGAGE SERVICING RIGHTS As of January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 122, Accounting For Mortgage Servicing Rights ( SFAS 122 ). SFAS 122 requires the recognition, as separate assets, of rights to service mortgage loans for others, when the related loans are sold and the servicing rights are retained. The amount capitalized is based on an allocation of the total cost of the mortgage loans to the mortgage servicing rights and the loans (without the mortgage servicing rights) based on their relative fair values. SFAS 122 also requires capitalized mortgage servicing rights to be assessed for impairment based on the fair value of those rights. This change in accounting was adopted prospectively for mortgage loans sold on or after January 1, 1996. Mortgage servicing rights capitalized during the year ended December 31, 1996 net of amortization recorded using the proportional method, totaled $1,189,000. In June 1996, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which superseded SFAS 122 effective January 1, 1997. Under the financial-components approach set forth in SFAS 125, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. The Statement also provides consistent standards for distinguishing transfers of financial assets that are <PAGE 19> sales from transfers that are secured borrowings. The Company expects the adoption of SFAS 125 will not have a significant impact on the Company s financial position or results of operation. MORTGAGE LOANS HELD FOR SALE Mortgage loans held for sale are carried at the lower of aggregate cost or market value. Gains and losses on sales of mortgage loans are recognized at the time of the sale and are adjusted when the interest rate charged to the borrower and the interest rate paid to the purchaser, after considering a normal servicing fee (and, in the case of mortgage-backed securities, a guarantee fee), differ. PREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is provided using the straight line method over the estimated useful lives of the premises and equipment. Leasehold improvements are amortized over the shorter of the terms of the respective leases or the estimated useful lives of the improvements. Expenditures for maintenance, repairs, and renewals of minor items are charged to expense as incurred. OTHER REAL ESTATE OWNED Collateral acquired through foreclosure ( Other Real Estate Owned or OREO ) is recorded at the lower of the carrying amount of the loan or the fair value of the property, less estimated costs to sell, at the time of acquisition. A valuation allowance for the estimated costs to sell is charged to expense. Subsequent changes in the fair value of OREO are reflected in the valuation allowance and charged or credited to expense. Such amounts and net operating income or expense related to OREO are included in noninterest expense in the accompanying consolidated statements of income. INTANGIBLE ASSETS Intangible assets include the excess of the purchase price over the fair value of net assets acquired (goodwill) in the acquisition of BWM as well as a core deposit intangible (see Note 2). Goodwill is being amortized on a straight-line basis over 15 years. The core deposit intangible is being amortized on an accelerated basis over 10 years. The Company periodically evaluates intangible assets for impairment on the basis of whether these assets are fully recoverable from projected, undiscounted net cash flows of the related acquired entity. INCOME TAXES The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109), which recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are established for the temporary differences between the accounting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. EARNINGS PER SHARE The calculation of earnings per share is based on the weighted average number of shares of common stock outstanding, adjusted for the incremental shares attributed to outstanding common stock equivalents, using the treasury stock method. Common stock equivalents include options granted under the Company's stock plans and shares to be issued under the Directors' Deferred Compensation Plan. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of cash on hand, amounts due from banks, interest- bearing deposits, certain money market mutual fund investments, and investments with original maturities of less than three months. Cash equivalents are accounted for at cost which approximates fair value. TRUST DEPARTMENT Trust department assets of approximately $2.6 billion and $2.2 billion at December 31, 1996 and 1995, respectively, held by the Banks in a fiduciary or agency capacity for customers are not included in the accompanying consolidated balance sheets as they are not assets of the Company. Trust income is recorded on the cash basis in accordance with industry practice. CREDIT CARD INCOME Credit card income includes annual fees and interchange income from credit cards issued by the Banks, and merchant discount income. Merchant discount income consists of the fees charged on credit card receipts submitted by the Company's business customers. Credit card income is presented net of credit card expense, which includes fees paid by the Company to credit card issuers and third-party processors. Such amounts are recognized on the accrual basis, and are presented in noninterest income in the accompanying statements of income. <PAGE 20> STOCK-BASED COMPENSATION Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, encourages but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the exercise price of the stock. RECLASSIFICATIONS Certain amounts in the 1995 and 1994 financial statements have been reclassified to be consistent with current year presentation. NOTE 2 ACQUISITIONS THE BANK OF WESTERN MASSACHUSETTS On March 17, 1995, the Company acquired all of the outstanding shares of the common stock of The Bank of Western Massachusetts. The Company issued 980,508 shares at a price of $14.56 per share; 510,742 of the shares issued were treasury stock. The total cash outlay, including payments made with respect to outstanding stock options and warrants issued by BWM, was $12.2 million. This transaction has been accounted for as a purchase and, accordingly, the consolidated statement of income includes BWM s results of operations from the date of acquisition. The purchase price has been allocated to assets acquired and liabilities assumed based on estimates of fair value at the date of acquisition. The excess of purchase price over the fair value of assets acquired, including a core deposit intangible asset, has been recorded as goodwill. The fair value of these assets and liabilities is summarized as follows (in thousands): Cash and cash equivalents $ 8,715 Securities available for sale 42,123 Net loans 158,975 Premises and equipment 1,422 Core deposit intangible 5,021 Goodwill 7,123 Other real estate owned 1,296 Prepaid expenses and other assets 5,296 Deposits (176,395) Short-term borrowings (18,980) Accrued expenses and other liabilities (8,143) ---------- Total acquisition cost $ 26,453 ========== Included in the total acquisition cost is approximately $100,000 of capitalized costs incurred in connection with the acquisition. Following is supplemental information reflecting selected pro forma results for the Company as if this acquisition had been consummated as of January 1, 1994: 1995 1994 ------------------------ (in thousands, except EPS) Total revenue $103,037 $ 91,008 Income before income taxes 33,379 28,747 Net income 21,804 18,421 Earnings per share (EPS) 1.80 1.61 Total revenue includes net interest income and noninterest income. <PAGE 21> FLAGSHIP BANK AND TRUST COMPANY On February 29, 1996, the Company acquired Flagship Bank and Trust Company (FBT) of Worcester, Massachusetts for stock. Under the agreement, FBT shareholders received 1.2 shares of Chittenden Corporation common stock for each share of FBT stock. Total shares outstanding of Chittenden Corporation stock increased by 1.6 million shares as a result of the acquisition. Based on the closing price of Chittenden stock as of February 29, 1996, the market value of the shares exchanged totaled $35.2 million. The acquisition was accounted for as a pooling of interests. Accordingly, the financial statements for 1995 and 1994 have been restated to include FBT. Total revenue, income before income taxes, net income, and earnings per share data of the separate companies for the periods preceding the acquisition were: 1995 1994 Chittenden Chittenden Corporation FBT Combined Corporation FBT Combined ---------------------------------------------------------------------------- (in thousands, except EPS) Total Revenue $86,176 $14,195 $100,371 $71,964 $12,683 $84,647 Income before Income Taxes 31,178 2,609 33,787 23,755 3,999 27,754 Net Income 20,885 1,246 22,131 15,537 2,500 18,037 Earnings per Share 2.00 0.76 1.83 1.58 1.54 1.57 Total revenue includes net interest income and noninterest income. Total transaction costs expensed in relation to the transaction were $295,000 and $1,842,000 in 1996 and 1995, respectively. NOTE 3 SECURITIES Investment securities at December 31, 1996 and 1995 are as follows: Amortized Unrealized Unrealized Fair Cost Gains Losses Value -------------------------------------------------- 1996 (in thousands) SECURITIES AVAILABLE FOR SALE: U.S. Treasury securities $109,606 $ 440 $ (575) $109,471 U.S. government agency obligations 76,179 695 (167) 76,707 Obligations of states and political subdivisions 45,123 45,123 Mortgage-backed securities 51,850 245 (491) 51,604 Corporate bonds and notes 65,248 133 (191) 65,190 Government bond mutual funds 10,605 - (502) 10,103 Marketable equity securities 235 103 - 338 --------------------------------------------------- Total securities available for sale $358,846 $1,616 $(1,926) $358,536 =================================================== SECURITIES HELD FOR INVESTMENT: U.S. government agency obligation $ 198 $ $ $ 198 Obligations of states and political subdivisions 3,466 3,466 Mortgage-backed securities 34,761 77 (252) 34,586 Corporate bonds and notes 25 25 Other debt securities 106 106 ------------------------------------------------------ Total securities held for investment $ 38,556 $77 $(252) $38,381 ====================================================== 1995 SECURITIES AVAILABLE FOR SALE: U.S. Treasury securities $ 81,625 $1,101 $(123) $ 82,603 U.S. government agency obligations 60,448 556 (57) 60,947 Obligations of states and political subdivisions 44,853 44,853 Mortgage-backed securities 49,187 334 (194) 49,327 Corporate bonds and notes 30,072 70 (118) 30,024 Government bond mutual funds 10,605 (288) 10,317 Marketable equity securities 231 20 251 ----------------------------------------------------- Total securities available for sale $277,021 $2,081 $(780) $278,322 ===================================================== SECURITIES HELD FOR INVESTMENT: U.S. government agency $ 298 $ $ (1) $ 297 obligation Obligations of states and political subdivisions 5,119 5,119 Mortgage-backed securities 37,747 211 (740) 37,218 ------------------------------------------------------ Total securities held for investment $43,164 $211 $(741) $42,634 ====================================================== <PAGE 22> Proceeds from sales of debt securities amounted to $9,291,000, $9,473,000 and $46,083,000 in 1996, 1995, and 1994, respectively. Realized gains on sales of debt securities were $13,000 and $246,000 in 1995 and 1994, respectively. Realized losses on sales of debt securities were $98,000, $73,000 and $142,000 in 1996, 1995, and 1994, respectively. In 1994, the Company sold government bond mutual funds at a loss of $466,000. The Company sold marketable equity securities at a gain of $265,000 in 1995. Market value of securities pledged to secure U.S. Treasury borrowings, public deposits, securities sold under agreements to repurchase, and for other purposes required by law, amounted to $179,642,000 and $73,698,000 at December 31, 1996 and 1995, respectively. The following table shows the maturity distribution of the amortized cost of the Company's investment securities at December 31, 1996, with a comparative total for 1995: After After One But Five But Within Within Within One Five Ten Year Years Years ----------------------------------------- (in thousands) SECURITIES AVAILABLE FOR SALE: U.S. Treasury securities $ 24,265 $ 80,297 $ 5,044 U.S. government agency obligations 7,439 63,940 3,000 Obligations of states and political subdivisions 42,587 2,130 406 Mortgage-backed securities (1) 8,663 29,129 11,529 Corporate bonds and notes 17,297 47,951 Government bond mutual funds Marketable equity securities ---------------------------------------- Total securities available for sale 100,251 223,447 19,979 ---------------------------------------- SECURITIES HELD FOR INVESTMENT: U.S. government agency obligations 198 Obligations of states and political subdivisions 2,549 605 312 Mortgage-backed securities (1) 11,944 17,868 2,389 Corporate bonds and notes 25 Other debt securities 20 51 ------------------------------------------ Total securities held for investment 14,691 18,493 2,777 ------------------------------------------ Total securities $114,942 $241,940 $22,756 ========================================== Comparative amounts at December 31, 1995 $116,649 $155,707 $29,222 After Ten No Fixed Years Maturity Total ----------------------------------------- (in thousands) SECURITIES AVAILABLE FOR SALE: U.S. Treasury securities $ $ $109,606 U.S. government agency obligations 1,800 76,179 Obligations of states and political subdivisions 45,123 Mortgage-backed securities (1) 2,529 51,850 Corporate bonds and notes 65,248 Government bond mutual funds 10,605 10,605 Marketable equity securities 235 235 ----------------------------------------- Total securities available for sale 4,329 10,840 358,846 ----------------------------------------- SECURITIES HELD FOR INVESTMENT: U.S. government agency obligations 198 Obligations of states and political subdivisions 3,466 Mortgage-backed securities (1) 2,560 34,761 Corporate bonds and notes 25 Other debt securities 35 106 ---------------------------------------- Total securities held for investment 2,595 38,556 ---------------------------------------- Total securities $6,924 $10,840 $397,402 ======================================== Comparative amounts at December 31, 1995 $7,771 $10,836 $320,185 _____________________________ (1) Maturities of mortgage-backed securities are based on forecasted mortgage loan prepayments. <PAGE 23> The following table shows the maturity distribution of the fair value of the Company's investment securities at December 31, 1996, with a comparative total for 1995: After After One But Five But Within Within Within One Five Ten Year Years Years ---------------------------------------- (in thousands) SECURITIES AVAILABLE FOR SALE: U.S. Treasury securities $ 24,338 $ 80,283 $ 4,850 U.S. government agency obligations 7,474 64,445 3,046 Obligations of states and political subdivisions 42,587 2,130 406 Mortgage-backed securities (1) 8,593 28,981 11,503 Corporate bonds and notes 17,259 47,931 Government bond mutual funds Marketable equity securities --------------------------------------- Total securities available for sale 100,251 223,770 19,805 --------------------------------------- SECURITIES HELD FOR INVESTMENT: U.S. government agency obligations 198 Obligations of states and political subdivisions 2,549 605 312 Mortgage-backed securities (1) 11,884 17,778 2,377 Corporate bonds and notes 25 Other debt securities 20 51 --------------------------------------- Total securities held for investment 14,631 18,403 2,765 --------------------------------------- Total securities $114,882 $242,173 $22,570 ======================================= Comparative amounts at December 31, 1995 $116,763 $156,635 $29,139 After Ten No Fixed Years Maturity Total -------------------------------------- (in thousands) SECURITIES AVAILABLE FOR SALE: U.S. Treasury securities $ $ $109,471 U.S. government agency obligations 1,742 76,707 Obligations of states and political subdivisions 45,123 Mortgage-backed securities (1) 2,527 51,604 Corporate bonds and notes 65,190 Government bond mutual funds 10,103 10,103 Marketable equity securities 338 338 --------------------------------------- Total securities available for sale 4,269 10,441 358,536 --------------------------------------- SECURITIES HELD FOR INVESTMENT: U.S. government agency obligations 198 Obligations of states and political subdivisions 3,466 Mortgage-backed securities (1) 2,547 34,586 Corporate bonds and notes 25 Other debt securities 35 106 --------------------------------------- Total securities held for investment 2,582 38,381 --------------------------------------- Total securities $6,851 $10,441 $396,917 ======================================= Comparative amounts at December 31, 1995 $7,851 $10,568 $320,956 _________________________ (1) Maturities of mortgage-backed securities are based on forecasted mortgage loan prepayments. The fair value adjustment is applied to the maturity distribution proportionately. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. <PAGE 24> NOTE 4 LOANS Major classifications of loans at December 31, 1996 and 1995 are as follows: 1996 1995 --------------------------- (in thousands) Commercial $ 272,969 $ 248,604 Real estate: Residential 406,850 388,705 Commercial 304,530 305,941 Construction 25,084 25,796 --------------------------- Total real estate 736,464 720,442 Home equity 84,319 78,600 Consumer 161,699 147,540 Leases 41,117 12,420 -------------------------- Total gross loans 1,296,568 1,207,606 Allowance for possible loan losses (28,096) (27,818) -------------------------- Net loans $1,268,472 $1,179,788 ========================== Mortgage loans held for sale $9,870 $14,692 ========================== Leases include the estimated residual value of leased vehicles of approximately $24,207,000 and $6,821,000 at December 31, 1996 and 1995, respectively, and are net of unearned interest income of approximately $5,855,000 and $1,880,000 at those dates. CTC's lending activities are conducted primarily in Vermont, with additional activity relating to nearby trading areas in Quebec, New York, New Hampshire, Maine, and Connecticut. BWM s lending activities are conducted primarily in the greater Springfield, Massachusetts area while FBT s lending activities are conducted primarily in the Worcester, Massachusetts area. The Banks make single family and multi-family residential loans, commercial real estate loans, commercial loans, and a variety of consumer loans. In addition, the Banks make loans for the construction of residential homes, multi-family and commercial properties, and for land development. The ability and willingness of the Banks' borrowers to honor their repayment commitments are impacted by many factors, including the level of overall economic activity within the borrowers geographic areas. Changes in the allowance for possible loan losses are summarized as follows: 1996 1995 1994 --------------------------------- (in thousands) Balance at beginning of year $27,818 $ 22,163 $ 21,672 Allowance of BWM at acquisition 4,135 Provision for possible loan losses 4,183 5,000 5,500 Loan recoveries 2,204 3,002 1,230 Loans charged off (6,109) (6,482) (6,239) ---------------------------------- Balance at end of year $28,096 $ 27,818 $ 22,163 ================================== The principal amount of loans on nonaccrual status was $10,601,000 and $9,939,000 at December 31, 1996 and 1995, respectively. Loans whose terms have been substantially modified in troubled debt restructurings amounted to $638,000 and $2,502,000 at December 31, 1996 and 1995, respectively. The amount of interest which was not earned but which would have been earned had the nonaccrual and restructured loans performed in accordance with their original terms and conditions was as follows: 1996 1995 1994 --------------------------------- (in thousands) Interest income in accordance with original loan terms $1,668 $1,007 $1,453 Interest income recognized 721 513 508 --------------------------------- Reduction in interest income $ 947 $ 494 $ 945 ================================= At December 31, 1996, the Banks were not committed to lend any additional funds to borrowers with loans whose terms have been restructured. <PAGE 25> Disclosures related to impaired loans at, and for the years ended, December 31, 1996 and 1995, are as follows: 1996 1995 (in thousands) At December 31 Investment in loans considered impaired under SFAS 114 (1) $6,035 $8,162 Impaired loans with a related loan loss allowance 4,324 3,389 Specific loan loss allowance for impaired loans 1,190 821 Impaired loans with no specific loan loss allowance 1,711 4,773 For the year ended Average recorded investment in impaired loans 7,609 9,433 Interest income on impaired loans 319 319 Amount of interest income recognized on a cash basis 76 221 ____________________________ (1) All such loans, except troubled debt restructurings, were on a nonaccrual basis. Residential mortgage loans serviced for others, which are not reflected in the consolidated balance sheets, totaled approximately $1,006,853,000 and $960,212,000 at December 31, 1996 and 1995, respectively. No formal recourse provisions exist in connection with such servicing. The following table is a summary of activity for mortgage servicing rights purchased and originated for the year ended December 31, 1996: Purchased Originated Total ----------------------------------- (in thousands) Balance at January 1, 1996 $2,126 $ - $2,126 Additions 35 1,334 1,369 Amortization (325) (145) (470) ------------------------------------ Balance at December 31, 1996 $1,836 $1,189 $3,025 ==================================== SFAS 122 requires enterprises to measure the impairment of servicing rights based on the difference between the carrying amount of the servicing rights and current fair value. At December 31, 1996, no allowance for impairment in the Company s mortgage servicing rights was necessary. <PAGE 26> NOTE 5 PREMISES AND EQUIPMENT Premises and equipment at December 31, 1996 and 1995 are summarized as follows: Estimated Original 1996 1995 Useful Lives ------------------------------------------- (in thousands) Land $ 3,162 $ 3,162 - Buildings and improvements 9,430 9,427 25 - 50 years Leasehold improvements 12,962 12,052 2 - 50 years Furniture and equipment 20,802 19,577 3 - 15 years Construction in progress 593 133 ----------------------- 46,949 44,351 Accumulated depreciation and amortization (22,652) (19,404) ------------------------ $24,297 $24,947 The Company is obligated under various noncancelable leases for premises and equipment expiring in various years through the year 2008. Total lease expense, less income from subleases, amounted to approximately $2,031,000, $1,849,000 and $1,273,000 in 1996, 1995, and 1994, respectively. Future minimum rental commitments for noncancelable leases for premises and equipment with initial or remaining terms of one year or more at December 31, 1996 are as follows: Year Capital Leases Operating Leases - -------------------------------------------------------------------------------- (in thousands) 1997 $ 83 $ 1,886 1998 87 1,714 1999 1,755 1,595 2000 - 1,549 2001 - 1,343 Thereafter - 6,897 --------------------------------------- Total minimum lease payments 1,925 $14,984 ====================== Amounts representing interest 385 ----------- Present value of net minimum lease payments $1,540 =========== NOTE 6 BORROWINGS Short-term borrowings at December 31, 1996 and 1995 consist of the following: 1996 1995 -------------------- (in thousands) Securities sold under agreements to repurchase: Due through January 6, 1997, weighted average rate of 9.20% $10,000 $ - Due through January 8, 1996, weighted average rate of 9.20% - 10,000 U.S. Treasury borrowings, 5.18% in 1996 and 5.16% in 1995, due on demand 13,894 11,927 FHLB Term Advances, 5.79% in 1995 due on October 3, 1996 - 3,000 FHLB Affordable Housing Program Advance, no fixed maturity, 5.79% 98 98 -------------------- $23,992 $25,025 ==================== Short-term borrowings are collateralized by U.S. Treasury and agency securities, mortgage-backed securities, and residential mortgage loans. These assets had a carrying value and a fair value of $28,019,000 and $28,006,000, respectively, at December 31, 1996, and $25,471,000 and $25,542,000, respectively, at December 31, 1995. <PAGE 27> The following information relates to securities sold under agreements to repurchase: 1996 1995 1994 ------------------------------- (in thousands) Average balance outstanding during the year $10,097 $11,304 $11,806 Average interest rate during the year 9.18% 8.83% 8.46% Maximum amount outstanding at any month-end $10,000 $20,000 $20,237 The following information relates to U.S. Treasury borrowings: 1996 1995 1994 ------------------------------ (in thousands) Average balance outstanding during the year $15,282 $19,556 $20,349 Average interest rate during the year 5.16% 5.73% 3.74% Maximum amount outstanding at any month-end $62,858 $70,669 $70,517 The following information relates to short-term FHLB borrowings: 1996 1995 1994 ------------------------------- (in thousands) Average balance outstanding during the year $2,307 $7,162 $5,954 Average interest rate during the year 5.77% 5.96% 5.34% Maximum amount outstanding at any month-end $3,000 $12,725 $6,098 The following information relates to long-term debt: 1996 1995 ------------------ (in thousands) FHLB Term Advance, 5.81%, due on October 19, 1998 $1,000 $1,000 Capitalized lease obligation 1,540 1,484 ------------------ $2,540 $2,484 ================== The advance from the Federal Home Loan Bank of Boston is collateralized by the Company s holdings of Federal Home Loan Bank of Boston stock and residential real estate loans equal to at least 200% of the advance. NOTE 7 INCOME TAXES The provision for income taxes consists of the following: 1996 1995 1994 ------------------------------ (in thousands) Current payable Federal $12,414 $10,713 $8,723 State 1,171 986 737 ------------------------------- 13,585 11,699 9,460 Deferred (prepaid) Federal (147) (45) 270 State 14 2 (13) ------------------------------- (133) (43) 257 ------------------------------- Provision for income taxes $13,452 $11,656 $9,717 =============================== Current income taxes receivable, included in other assets, were $410,000 and $943,000, at December 31, 1996 and 1995, respectively. Current income taxes payable, included in accrued expenses and other liabilities, was $330,000 at December 31, 1996. <PAGE 28> The State of Vermont assesses a franchise tax for banks in lieu of a bank income tax. The franchise tax, assessed based on deposits, amounted to approximately $562,000, $530,000, and $493,000 in 1996, 1995, and 1994, respectively. These amounts are included in provision for income taxes in the accompanying consolidated statements of income. The following is a reconciliation of the provision for Federal income taxes, calculated at the statutory rate of 35%, to the recorded provision for income taxes: 1996 1995 1994 ------------------------------- (in thousands) Computed tax at statutory Federal rate $14,061 $11,826 $9,714 Increase (decrease) in taxes from: Amortization of intangible assets 166 142 Tax-exempt interest, net (992) (1,109) (682) Dividends received deduction (238) (214) (134) State taxes, net of Federal Tax benefit 770 449 473 Other, net (315) 562 346 -------------------------------- Total $13,452 $11,656 $9,717 ================================ Effective income tax rate 33.5% 34.5% 35.0% The components of the net deferred tax asset at December 31, 1996 and 1995 are as follows: 1996 1995 ---------------------- (in thousands) Allowance for possible loan losses $ 9,209 $ 8,940 Deferred compensation and pension 2,332 2,522 Other real estate owned writedowns 94 133 Depreciation (535) (769) Accrued liabilities 294 714 Unrealized (gain) loss on securities available for sale 86 (535) Basis differences, purchase accounting 387 579 Core deposit intangible (1,614) (1,911) Other 394 486 --------------------- $10,647 $10,159 ===================== NOTE 8 STOCKHOLDERS EQUITY TREASURY STOCK On October 26 and November 7, 1994, the Company purchased 354,492 and 156,250 shares, Respectively, of its common stock for a total cost of $6.7 million. On March 17, 1995, the Company issued 510,742 common shares from treasury in the acquisition of The Bank of Western Massachusetts. DIVIDENDS Dividends paid by the Banks are the primary source of funds available to the Company for payment of dividends to its stockholders and for other corporate needs. Applicable Federal and state statutes, regulations, and guidelines impose restrictions on the amount of dividends that may be declared by the Banks. The Company declared dividends of $8,747,000, $4,803,000, and $3,136,000 during 1996, 1995, and 1994, respectively. These amounts represented $0.71, $0.40, and $0.27 per share. SURPLUS CTC is required by Vermont statute to transfer a minimum of 10% of net income from retained earnings to surplus on an annual basis. No transfer is required if net worth as a percent of deposits and other liabilities exceeds 10%. Prior to the payment of dividends, BWM and FBT are required by Massachusetts statute to transfer an amount from retained earnings to surplus such that the total of capital stock and surplus is a minimum of 10% of deposits. Because these levels were exceeded at December 31, 1996, no transfers were made during the year. <PAGE 29> STOCK SPLITS On May 24, 1996 and May 26, 1995, the Company distributed five-for-four stock splits. All historical share information presented in the consolidated financial statements has been restated to reflect these events. NOTE 9 STOCK PLANS The Company has two stock option plans: the 1988 Employee Stock Option plan and the 1993 Stock Incentive Plan. The Company accounts for these plans in accordance with APB Opinion No. 25, under which no compensation cost has been recognized. Under the Stock Incentive Plan, certain key employees and directors are eligible to receive various types of stock incentives: options to purchase a specified number of shares of stock at a specified price (including incentive stock options and non-qualified stock options); restricted stock which vests after a specified period of time; non-employee directors stock options to purchase stock at predetermined prices over a five-year period. A total of 732,422 shares are allocated to the Stock Incentive Plan. At December 31, 1996 there were 694,087 shares reserved under the plan. Information regarding the Company s stock option plans is summarized as follows: Weighted Average Price Per Share Options ------------------------- December 31, 1993 $ 7.51 614,943 Granted 10.46 37,673 Exercised 8.76 (19,548) Expired 7.47 (60,046) ------------------------- December 31, 1994 7.67 573,022 Granted 14.21 194,815 Exercised 9.82 (106,785) Expired 10.73 (10,225) ------------------------- December 31, 1995 9.37 650,827 Granted 25.47 177,533 Exercised 5.88 (324,048) Expired 17.62 (25,904) ------------------------- December 31, 1996 $17.26 478,408 ========================= If compensation cost for these plans had been determined in accordance with SFAS 123, the Company's net income and earnings per share would have been reduced to the following pro forma amounts: 1996 1995 ----------------------------------- (in thousands, except per share data) Net Income As Reported $26,721 $22,131 Pro Forma 26,434 22,049 Earnings Per Share As Reported $2.14 $1.83 Pro Forma 2.12 1.82 The SFAS 123 method of accounting has not been applied to options granted prior to January 1, 1995. Accordingly, the resulting pro forma compensation cost may not be representative of that to be expected in future years. Of the 478,408 options outstanding at December 31, 1996, 286,759 have exercise prices between $3.20 and $16.64, with a weighted average exercise price of $12.07 and a weighted average remaining contractual life of 6.76 years. All of these options are exercisable. The remaining 191,649 options have exercise prices between $19.14 and $29.93, with a weighted average exercise price of $25.03 and a weighted average remaining contractual life of 6.83 years. Of these options, 5,397 are exercisable and their weighted average exercise price is $22.73. <PAGE 30> The fair value of each option granted is estimated on the date of grant using the Black- Scholes option pricing model with the following weighted-average assumptions used for grants in 1996 and 1995: 1996 1995 --------------- Expected life (years) 7.75 7.75 Interest rate 6.75% 6.50% Volatility 25.4 25.4 Dividend yield 3.60 5.61 Using these assumptions, the weighted average fair value of options granted was $5.78 and $2.74 per share, in 1996 and 1995, respectively. NOTE 10 EMPLOYEE BENEFITS PENSION PLAN CTC has a noncontributory pension plan covering substantially all of its employees. Benefits are based on years of service and the level of compensation during each year of employment, and accumulate using a cash balance formula. The funding policy of the Bank for the plan is to contribute annually the amount necessary to meet the minimum funding standards established by the Employee Retirement Income Security Act (ERISA). This contribution is based on an actuarial method that recognizes estimated future salary levels and service. The funded status of the plan is as follows at December 31, 1996 and 1995: 1996 1995 ------------------- (in thousands) Vested benefits $13,851 $12,699 Nonvested benefits 195 1,364 ------------------- Accumulated benefit obligation 14,046 14,063 Additional benefits related to future compensation levels 1,680 1,766 ------------------- Projected benefit obligation 15,726 15,829 Fair value of plan assets, invested primarily in equity securities and bonds 16,036 14,083 ------------------- Plan assets in excess of (less than) projected benefit obligation $ 310 $(1,746) ==================== Amounts resulting from changes in actuarial assumptions used to measure the Bank's benefit obligations are not recognized as they occur, but are amortized systematically over subsequent periods. Unrecognized amounts to be amortized and the reconciliation of the plan assets less than the projected benefit obligation to the amounts included in the consolidated balance sheets at December 31, 1996 and 1995 are shown below: 1996 1995 ----------------------- (in thousands) Plan assets in excess of (less than) projected benefit obligation $ 310 $(1,746) Unrecognized net transition asset being amortized over participants period of service (118) (130) Prior service cost not yet recognized in net periodic pension cost (2,659) (3,043) Unrecognized net loss from past experience different from that assumed 278 1,956 ------------------------ Accrued pension cost included in accrued expenses and other liabilities $(2,189) $(2,963) ======================== Net pension expense, included in employee benefits in the consolidated statements of income, includes the following components: 1996 1995 1994 ---------------------------------- (in thousands) Service cost - benefits attributable to service during the period $ 441 $ 814 $ 868 Interest cost on projected benefit obligation 1,112 1,297 1,136 Actual return on plan assets (1,947) (2,301) 72 Net amortization and deferral 419 1,257 (1,186) ----------------------------------- Net pension expense $ 25 $1,067 $ 890 =================================== <PAGE 31> The weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.5%, 7.0%, and 8.0% at December 31, 1996, 1995 and 1994, respectively. Future compensation levels were estimated using average salary increases of 5.25%, 5.0%, and 6.0% at December 31, 1996, 1995 and 1994, respectively. The expected long-term rate of return on plan assets was 9.0% in 1996, 1995, and 1994. In September 1995, the Company approved an amendment to the pension plan, effective January 1, 1996, adopting a cash balance approach. This amendment led to the reduction of the Company s pension expense from $1,067,000 in 1995 to $25,000 in 1996. Based on current actuarial assumptions, management expects future annual pension expense of approximately $600,000. CTC has supplemental pension arrangements with certain retired employees. The liability, included in accrued expenses and other liabilities, related to such arrangements was $772,000 and $883,000 at December 31, 1996 and 1995, respectively. The Company has established a Supplemental Executive Retirement Plan (SERP) for its Chief Executive Officer. The SERP is a defined contribution plan in which contributions are accrued based upon the Company s Return on Equity (ROE). An ROE of 10% is the minimum threshold at which any contribution will be made. Benefits are payable upon attaining the age of 55, except in the event of death or disability. The liability related to the SERP, included in accrued expenses and other liabilities, was $379,000 and $234,000 at December 31, 1996 and 1995, respectively. POSTRETIREMENT BENEFITS In addition to providing pension benefits, CTC provides certain postretirement health care benefits to retirees who meet certain age and length of service criteria. The Company accounts for postretirement and postemployment benefits in accordance with Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (SFAS 106). This accounting standard requires that the expected cost of postretirement benefits be charged to expense during the years that the employees render service. The Company has elected to amortize the unfunded obligation that was measured as of January 1, 1993 over a period of 20 years. The following table reconciles the plan's funded status to the accrued post- retirement health care liability as reflected in the balance sheets at December 31, 1996 and 1995: 1996 1995 ------------------ (in thousands) Accumulated postretirement benefit obligation: Retirees $ 725 $ 781 Other fully eligible participants 157 147 Other active participants 274 466 ------------------- $1,156 1,394 Unrecognized actuarial gain 340 152 Unrecognized transition obligation (1,286) (1,366) ------------------- Accrued postretirement health care liability $ 210 $ 180 =================== Net postretirement health care expense includes the following components: Service cost - benefits attributed to service during the period $ 11 $ 16 Interest cost on accumulated postretirement benefit obligation 83 101 Net amortization and deferral 48 64 ------------------ Net postretirement health care expense $142 $181 ================== The weighted average discount rate used in determining the accumulated post- retirement benefit obligation at December 31, 1996 and 1995, was 7.5% and 7.0%, respectively. For measurement purposes, 7.0% and 9.0% annual rate of increase in the per capita cost of covered health care benefits was assumed for the respective periods. OTHER BENEFIT PLANS CTC has an incentive savings and profit sharing plan to provide eligible employees with a means to save and invest a portion of their earnings, supplemented by contributions from CTC. Investment in the Company's common stock is one of four investment options available to employees. Eligible employees of CTC may contribute, by salary reductions, up to 6% of their compensation as a basic employee contribution and may contribute up to an additional 10% of their compensation as a supplemental employee contribution. CTC makes an incentive savings contribution in an amount equal to 35% of each employee's basic contribution. In 1996, 1995, and 1994, 49,422, 38,580 and <PAGE 32> 22,795 shares, respectively, of the Company's common stock were purchased through the incentive savings and profit sharing plan; $290,000, $274,000, and $214,000, respectively, were charged to expense for contributions and payments made, or to be made, under the plan. CTC may also make an additional matching contribution based on the extent to which the annual corporate profitability goal established by the Board of Directors is met. Expenses related to achievement of profitability goals totaled $319,000, $364,000, and $214,000, in 1996, 1995, and 1994, respectively. CTC also has an Executive Management Incentive Compensation Plan. Executives performing at defined levels of responsibility are eligible to participate in the plan. Incentive award payments are determined on the basis of corporate profitability and individual performance, with incentive awards ranging from zero to 100% of annual compensation. These awards are paid over a four-year period, contingent upon meeting profitability goals in subsequent years. Expenses for this plan totaled $769,000, $599,000, and $529,000 in 1996, 1995, and 1994, respectively. The Company has a Directors' Deferred Compensation Plan. Under the plan, Directors may defer fees and retainers that would otherwise be payable currently. Deferrals may be made to an uninsured interest account or an account recorded in equivalents of the Company's common stock. Expenses for this plan totaled $365,000, $183,000, and $202,000 for 1996, 1995, and 1994, respectively. Shares which will be issued under the plan totaled 168,505 at December 31, 1996. BWM and FBT have separate 401(k) plans under which $178,000 and $157,000 were contributed by those banks in 1996 and 1995, respectively. NOTE 11 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK In the normal course of business, to meet the financing needs of their customers and to reduce their own exposure to fluctuations in interest rates, the Banks are parties to financial instruments with off-balance sheet risk, held for purposes other than trading. The financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Banks' exposure to credit loss in the event of nonperformance by the other party to the financial instrument, for loan commitments and standby letters of credit, is represented by the contractual amount of those instruments, assuming that the amounts are fully advanced and that collateral or other security is of no value. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments. The Banks evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Banks upon extension of credit,is based on management's credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income- producing commercial properties. Commitments to originate loans, unused lines of credit, and unadvanced portions of construction loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Many of the commitments are expected to expire without being drawn upon. Therefore, the amounts presented below do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance by a customer to a third party. These guarantees are issued primarily to support public and private borrowing arrangements, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers. Financial instruments whose contractual amounts represent off-balance sheet risk at December 31, 1996 and 1995 are as follows: 1996 1995 ------------------- (in thousands) Commitments to originate loans $33,450 $ 34,189 Unused lines of credit 172,240 189,317 Standby letters of credit 24,231 13,329 Unadvanced portions of construction loans 11,635 9,268 Equity commitments to limited partnerships 675 - <PAGE 33> NOTE 12 COMMITMENTS AND CONTINGENCIES As nonmembers of the Federal Reserve System, the Banks are required to maintain certain reserve requirements of vault cash and/or deposits with the Federal Reserve Bank of Boston. The amount of this reserve requirement, included in cash and cash equivalents, was $27,189,000 and $25,520,000 at December 31, 1996 and 1995, respectively. CTC and FBT have contracts for data processing services that extend to July 1998 and April 1999, respectively. Base fees required to be paid during the remaining terms of the contracts are approximately $6,785,000. Total fees to be paid may be the same as or exceed the base fees depending on additional services rendered and consumer price index changes during the remaining term of the contract. The Company has entered into severance agreements with several members of senior management. Payments under these agreements are triggered by a change of control and subsequent termination of employment under certain circumstances and are equal to 1.5 to 2.99 times annual salary for the individual participating members of senior management. Various legal claims against the Company arising in the normal course of business were outstanding at December 31, 1996. Management, after reviewing these claims with legal counsel, is of the opinion that the resolution of these claims will not have a material effect on financial condition or results of operations. NOTE 13 OTHER NONINTEREST EXPENSE The components of other noninterest expense for the years presented are as follows: 1996 1995 1994 ------------------------------ (in thousands) Data processing $ 5,023 $ 4,463 $ 3,906 Amortization of intangible assets 1,223 1,031 - Legal and professional 1,453 1,254 985 Other 14,177 13,518 10,055 -------------------------------- $21,876 $20,266 $14,946 ================================ NOTE 14 RELATED PARTY TRANSACTIONS Directors and executive officers of the Banks and their associates are credit customers of the Banks in the normal course of business. All loans and commitments included in such transactions are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and do not involve more than normal risk of collectibility or present other unfavorable features. An analysis of loans to directors and executive officers of the Banks and their associates, for 1996, is as follows (in thousands): Balance at Balance at December 31, 1995 Additions Reductions December 31, 1996 ------------------------------------------------------------------------ $8,104 $4,519 $3,763 $8,860 ========================================================================= BWM does business with several businesses controlled by members of its Board of Directors. Amounts paid for rent, marketing, legal services, and insurance to these businesses totaled $439,000 and $370,000 in 1996 and 1995, respectively. FBT purchases loans from a finance company controlled by a member of its Board of Directors. Prepaid interest advanced to this company totaled $1,205,000, $238,000, and $47,000 in 1996, 1995, and 1994, respectively. A construction company, whose principal owner is a member of the Board of Directors of the Company and of CTC, was hired in 1994 to build a new banking facility for CTC. CTC paid the construction company approximately $2,391,000 and $1,575,000 in 1995 and 1994, respectively. <PAGE 34> NOTE 15 QUARTERLY FINANCIAL DATA (UNAUDITED) A summary of quarterly financial data for 1996 and 1995 is presented below: 1996 Three Months Ended March 31 June 30 Sept. 30 Dec. 31 --------------------------------------------------- (in thousands, except per share amounts) Total interest income $34,656 $35,040 $35,941 $36,955 Total interest expense 14,592 14,397 14,828 14,782 ------------------------------------------------- Net interest income 20,064 20,643 21,113 22,173 Provision for possible loan losses 983 1,025 850 1,325 Noninterest income 6,132 6,337 6,306 6,145 Noninterest expense 16,092 15,934 16,252 16,279 ------------------------------------------------- Income before income taxes 9,121 10,021 10,317 10,714 Provision for income taxes 3,108 3,324 3,440 3,580 ------------------------------------------------- Net income $ 6,013 $ 6,697 $ 6,877 $ 7,134 ================================================== Earnings per share $ 0.49 $ 0.54 $ 0.55 $ 0.57 Dividends declared per share $ 0.11 $ 0.20 $ 0.20 $ 0.20 1995 Three Months Ended March 31 June 30 Sept. 30 Dec. 31 ------------------------------------------------------ (in thousands, except per share amounts) Total interest income $29,812 $34,558 $35,164 $35,569 Total interest expense 12,191 14,835 14,806 14,940 ----------------------------------------------------- Net interest income 17,621 19,723 20,358 20,629 Provision for possible loan losses 1,150 800 1,400 1,650 Noninterest income 5,196 5,387 5,795 5,662 Noninterest expense(1) 13,593 15,611 15,051 17,329 ---------------------------------------------------- Income before income taxes 8,074 8,699 9,702 7,312 Provision for income taxes 2,732 2,993 3,262 2,669 ---------------------------------------------------- Net income $ 5,342 $ 5,706 $ 6,440 $ 4,643 ==================================================== Earnings per share $ 0.47 $ 0.47 $ 0.52 $ 0.38 Dividends declared per share $ 0.08 $ 0.10 $ 0.11 $ 0.11 ___________________________ (1) Merger expenses of $1,703,000 related to the FBT acquisition were recognized in the fourth quarter. Also, noninterest expense increased in the fourth quarter due to accruals for various performance-based incentive plans. NOTE 16 FAIR VALUE OF FINANCIAL INSTRUMENTS CASH AND CASH EQUIVALENTS The carrying amounts for cash and cash equivalents approximate fair value because they mature in 90 days or less and do not present unanticipated valuation risk. SECURITIES The fair value of investment securities, other than obligations of states, political subdivisions, and Federal Home Loan Bank (FHLB) stock, is based on quoted market prices. The fair value of obligations of states and political subdivisions is estimated to be equal to amortized cost since most of these notes mature within six months and there is no active market for these instruments. The carrying value of FHLB stock represents its redemption value. LOANS Fair values are estimated for portfolios of loans with similar financial and credit characteristics. The loan portfolio was evaluated in the following segments: commercial, residential real estate, commercial real estate, construction, home equity, and other consumer loans. Other consumer loans include installment, credit card, and student loans. Each of these consumer portfolios also was evaluated separately. The fair value of performing commercial and real estate loans is estimated by discounting cash flows through the estimated maturity using discount rates that reflect the expected maturity and the credit and interest rate risk inherent in <PAGE 35> such loans. The fair value of nonperforming commercial and real estate loans is estimated using historical net charge- off experience applied to the nonperforming balances. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources. The fair value of home equity, credit card, leasing, and other consumer loans is estimated based on secondary market prices for asset-backed securities with similar characteristics. PURCHASED MORTGAGE SERVICE RIGHTS & ORIGINATED MORTGAGE SERVICE RIGHTS The fair value is estimated by discounting the future cash flows through the estimated maturity of the underlying mortgage loans. DEPOSITS The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings and N.O.W. accounts, and money market and checking accounts, is equal to the amount payable on demand,that is, the carrying amount. The fair value of certificates of deposit and retirement accounts is based on the discounted value of contractual cash flows. The discount rate used is based on the estimated rates currently offered for deposits of similar remaining maturities. BORROWINGS The carrying amounts for short-term borrowings approximate fair value because they mature or are callable in ten days or less and do not present unanticipated valuation risk. Long-term debt has an estimated fair value equal to its carrying amount. COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of financial standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. ASSUMPTIONS Fair value estimates are made at a specific point in time, based on relevant market information and information about specific financial instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Banks entire holdings of a particular financial instrument. Because no active observable market exists for a significant portion of the Banks financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. The estimated fair values of the Company s financial instruments are as follows: December 31, ----------------------------------- 1996 1995 ------------------------------------ Carrying Amount Fair Value ------------------------------------ (in thousands) Financial assets: Cash and cash equivalents $ 230,259 $ 230,259 Securities available for sale 358,536 358,536 Securities held for investment 38,556 38,381 Federal Home Loan Bank Stock 5,591 5,591 Loans, net 1,268,472 1,271,139 Mortgage loans held for sale 9,870 9,870 Mortgage servicing rights 3,025 3,938 Financial liabilities: Deposits: Demand 286,932 286,932 Savings 961,902 961,902 Time: Certificates of deposit $100,000 and over 104,295 104,346 Other time deposits 408,450 409,303 Short-term borrowings 23,992 23,992 Long-term debt 2,540 2,540 Commitments 121 105 December 31, --------------------------------- 1995 --------------------------------- Carrying Amount Fair Value --------------------------------- (in thousands) Financial assets: Cash and cash equivalents $ 197,140 $ 197,140 Securities available for sale 278,322 278,322 Securities held for investment 43,164 42,634 Federal Home Loan Bank Stock 5,591 5,591 Loans, net 1,179,788 1,191,666 Mortgage loans held for sale 14,692 14,692 Mortgage servicing rights 2,126 2,126 Financial liabilities: Deposits: Demand 252,421 252,421 Savings 807,132 807,132 Time: Certificates of deposit $100,000 and over 105,604 105,755 Other time deposits 422,566 423,529 Short-term borrowings 25,025 25,025 Long-term debt 2,484 2,484 Commitments 130 125 <PAGE 36> NOTE 17 PARENT COMPANY FINANCIAL STATEMENTS CHITTENDEN CORPORATION (PARENT COMPANY ONLY) BALANCE SHEETS December 31, --------------------- 1996 1995 --------------------- (in thousands) Assets Restated Cash and cash equivalents $ 9,732 $ 6,621 Investment securities 330 247 Investment in bank subsidiaries at equity in net assets 164,240 146,813 Other assets 376 323 --------------------- Total assets $174,678 $154,004 ===================== Liabilities and stockholders' equity Liabilities: Accrued expenses and other liabilities $ 277 $ 55 --------------------- Total liabilities 277 55 --------------------- Total stockholders' equity 174,401 153,949 --------------------- Total liabilities and stockholders equity $174,678 $154,004 ===================== STATEMENTS OF INCOME Years Ended December 31, ------------------------------ 1996 1995 1994 ------------------------------ (in thousands) Operating income: Restated Dividends from bank subsidiaries $10,383 $17,324 $13,573 Dividends from investment securitie 11 10 19 Interest income 92 135 13 --------------------------------- Total operating income 10,486 17,469 13,605 --------------------------------- Operating expense 929 610 1,268 --------------------------------- Total operating expense 929 610 1,268 --------------------------------- Income before income taxes and equity in undistributed earnings of subsidiaries 9,557 16,859 12,337 Income tax benefit 260 143 420 --------------------------------- Income before equity in undistributed earnings of subsidiaries 9,817 17,002 12,757 Equity in undistributed earnings of bank subsidiaries 16,904 5,129 5,280 --------------------------------- Net income $26,721 $22,131 $18,037 ================================= STATEMENTS OF CASH FLOWS Years Ended December 31, -------------------------------- 1996 1995 1994 -------------------------------- (in thousands) Cash flows from operating activities: Restated Net income $26,721 $22,131 $18,037 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of bank subsidiaries (16,904) (5,129) (5,280) (Increase) decrease in other assets (136) 404 (252) Increase (decrease) in accrued expenses and other liabilities (29) (96) 105 ---------------------------------- Net cash provided by operating activities 9,652 17,310 12,610 ---------------------------------- Cash flows from investing activities: Purchase of The Bank of Western Massachusetts - (12,177) - ----------------------------------- Net cash used in investing activities - (12,177) - ----------------------------------- Cash flows from financing activities: Proceeds from issuance of treasury and common stock 2,206 1,280 320 Dividends on common stock (8,747) (4,803) (3,136) Repurchase of common stock - - (6,685) ----------------------------------- Net cash used in financing activities (6,541) (3,523) (9,501) ----------------------------------- Net increase in cash and cash equivalents 3,111 1,610 3,109 Cash and cash equivalents at beginning of year 6,621 5,011 1,902 ---------------------------------- Cash and cash equivalents at end of year $ 9,732 $ 6,621 $ 5,011 ================================== <PAGE 37> NOTE 18 REGULATORY MATTERS The Company and the Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Each entity s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Banks to maintain minimum amounts and ratios (set forth in the tables below) of total and Tier I capital (as defined in the regulation) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of December 31, 1996, that the Company and the Banks meet all capital adequacy requirements to which they are subject. As of December 31, 1996, the most recent notification from the Federal Deposit Insurance Corporation categorized the Company and the Banks as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately or well-capitalized, the Company and the Banks must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the tables below. There are no conditions or events since that date that management believes have changed the institutions categories. The Company's and the Banks actual capital amounts (dollars in thousands) and ratios are presented in the following tables: For Capital Actual Adequacy Purposes ------------------------------------------ Amount Ratio Amount Ratio ------------------------------------------ As of December 31, 1996: Total Capital (to Risk Weighted Assets): Consolidated $180,962 13.06% $110,822 8.00% Chittenden Trust Company 126,285 12.51 80,736 8.00 Bank of Western Massachusetts 21,270 11.44 14,878 8.00 Flagship Bank & Trust 23,364 12.21 15,302 8.00 Tier 1 Capital (to Risk Weighted Assets): Consolidated 163,513 11.71 55,837 4.00 Chittenden Trust Company 113,577 11.17 40,666 4.00 Bank of Western Massachusetts 18,918 10.05 7,528 4.00 Flagship Bank & Trust 20,961 10.90 7,690 4.00 Tier 1 Capital (to Average Assets): Consolidated 163,513 8.58 76,245 4.00 Chittenden Trust Company 113,577 8.42 53,968 4.00 Bank of Western Massachusetts 18,918 7.85 9,642 4.00 Flagship Bank & Trust 20,961 6.85 12,238 4.00 To Be Well Capitalized Under Prompt Correction Action Provisions: ------------------- Amount Ratio ------------------- As of December 31, 1996: Total Capital (to Risk Weighted Assets): Consolidated N/A N/A Chittenden Trust Company $100,920 10.00% Bank of Western Massachusetts 18,598 10.00 Flagship Bank & Trust 19,128 10.00 Tier 1 Capital (to Risk Weighted Assets): Consolidated N/A N/A Chittenden Trust Company 60,999 6.00 Bank of Western Massachusetts 11,292 6.00 Flagship Bank & Trust 11,534 6.00 Tier 1 Capital (to Average Assets): Consolidated N/A N/A Chittenden Trust Company 67,460 5.00 Bank of Western Massachusetts 12,053 5.00 Flagship Bank & Trust 15,297 5.00 <PAGE 38> For Capital Actual Adequacy Purposes ---------------------------------------- Amount Ratio Amount Ratio ---------------------------------------- As of December 31, 1995 (unaudited): Total Capital (to Risk Weighted Assets): Consolidated $157,326 12.53% $100,437 8.00% Chittenden Trust Company 112,665 12.42 72,559 8.00 Bank of Western Massachusetts 18,512 10.54 14,048 8.00 Flagship Bank & Trust 19,347 11.21 13,810 8.00 Tier 1 Capital (to Risk Weighted Assets): Consolidated 141,453 11.16 50,697 4.00 Chittenden Trust Company 101,215 11.05 36,639 4.00 Bank of Western Massachusetts 16,290 9.16 7,112 4.00 Flagship Bank & Trust 17,149 9.89 6,937 4.00 Tier 1 Capital (to Average Assets): Consolidated 141,453 8.05 70,280 4.00 Chittenden Trust Company 101,215 8.01 50,572 4.00 Bank of Western Massachusetts 16,290 7.18 9,080 4.00 Flagship Bank & Trust 17,149 6.43 10,675 4.00 To Be Well Capitalized Under Prompt Correction Action Provisions: -------------------- Amount Ratio -------------------- As of December 31, 1995 (unaudited): Total Capital (to Risk Weighted Assets): Consolidated N/A N/A Chittenden Trust Company $ 90,698 10.00% Bank of Western Massachusetts 17,560 10.00 Flagship Bank & Trust 17,263 10.00 Tier 1 Capital (to Risk Weighted Assets): Consolidated N/A N/A Chittenden Trust Company 54,958 6.00 Bank of Western Massachusetts 10,667 6.00 Flagship Bank & Trust 10,406 6.00 Tier 1 Capital (to Average Assets): Consolidated N/A N/A Chittenden Trust Company 63,215 5.00 Bank of Western Massachusetts 11,350 5.00 Flagship Bank & Trust 13,344 5.00 NOTE 19 SUBSEQUENT EVENT On January 16, 1997, the Company s Board of Directors authorized the repurchase of up to one million shares of the Company s common stock in negotiated transactions or open market purchases. The authorized repurchases may be made over a period of up to two years and will be used to fund obligations for employee and director stock ownership plans. <PAGE 39> REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF CHITTENDEN CORPORATION: We have audited the accompanying consolidated balance sheets of Chittenden Corporation and its subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders equity and cash flows for each of the three years in the period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Chittenden Corporation and its subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. As explained in Note 1 to the financial statements, effective January 1, 1996, the Company changed its method of accounting for originated mortgage servicing rights. S/ARTHUR ANDERSEN LLP Boston, Massachusetts January 16, 1997 <PAGE 40> FIVE-YEAR CONSOLIDATED FINANCIAL SUMMARY Years Ended December 31, ---------------------------------------- 1996 1995 1994 ---------------------------------------- (in thousands, except share amounts) Statements of income: Interest income $142,592 $135,103 $101,383 Interest expense 58,599 56,772 36,088 ---------------------------------------- Net interest income 83,993 78,331 65,295 Provision for possible loan losses 4,183 5,000 5,500 Net interest income after provision for possible loan losses 79,810 73,331 59,795 Noninterest income 24,920 22,040 19,352 Noninterest expense 64,557 61,584 51,393 ---------------------------------------- Income before provision for income taxes 40,173 33,787 27,754 Provision for income taxes 13,452 11,656 9,717 ----------------------------------------- Income before cumulative effect of change in accounting principle 26,721 22,131 18,037 Cumulative effect of change in accounting principle - - - ------------------------------------------ Net income $ 26,721 $ 22,131 $ 18,037 ========================================== Total assets at year-end $1,988,746 $1,794,704 $1,461,419 Long-term debt at year-end 2,540 2,484 1,528 Balance sheets - average daily balances: Total assets $1,841,944 $1,687,803 $1,436,462 Loans, net of allowance 1,241,166 1,146,239 960,807 Investment securities and interest- bearing cash equivalents 451,670 404,380 362,510 Total deposits 1,627,834 1,486,500 1,268,338 Long-term debt 2,514 1,662 1,406 Total stockholders equity 162,823 138,641 115,439 Per common share: Net income $2.14 $1.83 $1.57 Cash dividends declared 0.71 0.40 0.27 Book value 14.21 12.85 10.43 Weighted average shares outstanding 12,468,200 12,084,731 11,472,933 Selected financial percentages: Return on average total assets 1.45% 1.31% 1.25% Return on average stockholders' equity 16.41 15.96 15.62 Interest rate spread 4.23 4.34 4.37 Net yield on earning assets 4.99 5.08 4.95 Net charge-offs as a percent of average loans 0.31 0.30 0.51 Nonperforming assets ratio1 1.04 1.25 1.08 Allowance for possible loan losses as a percent of year-end loans 2.17 2.30 2.18 Year-end leverage capital ratio 8.58 8.05 8.10 Risk-based capital ratios: Tier 1 11.71 11.16 11.40 Total 13.06 12.53 12.76 Average stockholders equity to average assets 8.84 8.21 8.03 Common stock dividend payout ratio(2) 32.73 21.71 17.38 Years Ended December 31, ---------------------------- 1993 1992 ---------------------------- (in thousands, except share amounts) Statements of income: Interest income $93,889 $101,877 Interest expense 34,395 47,421 ---------------------------- Net interest income 59,494 54,456 Provision for possible loan losses 8,135 11,096 Net interest income after provision for possible loan losses 51,359 43,360 Noninterest income 22,793 19,983 Noninterest expense 54,263 52,059 ---------------------------- Income before provision for income 19,889 11,284 taxes Provision for income taxes 6,387 2,865 ---------------------------- Income before cumulative effect of change in accounting principle 13,502 8,419 Cumulative effect of change in accounting principle (575) - ---------------------------- Net income $12,927 $ 8,419 ============================ Total assets at year-end $1,466,292 $1,397,552 Long-term debt at year-end 4,377 7,384 Balance sheets - average daily balances: Total assets $1,379,830 $1,361,189 Loans, net of allowance 975,027 976,083 Investment securities and interest- bearing cash equivalents 291,414 267,698 Total deposits 1,200,778 1,188,535 Long-term debt 1,360 3,336 Total stockholders equity 105,732 95,008 Per common share: Net income $1.14 $0.74 Cash dividends declared 0.13 0.07 Book value 9.96 8.78 Weighted average shares outstanding 11,314,546 11,328,386 Selected financial percentages: Return on average total assets 0.94% 0.62% Return on average stockholders equity 12.23 8.86 Interest rate spread 4.22 3.87 Net yield on earning assets 4.70 4.43 Net charge-offs as a percent of average loans 0.59 0.92 Nonperforming assets ratio1 1.92 2.98 Allowance for possible loan losses as a percent of year-end loans 2.22 1.92 Year-end leverage capital ratio 7.94 7.14 Risk-based capital ratios: Tier 1 10.91 9.55 Total 12.25 10.91 Average stockholders equity to average assets 7.66 6.98 Common stock dividend payout ratio2 11.70 9.81 __________________________ (1) The sum of nonperforming assets (nonaccrual loans, restructured loans, and other real estate owned) divided by the sum of total loans and other real estate owned (2) Common stock cash dividends declared divided by net income (3) All information for the years 1992-1995 has been restated to include FBT, which was acquired on February 29, 1996, and accounted for as a pooling of interests. <PAGE 41> MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For the Years Ended December 31, 1996, 1995, and 1994 OVERVIEW The following discussion and analysis of financial condition and results of operations of Chittenden Corporation ( Chittenden or the Company ) and its subsidiaries, Chittenden Trust Company (CTC), The Bank of Western Massachusetts (BWM), Flagship Bank and Trust Company (FBT), (collectively, the Banks ), and Chittenden Connecticut Corporation should be read in conjunction with the consolidated financial statements and notes thereto and selected statistical information appearing in this annual report. On March 17, 1995, the Company acquired all of the outstanding shares of BWM for a combination of cash and common stock of the Company. The transaction has been accounted for as a purchase and, accordingly, the consolidated statements of income for 1996 and 1995 include BWM s results of operations for the period from the acquisition date. On February 29, 1996, the Company acquired all of the outstanding shares of FBT in exchange for 1.6 million shares of Chittenden stock. The transaction has been accounted for as a pooling of interests and, accordingly, all historical financial information has been restated to reflect the acquired bank. Chittenden reported net income of $26.7 million for 1996, up from $22.1 million for 1995, and $18.0 million in 1994. Total assets at December 31, 1996 were $2.0 billion, up from $1.8 billion at year-end 1995. The return on average assets was 1.45% for 1996, up from 1.31% in 1995 and 1.25% in 1994. The return on average stockholders' equity was 16.41% for 1996, compared with 15.96% for 1995 and 15.62% for 1994. The growth in total assets of the Company from year-end 1995 to year-end 1996 was distributed across all three banks and was concentrated in loans as well as investments. Earnings continued their upward trend in 1996 due to several factors. Net interest income increased $5.7 million to $84.0 million due to the higher level of average earning assets, which offset a decrease in the net yield from 5.08% to 4.99%. The provision for possible loan losses was $4.2 million, down $817,000 from the 1995 level reflecting continued strength in asset quality. Revenues from noninterest sources were $24.9 million, up $2.9 million, led by higher gains on sales of mortgage loans and by higher net credit card processing revenues. The increase in mortgage gains was attributable to the adoption of SFAS No. 122, effective January 1, 1996, which requires the capitalization of originated servicing rights related to loans sold on a servicing retained basis. An additional $1.3 million in gains representing the value of the mortgage servicing rights were recognized in 1996. Net credit card revenue increased 16% to $4.2 million as a result of higher processing volumes in 1996 over 1995 levels. Noninterest expense, at $64.6 million, increased by $3.0 million. Total noninterest expenses were $1.6 million higher in 1996 than in the previous year due to the completion of the BWM acquisition late in the first quarter of 1995. Considering the effect of including The Bank of Western Massachusetts for the full year, noninterest expenses were up 2% for 1996 compared to the previous year. The $4.1 million increase in net income from 1994 to 1995 resulted from improvements in several elements of earnings. Net interest income increased $13.0 million to $78.3 million due to the higher level of average earning assets contributed by the BWM acquisition, as well as to an increase in the net yield. The provision for possible loan losses was $5.0 million, down $500,000 from the 1994 level reflecting continued strength in asset quality. Revenues from noninterest sources were $22.0 million, up $2.7 million, led by higher credit card processing revenues and higher service charges on deposit accounts. Noninterest expense, at $61.6 million, increased by $10.2 million, owing primarily to increased salaries and employee benefits costs of $4.7 million approximately half of which resulted from the inclusion of the Bank of Western Massachusetts since its March 17, 1995 acquisition date. Other increases in noninterest expense included transaction costs related to the acquisition of FBT totalling $1.8 million in 1995 and increased amortization of intangible assets relating to the BWM acquisition totalling $1.0 million. Despite a lower effective tax rate, the 1995 income tax provision of $11.7 million exceeded the 1994 provision by $1.9 million, as the level of taxable income increased. <PAGE 42> FINANCIAL CONDITION LOANS Chittenden's gross loan portfolio increased by $89.0 million during 1996, to end the year at $1,296.6 million. In addition, the overall proportions of commercial-related and consumer types of loans changed from the mix at the end of 1995. The Company continues to pursue its strategy of gradually shifting the loan mix through continued focus on commercial and non-real estate consumer lending simultaneous with secondary market sales of originated fixed-rate residential mortgage loans. Growth in non-residential consumer loans, including leases, was $42.9 million or 27% from the previous year, while non-real estate commercial loan growth was $24.4 million or 10% from year-end 1995. More modest growth was seen in the real estate portfolio, which increased $16.0 million or 2.2%. The classification of the Company s loan portfolio is based on underlying collateral. At December 31, 1996, commercial loans secured by non-real estate business assets totaled $273.0 million, or 21% of total loans, up from the $248.6 million, or 21% of total loans, posted at year-end 1995. Commercial real estate loans, representing slightly less than one quarter of the portfolio, stood at $304.5 million at year-end 1996, down slightly from $305.9 million at December 31, 1995. Construction loans amounted to $25.1 million at December 31, 1996, down slightly from $25.8 million the year before. Residential real estate loans stood at $406.9 million at year-end 1996, up from $388.7 million at December 31, 1995. Reflecting the shift in the Company s loan mix noted above, this category represented 31% of the portfolio at year-end 1996, down from 32% at year-end 1995. In total, $264.2 million in mortgages were originated during 1996, up from $193.0 million during 1995. Secondary market sales of mortgage loans totaled $201.4 million in 1996, up from $150.8 million in 1995. The Company underwrites substantially all of its residential mortgages to secondary market standards. During 1996, the Company continued to follow its policy of selling substantially all of its fixed-rate residential mortgage production on a servicing-retained basis. The portfolio of residential mortgages serviced for investors continued to grow, totaling $1,006.9 million at December 31, 1996, up from $960.2 million at year- end 1995. These assets are owned by investors other than Chittenden and there- fore are not included in the consolidated balance sheets of the Company. Of the loans serviced, $838.2 million were originated by the Company. During 1995, the Company acquired substantially all of the servicing portfolio of CUMEX, a Massachusetts mortgage company. For $1.8 million, the Company purchased rights to service a portfolio of $130.2 million in residential mortgages in its market area. The outstanding balances on home equity lines totaled $84.3 million at December 31, 1996, up from $78.6 million the previous year. The unused portion of these lines totaled $80.5 million at December 31, 1996, up from $75.2 million at year- end 1995. Consumer loans increased significantly again in 1996, ending the year at $202.8 million, compared with $160.0 million at year-end 1995. This increase resulted from the Company's movement into the indirect auto lending and leasing market, which reflects the Company's emphasis on responding to the marketplace through the development of correspondent bank and dealer relationships. Under the arrangements with smaller correspondent banks, the Company acquires indirect installment loans which the smaller banks do not have balance sheet capacity to retain. The Company underwrites all its indirect automotive loans, maintaining the same credit standards as for car loans originated in its branch offices. Indirect installment lending through auto dealers was up $15.0 million from year-end 1995 to $94.7 million at the end of 1996. During 1995, the Company began offering auto leases through its dealer base. This product is underwritten and priced similarly to indirect installment auto loans. Lease financing receivables outstanding at December 31, 1996 were $41.1 million, up from $12.4 million a year earlier. Contrary to these trends, direct installment and credit card balances at December 31, 1996 stood at $43.0 million and $24.0 million, respectively, compared with $42.4 million and $25.4 million at the end of 1995. Unused portions of credit card lines totaled $72.5 million at the end of 1996, up from $66.4 million one year earlier. The Company s lending activities are conducted in market areas focused in Vermont and western and central Massachusetts, with additional activity related to nearby trading areas in Quebec, New York, New Hampshire, Maine, and Connecticut. In addition to the portfolio diversification described above, the loans are widely diversified by borrowers and industry groups. <PAGE 43> The following table shows the composition of the loan portfolio for the five years ended December 31, 1996: December 31, -------------------------------------- 1996 1995 1994 -------------------------------------- (in thousands) Commercial $ 272,969 $ 248,604 $ 146,982 Real estate: Residential 406,850 388,705 372,344 Commercial 304,530 305,941 258,023 Construction 25,084 25,796 18,813 Home equity 84,319 78,600 76,457 Consumer 161,699 147,540 143,250 Leases 41,117 12,420 -------------------------------------------- Total gross loans 1,296,568 1,207,606 1,015,779 Allowance for possible loan losses (28,096) (27,818) (22,163) -------------------------------------------- Net loans $1,268,472 $1,179,788 $ 993,616 ============================================ Mortgage loans held for sale $9,870 $14,692 $2,870 December 31, ---------------------- 1993 1992 ---------------------- (in thousands) Commercial $ 139,963 $ 156,203 Real estate: Residential 362,292 382,672 Commercial 252,824 239,607 Construction 20,994 24,483 Home equity 75,759 83,219 Consumer 125,423 124,778 Leases - - -------------------------- Total gross loans 977,255 1,010,962 Allowance for possible loan losses (21,672) (19,392) -------------------------- Net loans $ 955,583 $ 991,570 ========================== Mortgage loans held for sale $ 11,646 $7,971 NONPERFORMING ASSETS Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Management classifies loans, except consumer and residential loans, as nonaccrual loans when they become 90 days past due as to principal or interest, unless they are adequately secured and are in the process of collection. In addition, loans which have not met this delinquency test may be placed on nonaccrual at management's discretion. Consumer and residential loans are included when management considers it to be appropriate. Generally, a loan remains on nonaccrual status until the factors which indicated doubtful collectibility no longer exist or the loan is determined to be uncollectible and is charged off against the allowance for possible loan losses. A loan is classified as a restructured loan when the interest rate is reduced and/or other terms are modified because of the inability of the borrower to service debt at current market rates and terms. Other real estate owned ( OREO ) is real estate that has been formally acquired through foreclosure. The following table shows the composition of nonperforming assets and loans past due 90 days or more and still accruing for the five years ended December 31, 1996: December 31, ----------------------------------- 1996 1995 1994 ----------------------------------- (in thousands) Loans on nonaccrual $10,601 $ 9,939 $ 8,289 Loans not included above which are troubled debt restructurings 638 2,502 515 Other real estate owned 2,251 2,652 2,141 ----------------------------------- Total nonperforming assets $13,490 $15,093 $10,945 =================================== Loans past due 90 days or more and still accruing $ 966 $ 1,054 $ 1,134 Percentage of nonperforming assets to total loans and other real estate owned 1.04% 1.25% 1.08% Nonperforming assets to total assets 0.68 0.84 0.75 Allowance for possible loan losses to nonperforming loans 249.99 223.59 251.74 December 31, -------------------- 1993 1992 -------------------- (in thousands) Loans on nonaccrual $13,992 $20,953 Loans not included above which are troubled debt restructurings 1,030 218 Other real estate owned 3,816 9,222 --------------------- Total nonperforming assets $18,838 $30,393 ===================== Loans past due 90 days or more and still accruing $1,576 $2,340 Percentage of nonperforming assets to total loans and other real estate owned 1.92% 2.98% Nonperforming assets to total assets 1.28 2.17 Allowance for possible loan losses to nonperforming loans 144.27 91.60 Total nonperforming assets stood at $13.5 million, or 0.68% of total assets, at year-end 1996, down from $15.1 million, or 0.84% of total assets at the previous year-end. Nonaccrual loans stood at $10.6 million at December 31, 1996, up from $9.9 million the year before. The nonaccrual loans consist of more than 214 loans, the largest of which amounted to $1.8 million at year-end 1996. Troubled debt restructurings stood at $638,000 on December 31, 1996, down from $2.5 million the year before. The nonaccrual loans and restructured debt were diversified across a range of industries, sectors, and geography. OREO totaled $2.3 million at year-end 1996, compared with $2.7 million at the end of 1995. <PAGE 44> The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 114, as amended, Accounting by Creditors for Impairment of a Loan (SFAS 114). The Company adopted the new standard January 1, 1995. In addition to the credit evaluation of the loan portfolios described above, and the evaluation of the allowance for possible loan losses discussed later in this report, the Company also undertakes an analysis of the portfolios and allowance using the impairment approach prescribed in SFAS 114. In this analysis, the Company considers all consumer and residential real estate loans to be smaller balance, homogeneous loans. This evaluation category also includes commercial and commercial real estate loans with balances under $100,000. All other loans are evaluated for impairment according to the Company's normal loan review process, including overall credit evaluation and rating, nonaccrual status, and payment experience. Loans identified as impaired are further evaluated to determine the estimated extent of impairment. For collateral-based loans, the extent of impairment is the shortfall, if any, between the collateral value less costs to dispose of such collateral and the carrying value of the loan. For other loans, the impairment is the shortfall, if any, between the discounted cash flow and the carrying value of the loan. The results of this SFAS 114 analysis are disclosed in the accompanying notes to the consolidated financial statements. Adopting SFAS 114 had no material effect on the Company's financial condition or results of operations. ALLOWANCE FOR POSSIBLE LOAN LOSSES The following table summarizes the activity in the Company s allowance for possible loan losses for the five years ended December 31, 1996: December 31, ------------------------------------------ 1996 1995 1994 ------------------------------------------ (in thousands) Balance of allowance for possible loan losses at beginning of year $27,818 $22,163 $21,672 BWM allowance acquired 4,135 Provision charged to expense 4,183 5,000 5,500 ----------------------------------------- Balance of allowance for possible loan losses after provision 32,001 31,298 27,172 ----------------------------------------- Loans charged off: Commercial 1,770 1,353 1,085 Real estate: Residential 966 1,525 878 Commercial 791 1,596 3,160 Construction 185 4 Home equity 167 108 51 Consumer 2,230 1,900 1,061 ---------------------------------------- Total loans charged off 6,109 6,482 6,239 ---------------------------------------- Recoveries of loans previously charged off: Commercial 822 1,161 555 Real estate: Residential 188 57 99 Commercial 546 1,130 158 Construction 91 Home Equity 8 29 Consumer 549 654 389 --------------------------------------- Total recoveries 2,204 3,002 1,230 --------------------------------------- Net loans charged off 3,905 3,480 5,009 --------------------------------------- Balance of allowance for possible loan losses at end of year $28,096 $27,818 $22,163 ======================================= Amount of loans outstanding at end of year $1,296,568 $1,207,606 $1,015,779 Average amount of loans outstanding 1,269,626 1,172,596 982,961 Ratio of net charge-offs during year to 0.31% 0.30% 0.51% average loans outstanding Allowance as a percent of loans 2.17 2.30 2.18 outstanding at end of year December 31, --------------------------- 1993 1992 --------------------------- (in thousands) Balance of allowance for possible loan losses at beginning of year $19,392 $17,415 BWM allowance acquired Provision charged to expense 8,135 11,096 --------------------------- Balance of allowance for possible loan losses after provision 27,527 28,511 --------------------------- Loans charged off: Commercial 2,606 3,173 Real estate: Residential 1,220 1,121 Commercial 1,639 3,681 Construction 63 87 Home equity 227 338 Consumer 1,292 1,521 ---------------------------- Total loans charged off 7,047 9,921 ---------------------------- Recoveries of loans previously charged off: Commercial 241 332 Real estate: Residential 201 74 Commercial 227 11 Construction Home Equity 51 53 Consumer 472 332 ---------------------------- Total recoveries 1,192 802 ---------------------------- Net loans charged off 5,855 9,119 ---------------------------- Balance of allowance for possible loan losses at end of year $21,672 $19,392 ============================ Amount of loans outstanding at end of year $977,255 $1,010,962 Average amount of loans outstanding 995,743 995,156 Ratio of net charge-offs during year to average loans outstanding 0.59% 0.92% Allowance as a percent of loans outstanding at end of year 2.22 1.92 <PAGE 45> The provision for possible loan losses totaled $4.2 million in 1996, down from $5.0 million in 1995 and $5.5 million in 1994. The provision was reduced due to, among other things, the reduction in the level of net losses experienced in the loan portfolio and the strength of the ratios in connection with the allowance for possible loan losses, as well as an improving economy. The allowance for possible loan losses is based on management s estimate of the amount required to reflect the risks in the loan portfolio, based on circum- stances and conditions known or anticipated at each reporting date. In addition to evaluating the collectibility of specific loans when determining the adequacy of the allowance for possible loan losses, management also takes into considera- tion other factors such as changes in the mix and volume of the loan portfolio, historic loss experience, the amount of delinquencies and loans adversely classified, and economic trends. The adequacy of the allowance for possible loan losses is assessed by an allocation process whereby specific loss allocations are made against adversely classified loans, and general loss allocations are made against segments of the loan portfolio which have similar attributes. As previously mentioned, the mix of the Company s loan portfolio changed during 1995, and this trend continued in 1996. This, and uncertainties concerning how changing interest rates and unclear, or contradictory economic indicators will affect the local and regional economy also were considered by management in determining the adequacy of the allowance for possible loan losses. The following table summarizes the allocation of the allowance for possible loan losses for the five years ended December 31, 1996: December 31, -------------------------------------------------------------- 1996 1995 -------------------------------------------------------------- Amount Loan Amount Loan Allocated Distribution Allocated Distribution -------------------------------------------------------------- (in thousands) Commercial $ 4,494 21% $ 3,901 19% Real estate: Residential 1,395 31 1,452 33 Commercial 5,960 23 6,024 25 Construction 500 2 439 1 Home equity 317 7 291 7 Consumer and leasing 3,149 16 1,754 15 Other 12,281 - 13,957 - ----------------------------------------------------------- $28,096 100% $27,818 100% =========================================================== December 31, ------------------------------------------------------------- 1994 1993 ------------------------------------------------------------- Amount Loan Amount Loan Allocated Distribution Allocated Distribution -------------------------------------------------------------- (in thousands) Commercial $ 2,417 14% $ 2,468 14% Real estate: Residential 764 37 819 37 Commercial 5,692 25 6,259 26 Construction 770 2 510 2 Home equity 268 8 370 8 Consumer and leasing 1,916 14 2,146 13 Other 10,336 - 9,100 - -------------------------------------------------------------- $22,163 100% $21,672 100% ============================================================== December 31, -------------------------- 1992 -------------------------- Amount Loan Allocated Distribution --------------------------- (in thousands) Commercial $ 2,965 16% Real estate: Residential 1,034 38 Commercial 5,662 24 Construction 701 2 Home equity 399 8 Consumer and leasing 1,912 12 Other 6,719 - ---------------------------- $ 19,392 100% ============================= Notwithstanding the foregoing analytical allocations, the entire allowance for possible loan losses is available to absorb charge-offs in any category of loans. (See "Provision for Possible Loan Losses.") INVESTMENT SECURITIES The investment portfolio is used to meet liquidity demands, mitigate interest rate sensitivity, and generate interest income. At December 31, 1996, the Company held investments totaling $358.5 million in the available for sale category and $38.6 million in the held for investment category. This compares with $278.3 million available for sale and $43.2 million held for investment at December 31, 1995. At December 31, 1996, net unrealized losses (net of taxes) of $208,000 resulted from marking to market value the available for sale port- folio. This compares with net unrealized gains (net of taxes) of $768,000 at December 31, 1995. These amounts are reflected in stockholders' equity. The mix of securities held changed little during 1996, with continued emphasis on U.S. Treasury securities. Obligations of U. S. government agencies, municipalities, and corporations continued to represent significant, balanced portions of the portfolio. <PAGE 46> The following tables show the composition of the Company s investment portfolio, at amortized cost, at December 31, 1996 and 1995: December 31, --------------------------- 1996 1995 --------------------------- Securities available for sale (in thousands) U.S. Treasury securities $109,606 $ 81,625 U.S. government agency obligations 76,179 60,448 Obligations of states and political subdivisions 45,123 44,853 Mortgage-backed securities 51,850 49,187 Corporate bonds and notes 65,248 30,072 Government bond mutual funds 10,605 10,605 Marketable equity securities 235 231 --------------------------- $358,846 $277,021 =========================== Securities held for investment U.S. government agency obligation $ 198 $ 298 Obligations of states and political subdivisions 3,466 5,119 Mortgage-backed securities 34,761 37,747 Corporate bonds and notes 25 - Other debt securities 106 - -------------------------- $38,556 $ 43,164 ========================== The following table shows the maturity distribution of the amortized cost of the Company's investment securities and weighted average yields of such securities on a fully taxable equivalent basis, at December 31, 1996, with comparative totals for 1995: After One Within But Within One Year Five Years --------------------------------------------------- Amount Yield Amount Yield --------------------------------------------------- Securities available for sale (in thousands) US Treasury securities $ 24,265 6.11% $ 80,297 5.85% US government agency obligations 7,439 7.10 63,940 6.33 Obligations of states and political subdivisions 42,587 6.18 2,130 8.34 Mortgage-backed securities (1) 8,663 6.85 29,129 6.80 Corporate bonds and notes 17,297 5.67 47,951 6.33 Government bond mutual funds - - - - Marketable equity securities - - - - --------- ----- -------- ------ Total available for sale 100,251 6.20 223,447 6.24 --------- -------- Securities held for investment U.S. Government agency obligations 198 4.99 Obligations of states and political subdivisions 2,549 5.92 605 7.54 Mortgage-backed securities (1) 11,944 5.88 17,868 6.90 Corporate bonds & notes - - - - Other debt securities - - 20 5.00 -------- --------- Total held for investment 14,691 5.87 18,493 6.92 -------- --------- Total securities $114,942 6.16% $241,940 6.29% ======== ========= Comparative amounts at December 31, 1995 $116,649 6.24% $155,707 6.26% After Five But Within After Ten Years Ten Years ------------------------------------------------- Amount Yield Amount Yield ------------------------------------------------- Securities available for sale (in thousands) US Treasury securities $ 5,044 5.58% $ - -% US government agency obligations 3,000 7.82 1,800 7.25 Obligations of states and political subdivisions 406 13.25 - - Mortgage-backed securities (1) 11,529 7.23 2,529 6.78 Corporate bonds and notes - - - - Government bond mutual funds - - - - Marketable equity securities - - - - -------- -------- Total available for sale 19,979 7.02 4,329 6.98 -------- -------- Securities held for investment U.S. Government agency obligations - - - - Obligations of states and political subdivisions 312 9.55 - - Mortgage-backed securities (1) 2,389 7.39 2,560 7.75 Corporate bonds & notes 25 7.00 - - Other debt securities 51 5.78 35 7.50 ------- --------- Total held for investment 2,777 7.60 2,595 7.74 ------- --------- Total securities $22,756 7.09% $6,924 7.26% ======= ========= Comparative amounts at December 31, 1995 $29,222 6.63% $7,771 6.77% No Fixed Maturity Total ------------------------------------------------ Amount Yield Amount Yield ------------------------------------------------ Securities available for sale (in thousands) US Treasury securities $- -% $109,606 5.90% US government agency obligations - - 76,179 6.47 Obligations of states and political subdivisions - - 45,123 6.35 Mortgage-backed securities (1) - - 51,850 6.92 Corporate bonds and notes - - 65,248 6.15 Government bond mutual funds 10,609 5.45 10,609 5.45 Marketable equity securities 231 4.90 231 4.90 ------ ------ Total available for sale 10,840 5.44 358,846 6.25 ====== ======= Securities held for investment U.S. Government agency obligations - - 198 4.99 Obligations of states and political subdivisions - - 3,466 6.53 Mortgage-backed securities (1) - - 34,761 6.95 Corporate bonds & notes - - 25 7.00 Other debt securities - - 106 6.20 ------ -------- Total held for investment - - 38,556 6.62 ------ -------- Total securities $10,840 5.44% $397,402 6.29% ====== ========= Comparative amounts at December 31, 1995 $10,836 5.28% $320,185 6.27% __________________________ (1) Maturities of mortgage-backed securities are based on forecasted mortgage loan prepayments. <PAGE 47> DEPOSITS During 1996, total deposits averaged $1,627.8 million, up from $1,486.5 million in 1995. Noninterest-bearing demand deposits averaged $251.3 million, up from $223.8 million in 1995. Savings and time deposits under $100,000 increased $114.9 million, to $1,263.2 million for 1996. Within this category, noncontractual interest bearing deposit products, such as savings, money market, and N.O.W. accounts had the most growth, increasing 11% over 1995. During 1996, time accounts (retirement and certificates of deposit) totaling $543.9 million increased 7% compared to $508.7 million in 1995. The Company has a number of institutional customers whose investment needs frequently are met by purchasing certificates of deposit over $100,000. During 1996, the average balance in this category decreased to $113.4 million, from $114.4 million for 1995. Depositors in this category tend to seek bids regularly, and the Company raises or lowers the interest rates it offers depending on its liquidity needs and on its investment opportunities. The following table shows average daily balances of the Company s deposits for the periods indicated: Years Ended in December 31, ---------------------------------------- 1996 1995 1994 ---------------------------------------- (in thousands) Demand deposits $ 251,276 $ 223,800 $ 200,352 Savings and time deposits under $100,000 1,263,178 1,148,305 1,000,276 Certificates of deposit $100,000 and over 113,380 114,395 67,710 ----------------------------------------- $1,627,834 $1,486,500 $1,268,338 ========================================= The Company's outstanding certificates of deposit and other time deposits in denominations of $100,000 and over had maturities as follows: December 31, --------------- 1996 --------------- (in thousands) Three months or less $ 73,043 Over three months to six months 15,421 Over six months to twelve months 15,831 Over twelve months 8,303 -------------- $112,598 ============== BORROWINGS During 1996, short-term borrowings averaged $28.2 million, down from the $42.6 million posted in 1995. This funding consists of borrowings from the U.S. Treasury, securities sold under agreements to repurchase, and Federal funds purchased. Treasury borrowings averaged $15.3 million for 1996 compared with $19.6 million during 1995. Treasury funding is attractive to the Company because the rate of interest paid on borrowings floats at 25 basis points below the Federal funds rate, there are no reserve requirements, and there are no FDIC insurance costs. Repurchase agreements averaged $10.1 million for 1996, down from the $11.3 million posted during 1995. These borrowings have neither reserve requirements nor FDIC insurance costs. FHLB borrowings averaged $2.3 million for 1996 compared with $7.2 million for 1995. U.S. Treasury and agency securities, mortgage-backed securities, corporate notes and residential mortgage loans are pledged as collateral for the Treasury borrowings and repurchase agreements. Federal funds purchased averaged $382,000 for 1996 compared with $4.5 million for 1995. Long-term borrowings averaged $2.5 million in 1996 compared with $1.7 million in 1995. CAPITAL RESOURCES The Company s capital forms the foundation for maintaining investor confidence as well as for developing programs for growth and new activities. The Company continued to maintain and build on its capital position during 1996. At December 31, 1996, capital stood at $174.4 million, up $20.5 million from $153.9 million at December 31, 1995. Earnings of $26.7 million and $3.5 million of common stock issued in connection with benefit plans added to capital during the year. Dividend payments totaling $8.7 million reduced the capital position, as did a change in the net unrealized gain on securities available for sale of $976,000. The capital position increased during 1995 by $40.6 million. Earnings of $22.1 million, $14.3 million of stock issued in connection with the acquisition of BWM, $1.3 million of stock issued in connection with benefit plans, and a $7.7 million improvement in the valuation allowance for unrealized losses on available for sale securities, were reduced by dividend payments of $4.8 million. <PAGE 48> Both the Board of Governors of the Federal Reserve System (the FRB ) and the Federal Deposit Insurance Corporation (the FDIC ) have defined leverage capital requirements. At December 31, 1996, the Company s leverage capital ratio (which is calculated pursuant to the FRB s regulations) was 8.58%, CTC's, BWM's, and FBT's leverage capital ratios (which are calculated pursuant to the FDIC s regulations) were 8.42%, 7.85% and 6.85%, respectively. The ratios in 1995 were 8.05% for the Company, 8.01% for CTC, 7.18% for BWM, and 6.43% for FBT. Additionally, the FRB and the FDIC have a risk-based capital standard. Under this measure of capital, banks are required to hold more capital against certain assets perceived as more-risky, such as commercial loans, than against other assets perceived as less-risky, such as residential mortgage loans and U.S. Treasury securities. Further, off-balance sheet items such as unfunded loan commitments and standby letters of credit, are included for the purposes of determining risk-weighted assets. Commercial banking organizations are required to have total capital equal to 8% of risk-weighted assets, and Tier 1 capital consisting of common stock and certain types of preferred stock equal to at least 4% of risk-weighted assets. Tier 2 capital, included in total capital, includes the allowance for possible loan losses up to a maximum of 1.25% of risk-weighted assets. At December 31, 1996, the Company s risk-based capital ratio was 13.06% and its Tier 1 capital, consisting entirely of common stock, was 11.71% of risk-weighted assets. This compares with year-end 1995 ratios of 12.53% and 11.16%, respectively. FDIC regulations pertaining to capital adequacy, which apply to the Banks, require a minimum 3% leverage capital ratio for those institutions with the most favorable composite regulatory examination rating. In addition, a 4% Tier 1 risk-based capital ratio, and an 8% total risk-based capital ratio are required for a bank to be considered adequately capitalized. Leverage, Tier 1 risk-based and total risk-based capital ratios exceeding 5%, 6%, and 10%, respectively, qualify a bank for the well-capitalized designation. At December 31, 1996, CTC's leverage capital ratio was 8.42%, its Tier 1 risk-based capital ratio was 11.17%, and its total risk-based capital ratio was 12.51%; BWM s ratios were 7.85%, 10.05%, and 11.44%, respectively, while FBT s ratios were 6.85%, 10.90%, and 12.21%, respectively. These ratios placed the Banks in the FDIC s highest capital category. Capital ratios in excess of minimum requirements indicate capacity to take advantage of profitable and credit-worthy opportunities as they occur in the future. The following table presents capital components and ratios of the Company at December 31, 1996, 1995, and 1994: December 31, ---------------------------------------- 1996 1995 1994 ---------------------------------------- (in thousands) Leverage Stockholders equity $ 163,513 $ 141,453 $ 119,568 Total average assets (1) 1,906,114 1,757,002 1,475,612 Leverage capital ratio 8.58% 8.05% 8.10% Risk-based Capital components: Tier 1 $ 163,513 $ 141,453 $ 119,568 Tier 2 17,449 15,873 13,133 -------------------------------------------- Total $ 180,962 $ 157,326 $ 132,701 ============================================ Risk-weighted assets: On-balance sheet $1,331,203 $1,216,807 $983,346 Off-balance sheet 75,308 62,347 65,764 -------------------------------------------- $1,406,511 $1,279,154 $1,049,110 ============================================ Ratios: Tier 1 11.71% 11.16% 11.40% Total (including Tier 2) 13.06 12.53 12.76 __________________________ (1) Total average assets are for the most recent quarter. LIQUIDITY AND RATE SENSITIVITY The Company s liquidity and rate sensitivity are monitored by the asset and liability committee. Strategies are imple-mented by the Banks asset and liability committees. These committees meet on a regular basis to review and direct the Banks' lending and deposit-gathering functions. Investment and borrowing activities are managed by the Company's Treasury function. The measure of an institution s liquidity is its ability to meet its cash commitments at all times with available cash or by conversion of other assets to cash at a reasonable price. At December 31, 1996, the Company maintained cash and cash equivalents of $230.3 million, compared with $197.1 million at the end of 1995. During 1996, the Company continued to be an average daily net seller of Federal funds. <PAGE 49> Interest rate sensitivity is managed by the asset and liability committee whose goals include achieving adequate and stable interest income. One of the tools used to measure rate sensitivity is the funds gap. The funds gap is defined as the amount by which a bank's rate sensitive assets exceed its rate sensitive liabilities. A positive gap exists when rate sensitive assets exceed rate sensitive liabilities. This indicates that a greater volume of assets than liabilities will reprice during a given period. This mismatch will improve earnings in a rising rate environment and inhibit earnings when rates decline. Conversely, when rate sensitive liabilities exceed rate sensitive assets, the gap is referred to as negative and indicates that a greater volume of liabilities than assets will reprice during the period. In this case, a rising rate environment will inhibit earnings and declining rates will improve earnings. Notwithstanding this general description of the effect on income of the gap position, it may not be an accurate predictor of changes in net income. The following table shows the amounts of interest-earning assets and interest- bearing liabilities at December 31, 1996 which reprice during the periods indicated: Repricing Date ------------------------------------------------------------- Over One Day Over Six One Year Over To Six Months To To Five Five Months One Year Years Years Total ------------------------------------------------------------- Interest-earning assets: (in thousands) Loans: Commercial $218,826 $5,787 $32,288 $16,068 $272,969 Real estate: Commercial and construction 237,814 7,612 51,457 32,731 329,614 Residential 124,629 91,510 91,282 99,429 406,850 Home equity 71,519 924 11,876 - 84,319 Consumer 74,432 25,904 95,484 6,996 202,816 -------------------------------------------------------------- Total loans 727,220 131,737 282,387 155,224 1,296,568 Investment securities (1) 68,691 51,584 252,495 24,322 397,092 Interest-bearing cash equivalents 128,722 - - - 128,722 --------------------------------------------------------------- Total interest-earning assets 924,633 183,321 534,882 179,546 1,822,382 --------------------------------------------------------------- Interest-bearing liabilities: Certificates of deposit $100,000 and over 85,297 12,909 6,089 104,295 Other time deposits (2) 765,855 116,462 90,659 278 973,254 Short-term borrowings 23,894 - 98 - 23,992 Long-term borrowings - - 1,000 1,540 2,540 ---------------------------------------------------------------- Total interest-bearing liabilities 875,046 129,371 97,846 1,818 1,104,081 ---------------------------------------------------------------- Net interest rate sensitivity gap $49,587 $53,950 $437,036 $177,728 $718,301 ================================================================ Cumulative gap at December 31, 1996 $49,587 $103,537 $540,573 $718,301 Cumulative gap at December 31, 1995 $184,883 $227,557 $486,128 $642,113 ___________________________ (1) Amounts are based on amortized cost balances. (2) Regular savings deposits and N.O.W. accounts of $397.1 million at December 31, 1996, and $394.9 million at December 31, 1995, are not included because repricing of these liabilities is neither required nor defined. The following table shows scheduled maturities of selected loans at December 31, 1996: Less One Year Over Than One To Five Five Year Years Years Total ----------------------------------------------------- (in thousands) Predetermined rates: Commercial $13,577 $31,752 $16,019 $61,348 Commercial real estate and construction 15,547 43,460 35,319 94,326 ------------------------------------------------------ $29,124 $75,212 $51,338 $155,674 ====================================================== Floating or adjustable rates: Commercial $ 92,409 $ 92,374 $26,838 $211,621 Commercial real estate and construction 62,911 101,262 71,115 235,288 ------------------------------------------------------ $155,320 $193,636 $97,953 $446,909 ======================================================= <PAGE 50> RESULTS OF OPERATIONS Comparison of Years Ended December 31, 1996 and 1995 NET INTEREST INCOME For 1996, net interest income was $84.0 million, up $5.7 million from the 1995 level. On a fully taxable equivalent basis, net interest income increased $5.8 million from 1995, to $85.9 million in 1996. These improvements resulted from higher levels of interest-earning assets which outpaced a decrease in the net yield on earning assets. Average interest-earning assets totaled $1,721.3 million for 1996, up $144.3 million from the 1995 level. The taxable equivalent net yield on earning assets was 4.99% in 1996, down nine basis points from 5.08% in 1995. Because the reduction in the average yield on earning assets was greater than the reduction in the cost of interest-bearing liabilities, the net yield on earning assets declined from the year before, although growth in net earning assets produced a higher net interest income on a tax equivalent basis than a year ago. The following table presents an analysis of average rates and yields on a fully taxable equivalent basis for the years indicated: 1996 -------------------------------------- Interest Average Average Income/ Yield/ Balance Expense(1) Rate(1) --------------------------------------- Assets (in thousands) Interest-earning assets: Loans $1,264,640 $116,168 9.19% Industrial revenue bonds2 4,986 571 11.45 Investments: Taxable 332,690 20,589 6.19 Tax-favored debt securities 67,671 4,307 6.36 Tax-favored equity securities 22,897 1,325 5.79 Interest-bearing deposits in banks 100 3 3.00 Federal funds sold 28,312 1,524 5.38 ------------------------ Total interest-earning assets 1,721,296 144,487 8.39 --------- Noninterest-earning assets 149,108 Allowance for possible loan losses (28,460) ----------- Total assets $1,841,944 =========== Liabilities and stockholders equity Interest-bearing liabilities: Savings and interest-bearing transactional accounts $832,677 27,268 3.27 Certificates of deposit $100,000 and over 113,380 6,259 5.52 Other time deposits 430,501 22,988 5.34 ------------------------ Total interest-bearing deposits 1,376,558 56,515 4.11 Short-term borrowings 28,165 1,887 6.70 Long-term debt 2,514 197 7.84 ------------------------ Total interest-bearing liabilities 1,407,237 58,599 4.16 ------- Noninterest-bearing liabilities: Demand deposits 251,276 Other liabilities 20,608 ---------- Total liabilities 1,679,121 Stockholders' equity 162,823 ---------- Total liabilities and stockholders' equity $1,841,944 ========== Net interest income $85,888 ======== Interest rate spread(3) 4.23% Net yield on earning assets(4) 4.99 1995 --------------------------------------- Interest Average Average Income/ Yield/ Balance Expense(1) Rate(1) ---------------------------------------- Assets (in thousands) Interest-earning assets: Loans $1,166,438 $110,591 9.48% Industrial revenue bonds2 6,158 718 11.66 Investments: Taxable 297,189 18,638 6.27 Tax-favored debt securities 57,948 3,924 6.77 Tax-favored equity securities 15,233 964 6.33 Interest-bearing deposits in banks 100 3 3.00 Federal funds sold 33,910 1,988 5.86 ------------------------- Total interest-earning assets 1,576,976 136,826 8.68 --------- Noninterest-earning assets 137,184 Allowance for possible loan losses (26,357) ----------- Total assets $1,687,803 =========== Liabilities and stockholders' equity Interest-bearing liabilities: Savings and interest-bearing transactional accounts $760,029 26,211 3.45 Certificates of deposit $100,000 and over 114,395 7,144 6.25 Other time deposits 388,276 20,416 5.26 ------------------------- Total interest-bearing deposits 1,262,700 53,771 4.26 Short-term borrowings 42,628 2,858 6.70 Long-term debt 1,662 143 8.60 ------------------------- Total interest-bearing liabilities 1,306,990 56,772 4.34 -------- Noninterest-bearing liabilities: Demand deposits 223,800 Other liabilities 18,372 ----------- Total liabilities 1,549,162 Stockholders' equity 138,641 ----------- Total liabilities and stockholders' equity $1,687,803 =========== Net interest income $80,054 ========= Interest rate spread(3) 4.34% Net yield on earning assets(4) 5.08 1994 ---------------------------------- Interest Average Average Income/ Yield/ Balance Expense(1) Rate(1) ---------------------------------- Assets (in thousands) Interest-earning assets: Loans $973,240 $81,757 8.40% Industrial revenue bonds2 9,721 939 9.66 Investments: Taxable 278,579 15,786 5.67 Tax-favored debt securities 44,756 2,460 5.50 Tax-favored equity securities 16,609 728 4.38 Interest-bearing deposits in banks 1,045 35 3.35 Federal funds sold 21,521 959 4.46 ------------------------- Total interest-earning assets 1,345,471 102,664 7.63 --------- Noninterest-earning assets 113,145 Allowance for possible loan losses (22,154) ----------- Total assets $1,436,462 =========== Liabilities and stockholders equity Interest-bearing liabilities: Savings and interest-bearing transactional accounts $675,352 18,351 2.72 Certificates of deposit $100,000 and over 67,710 2,724 4.02 Other time deposits 324,924 12,768 3.93 ------------------------- Total interest-bearing deposits 1,067,986 33,843 3.17 Short-term borrowings 38,682 2,118 5.48 Long-term debt 1,406 127 9.03 ------------------------- Total interest-bearing liabilities 1,108,074 36,088 3.26 -------- Noninterest-bearing liabilities: Demand deposits 200,352 Other liabilities 12,597 ---------- Total liabilities 1,321,023 Stockholders' equity 115,439 ---------- Total liabilities and stockholders' equity $1,436,462 ========== Net interest income $66,576 ========= Interest rate spread(3) 4.37% Net yield on earning assets(4) 4.95 ___________________________ (1) On a fully taxable equivalent basis. Calculated using a Federal income tax rate of 35%. Loan income includes fees. (2) Industrial revenue bonds are included in loans in the financial statements. (3) Interest rate spread is the average rate earned on total interest-earning assets less the average rate paid on interest-bearing liabilities. (4) Net yield on earning assets is net interest income divided by total interest-earning assets. <PAGE 51> The following table attributes changes in the Company s net interest income (on a fully taxable equivalent basis) to changes in either average daily balances or average rates. Changes due to both interest rate and volume have been allocated to change due to balance and change due to rate in proportion to the relation- ship of the absolute dollar amounts of the change in each. 1996 Compared with 1995 ------------------------------------ Increase (Decrease) Due to Change in: Total -------------------- Average Average Increase Rate Balance (Decrease) ---------------------------------------- (in thousands) Interest income: Loans, including fees $(3,522) $9,099 $5,577 Industrial revenue bonds (13) (134) (147) Investments: Taxable (249) 2,200 1,951 Tax-favored debt securities (246) 629 383 Tax-favored equity securities (89) 450 361 Interest-bearing deposits in banks Federal funds sold (154) (310) (464) --------------------------------------- Total interest income (4,273) 11,934 7,661 --------------------------------------- Interest expense: Savings and interest-bearing transactional accounts (1,366) 2,423 1,057 Certificates of deposit $100,000 and over (822) (63) (885) Other time deposits 322 2,250 2,572 -------------------------------------- Total deposits (1,866) 4,610 2,744 Short-term borrowings (2) (969) (971) Long-term debt (14) 68 54 -------------------------------------- Total interest expense (1,882) 3,709 1,827 -------------------------------------- Change in net interest income $(2,391) $8,225 $5,834 ====================================== 1995 Compared with 1994 -------------------------------------- Increase (Decrease) Due to Change in: ------------------- Total Average Average Increase Rate Balance (Decrease) --------------------------------------- (in thousands) Interest income: Loans, including fees $11,339 $17,496 $28,835 Industrial revenue bonds 169 (389) (221) Investments: Taxable 1,754 1,097 2,852 Tax-favored debt securities 645 819 1,464 Tax-favored equity securities 301 (65) 236 Interest-bearing deposits in banks (3) (29) (32) Federal funds sold 364 665 1,029 ------------------------------------- Total interest income 14,569 19,594 34,163 ------------------------------------- Interest expense: Savings and interest-bearing transactional accounts 5,362 2,498 7,860 Certificates of deposit $100,000 and over 1,966 2,454 4,420 Other time deposits 4,851 2,797 7,648 -------------------------------------- Total deposits 12,179 7,749 19,928 Short-term borrowings 509 231 740 Long-term debt (6) 22 16 ------------------------------------- Total interest expense 12,682 8,002 20,684 ------------------------------------- Change in net interest income $(1,887) $11,592 $13,479 ===================================== PROVISION FOR POSSIBLE LOAN LOSSES The Company provides for possible loan losses using the allowance method. The allowance for possible loan losses is increased by provisions charged against current earnings. Loan losses are charged against the allowance when management believes that the collectibility of the loan principal is unlikely. Recoveries on loans previously charged off are credited to the allowance. The allowance is the amount management believes is necessary to absorb possible loan losses based on evaluations of collectibility and prior loan loss experience, changes in the nature and volume of the loan portfolio, overall portfolio quality, specific problem loans, and current and anticipated economic conditions that may affect the borrowers ability to pay. Management believes that the allowance for possible loan losses is adequate. While management uses available information to assess possible losses on loans, future additions to the allowance may be necessary. In addition, various regulatory agencies periodically review the Company s allowance for possible loan losses as an integral part of their examination process. Such agencies may require the Company to recognize additions to the allowance based on judgements different from those of management. The provision for possible loan losses totaled $4.2 million in 1996 and $5.0 million in 1995. (See Allowance for Possible Loan Losses. ) NONINTEREST INCOME AND NONINTEREST EXPENSE Noninterest income was $24.9 million in 1996, up $2.9 million from the $22.0 million reported in 1995. Trust income was up $420,000 from the 1995 level, to $4.9 million. The effects of an increase in the number of trust clients served and higher levels of administered assets were enhanced by the impact of advances in the stock and bond markets during the year. Service charges on deposit accounts increased again in 1996, rising to $6.3 million from $5.9 million in the previous year. <PAGE 52> Mortgage banking activity was strong throughout 1996, as generally favorable interest rates impacted the business. Mortgage servicing income rose slightly to $2.5 million. The January 1, 1996 adoption of Financial Accounting Standards Board Statement No. 122, Accounting for Mortgage Servicing Rights, which requires the capitalization of mortgage servicing rights which relate to loans which have been originated and sold on a servicing retained basis, led to a $1.4 million increase in gain on sale of mortgages. Income related to credit card activities includes fees and costs related to the issuance of credit cards and revenue generated (net of processing costs) when credit card transactions are processed through the Company s merchant customers. The Company has emphasized development of the merchant business in recent years. This business has expanded to include local and national customers involved in retail, service, and mail order businesses. These activities generated income of $4.2 million in 1996, up from $3.6 million in the prior year. This increase resulted primarily from an increase in the number of merchants serviced, and consequently, significantly higher levels of merchant volume; $800 million was processed in 1996, compared with $477 million in 1995. The Company posted a total of $4.5 million in other noninterest income, up $320,000 from the 1995 level. This category represents over thirty categories of fee income. Noninterest expense totaled $64.6 million in 1996, up $3.0 million from the 1995 level. Salaries increased to $25.5 million from $23.4 million in 1995 resulting from the opening of a new branch at each of the Massachusetts banks in 1996, as well as additional full time equivalents at CTC in the non-deposit fee-based businesses. Employee benefits declined by $651,000 to $7.5 million in 1996 due to reduced pension expense at Chittenden Bank resulting from the conversion to a cash balance plan effective January 1, 1996. This $1.1 million savings was offset by higher performance-based incentive compensation expenses at Flagship Bank and Trust ($195,000) and by the inclusion of The Bank of Western Massachusetts for the entire year ($203,000). Occupancy expense was $9.5 million for 1996, up from $8.4 million in 1995. Additional depreciation at CTC related to a branch automation project completed in the second half of 1995 accounted for approximately $400,000 of the increase while the inclusion of BWM for the entire year in 1996 accounted for approxi- mately $300,000. FDIC insurance premiums totaled $27,000, down from $1.6 million in 1995. The Banks paid minimal insurance assessments in 1996 as compared to 1995, when assessment rates were reduced from 23 cents to 4 cents per $100 of deposits. Based upon federal legislation enacted in the third quarter of 1996, the Company anticipates that the Banks will pay assessments of 1.3 cents per $100 of deposits in 1997, which would amount to approximately $275,000 of expense for that year. In 1996, expenses associated with OREO, net of recoveries on OREO properties sold, were $153,000. Net OREO recoveries of $243,000 were recorded in 1995. Total other noninterest expense for 1996 totaled $21.9 million, up from $20.3 million in 1995. This increase was spread across several areas including data processing costs ($560,000) due to increases in contract costs based on inflation and volume of activity, and software expenses ($284,000) due to ongoing upgrades. Also included were increases in marketing ($357,000), professional fees ($199,000), and travel and training ($173,000) due to the expanded scope of the consolidated operations. INCOME TAXES For 1996, the Federal and state income tax provisions amounted to $13.4 million. This compares with an income tax provision of $11.7 million for 1995. The effective tax rates for 1996 and 1995 were 33.5% and 34.5%, respectively. During 1996 and 1995, the Company's statutory Federal corporate tax rate was 35%. The Company's effective tax rates differed from the statutory rates primarily because of the proportion of interest income from state and municipal securities and corporate dividend income which are partially exempt from Federal taxation. RESULTS OF OPERATIONS Comparison of Years Ended December 31, 1995 and 1994 NET INTEREST INCOME For 1995, net interest income was $78.3 million, up $13.0 million from the 1994 level. On a fully taxable equivalent basis, net interest income increased $13.5 million from 1994, to $80.1 million in 1995. These improvements resulted from higher levels of interest-earning assets, attributable primarily to the acquisition of BWM, as well as to an increase in the net yield on earning assets. The taxable equivalent yield on earning assets was 5.08% in 1995, up thirteen basis points from 4.95% in 1994. Although the 108-basis points increase in the cost of interest-bearing liabilities was greater than the 105-basis points increase in the yield on earning assets, the effect of non-interest bearing liabilities more than offset this to result in the improvement in the net yield. <PAGE 53> PROVISION FOR POSSIBLE LOAN LOSSES The provision for possible loan losses totaled $5.0 million in 1995, down from $5.5 million in 1994. The reduction was in response to stable net charge-offs and lower levels of nonaccrual loans. NONINTEREST INCOME AND NONINTEREST EXPENSE Noninterest income was $22.0 million in 1995, up $2.7 million from the $19.4 million reported in 1994. Trust income increased $418,000 from the 1994 level, to $4.5 million. The effects of an increase in the number of trust clients served and higher levels of administered assets were enhanced by the impact of advances in the stock and bond markets during the year. Service charges on deposit accounts increased in 1995, rising to $5.9 million from $5.3 million in the previous year. Two-thirds of the increase was contributed by BWM, the remainder reflected higher levels of transaction activity at CTC. During 1995, a net gain of $205,000 was realized on the sale of securities, compared with a net loss of $362,000 posted in 1994. Mortgage banking activity varied throughout 1995, as generally declining rates impacted the business. Mortgage servicing income rose 4.6% to $2.4 million. The increase was due to higher levels of serviced loans, including the servicing purchased from CUMEX. Continued refinancing activity combined with slightly narrower spreads on sold loans in 1995 netted a modest increase in gains on sales of mortgage loans. For 1995, gains totaled $1.3 million, up from $1.2 million in 1994. Income related to credit card activities includes fees and costs related to the issuance of credit cards and revenue (net of processing expenses) generated when credit card transactions are processed through the Company s merchant customers. These activities generated income of $3.5 million in 1995, up $805,000 million from the prior year. The Company posted a total of $4.2 million in other non- interest income, unchanged from the 1994 level. This category represents over thirty categories of fee income. Noninterest expense totaled $61.6 million in 1995, up $10.2 million from the 1994 level. BWM's noninterest expense of $5.9 million accounted for more than half of the increase. Salaries increased to $23.4 million from $19.9 million in 1994. Of this increase, $1.9 million was expensed at BWM. Employee benefits rose by $1.2 million to $8.2 million in 1995. This category includes accruals for performance-based incentive compensation amounting to $2.5 million, up from $1.6 million in 1994. Occupancy expense was $8.4 million, up from $7.1 million in 1994 primarily due to the acquisition of BWM. FDIC insurance premiums totaled $1.6 million, down $1.2 million from the 1994 level. Higher deposit balances on premium assessment dates were more than offset by lower premium rates owing to the statutory recapitalization of the Bank Insurance Fund and the Banks' qualifying for the lowest possible FDIC insurance premium rates throughout 1995. In 1995, expenses associated with OREO were more than offset by recoveries on OREO properties sold, so that a net credit of $243,000 was posted. Net OREO recoveries of $215,000 were recorded in 1994. Total other noninterest expense for 1995 totaled $20.3 million, up $5.3 million from 1994. This increase was primarily attributable to the purchase of BWM and the amortization of the related intangibles, and to merger expenses related to the FBT acquisition which totaled $1.8 million. INCOME TAXES For 1995, Federal and state income tax provisions amounted to $11.7 million, compared with $9.7 million in 1994. The effective tax rates for 1995 and 1994 were 34.5% and 35.0%, respectively. During 1995 and 1994, the Company's statutory Federal corporate tax rate was 35%. The Company s effective tax rates differed from the statutory rates primarily because of the proportion of interest income from state and municipal securities and corporate dividend income which are partially exempt from Federal taxation. <PAGE 54> DIRECTORS AND OFFICERS CHITTENDEN CORPORATION AND CHITTENDEN BANK Directors Frederic H. Bertrand David M. Boardman Paul J. Carrara Lyn Hutton Philip A. Kolvoord Paul A. Perrault President and Chief Executive Officer James C. Pizzagalli Barbara W. Snelling Chair Pall D. Spera Martel D. Wilson, Jr. Directors Emeriti Howard A. Allen, Jr. Edward R. Eurich William W. Freeman Edwin B. Gage Marvin B. Gameroff J. Robert Goodrich Norman H. Greenberg Frank J. Heinrich Robert D. Horton George E. Little, Jr. Maureen A. McNamara H. Gordon Page, M.D. Horace U. Ransom, Jr. Webster S. Thompson Hilton A. Wick CHITTENDEN CORPORATION Officers Barbara W. Snelling Chair, Board of Directors Paul A. Perrault President and Chief Executive Officer Lawrence W. DeShaw Executive Vice President John W. Kelly Executive Vice President Kirk W. Walters Executive Vice President Chief Financial Officer and Treasurer F. Sheldon Prentice Secretary Howard L. Atkinson Chief Auditor Eugenie J. Fortin Assistant Corporate Secretary John P. Barnes Senior Vice President Danny H. O Brien Senior Vice President CHITTENDEN BANK Officers Barbara W. Snelling Chair, Board of Directors Paul A. Perrault President and Chief Executive Officer Audit Howard L. Atkinson Chief Auditor Commercial Banking, Trust and Investment John W. Kelly Executive Vice President Small Business Banking Louise C. Sandberg Vice President Commercial Finance Matthew K. Durkee Vice President Corporate Banking Larry D. MacKinnon Senior Vice President Michael L. Seaver Vice President Corporate Trust Sonja R. Shaver Vice President Correspondent Banking, Specialized Industries Charles J. Stone, Jr. Senior Vice President Credit Department Amy J. Myers Vice President Employee Benefit Services Charles C. Claudio Vice President Government Banking David E. Olson Vice President Investment Management Jerry R. Condon Chief Investment Officer Personal Trust Services Louis J. Beaulieu Senior Vice President Private Banking Sylvia T. MacKinnon Vice President Community Banking Danny H. O Brien Senior Vice President Katharine H. Bosley Vice President, Branch Commercial Loan Administrator Kim E. Lemmo Vice President, Branch Administrator C. Lynn Medeiros Assistant Vice President, Sales Manager Bonnie L. Rivers Vice President, Branch Administrator Stuart F. Silloway, Jr. Senior Vice President, Business Development Administrator Corporate Secretary F. Sheldon Prentice Senior Vice President, General Counsel and Corporate Secretary Stephanie Barton Vice President and Counsel Paul A. Benoit Vice President and Counsel Eugenie J. Fortin Assistant Corporate Secretary, Stockholder Relations Credit Policy and Administration John P. Barnes Senior Vice President and Credit Policy Officer Debra E. Cross Vice President, Credit Administration Donald D. Martin Senior Vice President, Loan Resolution Rachel M. Sheridan Vice President, Credit Collections Sarah P. Slatter Senior Vice President, Credit Review and Administration MORTGAGE SERVICE CENTER OF NEW ENGLAND Richard J. Christensen Senior Vice President Nancy L. Dohl Director of Correspondent Lending Raymond M. O Connor Director of Secondary Market Alane G. Perkins Vice President, Loan Administration and Accounting Thomas W. Varno Director of Operations Gail D. Walsh Correspondent Manager Susan L. Williams Director of Credit Union Lending OPERATIONS AND ADMINISTRATION Lawrence W. DeShaw Executive Vice President Administration Christopher D. Bishop Senior Vice President, Facilities Management Robert D. Hofmann Senior Vice President, Marketing Sarah P. Merritt Senior Vice President, Human Resources <PAGE 55> Chittenden Home Mortgage Catherine S. Blackwell Assistant Vice President, Manager, Residential Mortgage Department Jennie H. Buchanan Vice President, Manager, Secondary Market Activities Carolyn S. Lyman Vice President, Manager, Mortgage Originations COMMERCIAL SERVICES AND CAPTIVE INSURANCE Rand L. Stretton Vice President, Commercial Services and Captive Insurance Operations Bruce W. Cote Vice President, Loan Accounting Services Paul J. Hamlin Senior Vice President, Branch Operations Florence F. Izzo Senior Vice President, Commercial, Deposit, and Trust Operations Services Payroll Services Nancy J. Barnes Vice President, Payroll Services Retail Credit Daniel G. Alcorn Senior Vice President, Retail Credit Division Ronald P. Bower Vice President, Automotive Financing Mary C. Chicoine Assistant Vice President, Merchant Services Treasury Kirk W. Walters Executive Vice President, Chief Financial Officer, and Treasurer Alan A. Fay Vice President, Treasury Services Timothy J. Keefe Vice President and Controller HEADQUARTERS, CHITTENDEN CORPORATION AND CHITTENDEN BANK Chittenden Bank Building Two Burlington Square Burlington, Vermont 05401 Mailing Address: P.O. Box 820 Burlington, Vermont 05402-0820 THE BANK OF WESTERN MASSACHUSETTS Directors John J. Cardone Edward J. Carroll, Jr. Martin J. Clayton Timothy P. Crimmins, Jr. President and Chief Executive Officer James J. Falcone Frank P. Fitzgerald, Esq. Chair William F. Frain John P. Isenburg Edward C. Leavy Carl B. Martin, III William G. Mazeine Paul A. Perrault Emilio J. Sibilia, Jr. Andrew E. Skroback, Jr. Benjamin Surner, Jr. THE BANK OF WESTERN MASSACHUSETTS Officers Frank P. Fitzgerald, Esq. Chair, Board of Directors Timothy P. Crimmins, Jr. President and Chief Executive Officer Branch Administration Shirley A. Bailey Office Manager and Consumer Loan Officer Gwendoline M. Briere Office Manager and Consumer Loan Officer Ann M. Destromp Office Manager and Consumer Loan Officer Robert Z. Garabedian Office Manager and Consumer Loan Officer Kimberely Hamilton Office Manager and Consumer Loan Officer Commercial Banking Daniel M. Flynn Vice President and Senior Loan Officer Pamela L. Baran Assistant Vice President James J. Carvalho Vice President William A. Fontes Vice President Charlene Golonka Assistant Vice President Rhoda A. Manoogian Vice President, Small Business Lending Sylvia Nadeau-Poole Assistant Vice President Cheryl A. Pesto Assistant Vice President, Deposit Acquisition Steven J. Robinson Vice President J. Jeffrey Sullivan Vice President Aldo F. Tiboni Vice President, Asset-based Lending Consumer Lending Pamela L. Baran Assistant Vice President Ronald W. Rice Assistant Vice President, Direct Automobile Lending Credit Administration Kevin M. Bowler Asset Recovery Officer Donna M. George-Ebbeling Assistant Vice President Finance Michael J. Hinchey Vice President and Treasurer Joanne M. Corliss Assistant Vice President Lynne A. Gino Operations Officer Operations Barbara J. Wallace Vice President and Senior Staff Development Officer Cheryl L. Podgorski Assistant Vice President Ralph V. Ritchie Assistant Vice President Trust and Investment Services John S. Newton Vice President HEADQUARTERS, THE BANK OF WESTERN MASSACHUSETTS 29 State Street Springfield, Massachusetts 01103 Mailing Address: P.O. Box 4950 Springfield, Massachusetts 01101-4950 <PAGE 56> FLAGSHIP BANK AND TRUST COMPANY Directors Robert S. Agnello Michael P. Angelini, Esq. Gene J. DeFeudis Robert P. Lombardi, Esq. Francis W. Madigan, Jr. Donald J. McGowan President and Chief Executive Officer Paul A. Perrault Alan M. Stoll Officers Donald J. McGowan President and Chief Executive Officer Branch Administration Andrea J. White Vice President, Branch Administrator Mary Ann Donovan Assistant Vice President, Branch Manager Patricia A. George Assistant Vice President, Branch Manager Edward J. Glotch, Jr. Assistant Vice President, Branch Manager Michael J. Quink Assistant Vice President, Branch Manager Consumer Lending Bettina M. Cullina Vice President, Senior Consumer Lending Officer Susan M. Simeone Assistant Vice President, Mortgage Officer Corporate Banking Services Michael J. Hanewich Executive Vice President, Senior Commercial Lending Officer Robert D. Babcock Vice President, Commercial Loan Officer Donald F. Doyle Vice President, Commercial Loan Officer Brenda M. Heindenreich Vice President, Cash Management Services Kevin H. Kane Vice President, Commercial Loan Officer Robert J. Kelley Vice President, Commercial Loan Officer V. Paul Lawless Vice President, Commercial Loan Group Leader Blain H. Marchand Vice President, SBA Loan Officer Mary T. McAdam Assistant Vice President, Commercial Loan Officer Credit Policy and Administration Helga M. Lyons Vice President, Credit Manager Keith R. Kirkland Assistant Vice President, Credit Officer Finance Denise L. Solodyna Executive Vice President, Chief Financial Officer Michael P. Rooney Vice President, Controller Marketing Janet L. Amorello Vice President, Marketing Officer Operations Martha A. Dean Vice President, Operations Manager Retail Banking, Operations and Technology Peter M. Buffone Executive Vice President, Chief Information and Operations Officer Technology John A. Reil Vice President, MIS Manager Andrea M. Dupell Assistant Vice President, Senior Business Analyst Trust and Investment Services Edward J. Connor, Jr. Senior Vice President, Senior Trust Officer HEADQUARTERS, FLAGSHIP BANK AND TRUST COMPANY 306 Main Street Worcester, Massachusetts 01613 Mailing Address: P.O. Box 487 Worcester, Massachusetts 01613-0487 <PAGE 57> The following table sets forth the range of the high and low prices for the Corporation's common stock, for the last five years: 1996 1995 1994 1993 1992 ------------------------------------------------------------------------------------------------- Quarter High Low High Low High Low High Low High Low First 25.60 19.20 15.36 13.12 12.32 11.20 10.75 7.55 7.68 4.22 Second 22.75 20.60 18.40 14.56 13.92 10.88 11.26 9.73 8.45 6.53 Third 25.75 20.75 22.20 17.20 14.08 12.80 11.68 9.73 8.19 6.78 Fourth 26.25 23.88 25.60 20.00 13.76 12.80 12.16 8.32 8.32 7.17 STOCKHOLDER INFORMATION FORM 10-K A copy of Chittenden Corporation s Annual Report for 1996 (on Form 10-K), as filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, will be furnished free of charge to beneficial owners of the Corporation s stock upon request. CHITTENDEN CORPORATION STOCK The $1 par value common stock of Chittenden Corporation has been publicly traded on the over-the-counter market since November 14, 1974. As of December 31, 1996, there were 3,167 record holders of the Corporation s common stock. The Corporation's stock is listed on NASDAQ, with the symbol CNDN, is included in additional over-the-counter securities lists, and is listed daily in the major newspapers. DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN The Dividend Reinvestment and Stock Purchase Plan for stockholders of Chittenden Corporation gives the participants the opportunity to reinvest dividends in additional shares of the Company s common stock and make optional cash investments in a convenient and cost-free manner without commissions or fees. For stockholder services and information, contact: Stockholder Relations Chittenden Corporation P.O. Box 820 Burlington,VT 05402-0820 660-1412 Chittenden Corporation is a three-bank holding company registered as a Vermont corporation. Organized in 1971 and activated in 1974, Chittenden Corporation is the parent company of Chittenden Trust Company, The Bank of Western Massachusetts and Flagship Bank and Trust Company. Chittenden Bank is the trade name for Chittenden Trust Company. ANNUAL MEETING The Annual Meeting of the Stockholders of Chittenden Corporation will be held on Wednesday, April 16, 1997, at 4:00 p.m. in the Emerald Ballroom in the Sheraton Burlington Hotel and Conference Center, located at 870 Williston Road, Burlington, Vermont. To find out about the wide range of products offered by Chittenden Bank, please call the Customer Information Center at 1-800-545-2236. For products and information offered by The Bank of Western Massachusetts, please call 1-800-331-5003. For products and information offered by Flagship Bank and Trust Company, please call (508) 799-4321. Our annual report has been printed on recycled paper, containing post-consumer fiber, with soy-based inks.