FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended 09/30/98 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ___________ Commission file number: 000-20809 SIS BANCORP, INC. (Exact Name of Issuer as Specified in its Charter) Massachusetts 04-3303264 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) SIS BANCORP, INC. 1441 Main Street Springfield, Massachusetts 01102 (Address of Principal Executive Offices) (Zip Code) (413) 748-8000 (Issuers Telephone Number, Including Area Code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ Indicate the number of shares outstanding of the registrant's common stock, as of the latest practicable date: 7,188,645 shares as of November 6, 1998. CAUTIONARY STATEMENT FOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This Report contains certain "forward-looking statements" including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact. SIS Bancorp, Inc. and its subsidiaries (the "Company") wishes to caution readers that the following important factors, among others, may have affected and could in the future affect the Company's actual results and could cause the Company's actual results for subsequent periods to differ materially from those expressed in any forward-looking statement made by or on behalf of the Company herein: (i) the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which the Company must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board; (iii) the effect on the Company's competitive position within its market area of the increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as nonbank providers of various financial services; (iv) the effect of changes in interest rates; (v) the effect of changes in the business cycle and downturns in the local, regional or national economies; (vi) the effect of the "year 2000" issue (i.e. that current computer programs use only two digits to identify a year in the date field and cannot reflect a change in the century) on the Company's financial condition or results of operations; and (vii) the impact of pending litigation on the Company's financial condition or results of operations. SIS BANCORP, INC. AND SUBSIDIARIES FORM 10-Q INDEX PAGE NO. PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheet at September 30, 1998 and December 31, 1997...............................1 Condensed Consolidated Statement of Operations for the three and nine months ended September 30, 1998 and 1997...................2 Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 1998 and 1997.............................3 Condensed Consolidated Statement of Changes in Stockholders' Equity for the nine months ended September 30, 1998 and 1997.....................5 Notes to the Unaudited Financial Statements...............................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................8 PART II. OTHER INFORMATION Item 1. Legal Proceedings................................................29 Item 2. Changes in Securities............................................29 Item 3. Default upon Senior Securities...................................29 Item 4. Submission of Matters to a Vote of Security Holders..............29 Item 5. Other Information................................................29 Item 6. Exhibits and Reports on Form 8-K.................................29 SIGNATURES...............................................................30 SIS BANCORP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEET (Dollars In Thousands) (Unaudited) September 30, December 31, 1998 1997 ------------- ------------- ASSETS Cash and due from banks $ 37,225 $ 50,297 Federal funds sold and short term investments 52,242 17,317 Investment securities available for sale 619,420 576,108 Investment securities held to maturity (fair value: $245,202 at September 30, 1998 and $193,396 at December 31, 1997) 244,238 193,007 Loans receivable, net of allowance for possible losses ($23,924 at September 30, 1998 and $22,724 at December 31, 1997) 875,250 828,761 Accrued interest and dividends receivable 11,676 10,749 Investments in real estate and real estate partnerships -- 2,903 Foreclosed real estate, net 679 1,209 Bank premises, furniture and fixtures, net 36,966 35,843 Other assets 22,722 17,424 ----------- ----------- Total assets $ 1,900,418 $ 1,733,618 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $ 1,343,063 $ 1,267,298 Federal Home Loan Bank advances 203,251 184,121 Securities sold under agreements to repurchase 175,065 113,299 Loans payable 2,294 2,492 Mortgage escrow deposits 6,945 5,642 Accrued expenses and other liabilities 30,660 35,294 ----------- ----------- Total liabilities 1,761,278 1,608,146 ----------- ----------- Commitments and contingent liabilities -- -- Stockholders' equity: Preferred stock ($.01 par value; 5,000,000 shares authorized: no shares issued and outstanding) -- -- Common stock ($.01 par value; 25,000,000 shares authorized; shares issued: 7,170,956 at September 30, 1998 and 7,081,187 at December 31, 1997; shares outstanding: 7,170,956 at September 30, 1998 and 6,947,787 at December 31, 1997) 72 71 Unearned compensation (2,807) (3,123) Additional paid-in capital 57,259 54,755 Retained earnings 84,850 75,153 Accumulated other comprehensive income - net after tax unrealized gain (loss) on investment securities available for sale (234) 2,133 Treasury stock, at cost (0 and 133,400 shares at September 30, 1998 and December 31, 1997, respectively) -- (3,517) ----------- ----------- Total stockholders' equity 139,140 125,472 ----------- ----------- Total liabilities and stockholders' equity $ 1,900,418 $ 1,733,618 =========== =========== See accompanying Notes to the Unaudited Financial Statements 1 SIS BANCORP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Dollars In Thousands Except Per Share Amounts) (Unaudited) (Unaudited) Three Months Ended Nine Months Ended --------------------------------- --------------------------------- September 30, September 30, September 30, September 30, 1998 1997 1998 1997 ------------- ------------- ------------- ------------- Interest and dividend income: Loans $ 18,934 $ 17,426 $ 54,963 $ 50,368 Investment securities available for sale 9,090 8,914 26,031 26,600 Investment securities held to maturity 3,901 3,519 11,067 10,988 Investment securities held for trading -- 3 -- 8 Federal funds sold and short term investments 505 378 1,596 808 ----------- ----------- ----------- ----------- Total interest and dividend income 32,430 30,240 93,657 88,772 ----------- ----------- ----------- ----------- Interest expense: Deposits 11,265 10,619 32,834 30,969 Borrowings 5,171 4,596 14,193 12,800 ----------- ----------- ----------- ----------- Total interest expense 16,436 15,215 47,027 43,769 ----------- ----------- ----------- ----------- Net interest and dividend income 15,994 15,025 46,630 45,003 Less: Provision for possible loan losses 252 466 755 1,431 ----------- ----------- ----------- ----------- Net interest and dividend income after provision for possible loan losses 15,742 14,559 45,875 43,572 Noninterest income: Net gain on sale of loans 362 136 986 328 Net gain on sale of securities available for sale 1 17 3 77 Net gain on sale of securities held for trading -- 24 -- 43 Fees and other income 4,180 4,044 12,059 11,038 ----------- ----------- ----------- ----------- Total noninterest income 4,543 4,221 13,048 11,486 ----------- ----------- ----------- ----------- Noninterest expense: Operating expenses: Salaries and employee benefits 6,870 6,203 19,725 18,258 Occupancy expense of bank premises, net 1,295 1,214 3,835 3,573 Furniture and equipment expense 844 858 2,739 2,421 Other operating expenses 5,071 4,312 13,553 12,683 ----------- ----------- ----------- ----------- Total operating expenses 14,080 12,587 39,852 36,935 ----------- ----------- ----------- ----------- Foreclosed real estate (income) expense (61) 100 7 15 Net (income) expense of real estate operations (1,149) (63) (1,740) 416 ----------- ----------- ----------- ----------- Total noninterest expense 12,870 12,624 38,119 37,366 Income before income tax expense 7,415 6,156 20,804 17,692 Income tax expense 2,817 2,327 7,905 6,867 ----------- ----------- ----------- ----------- Net income $ 4,598 $ 3,829 $ 12,899 $ 10,825 =========== =========== =========== =========== Earnings per share: Basic $ 0.66 $ 0.59 $ 1.89 $ 1.64 Diluted $ 0.63 $ 0.56 $ 1.79 $ 1.57 Weighted average shares outstanding: Basic 6,931,805 6,513,970 6,834,836 6,591,452 Diluted 7,256,700 6,828,948 7,211,812 6,891,860 See accompanying Notes to the Unaudited Financial Statements 2 SIS BANCORP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Dollars In Thousands) (Unaudited) Nine Months Ended September 30, -------------------------------- 1998 1997 --------- --------- Cash Flows From Operating Activities Net income $ 12,899 $ 10,825 Adjustments to reconcile net income to net cash provided by operating activities Provision for possible loan losses 755 1,431 Provision for foreclosed real estate -- 1 Depreciation 3,351 3,004 Amortization of premium on investment securities, net 3,831 2,222 ESOP and restricted stock expenses 1,912 1,375 Investment security gains (3) (120) Increase in assets held for trading -- (61) Income from equity investment in partnerships -- 6 Gain on sale of mortgage loans held for sale (986) (328) Disbursements for mortgage loans held for sale (122,454) (42,571) Receipts from mortgage loans held for sale 123,440 42,899 Gain on sale of fixed assets and real estate (1,216) (171) Changes in assets and liabilities: Increase in other assets, net (4,652) (2,537) (Decrease) increase in accrued expenses and other liabilities (3,301) 8,239 --------- --------- Net cash provided by operating activities 13,576 24,214 --------- --------- Cash Flows From Investing Activities Proceeds from sale of investment securities available for sale 2,358 11,472 Proceeds from maturities and principal payments received on investment securities available for sale 216,362 122,509 Purchase of investment securities available for sale (269,302) (210,216) Proceeds from maturities and principal payments received on investment securities held to maturity 64,700 37,006 Purchase of investment securities held to maturity (116,432) (23,913) Net increase in loans receivable (47,376) (73,350) Net decrease in foreclosed real estate 662 728 Proceeds from sale of loans -- 92 Proceeds from sale of investments in real estate 3,592 -- Proceeds from sale of fixed assets 358 135 Purchase of fixed assets and other (4,305) (4,220) --------- --------- Net cash used for investing activities (149,383) (139,757) --------- --------- See accompanying Notes to the Unaudited Financial Statements 3 SIS BANCORP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (continued) (Dollars In Thousands) (Unaudited) Nine Months Ended September 30, -------------------------------- 1998 1997 --------- --------- Cash Flows from Financing Activities Net increase in deposits 75,765 74,123 Net increase in borrowings 80,698 37,139 Net increase in mortgagors' escrow deposits 1,303 2,109 Net proceeds from exercise of stock options 3,096 168 Repurchase/retirement of common stock -- (4,193) Cash dividends paid (3,202) (2,478) --------- --------- Net cash provided by financing activities 157,660 106,868 --------- --------- Increase in cash and cash equivalents 21,853 (8,675) Cash and cash equivalents, beginning of period 67,614 68,090 --------- --------- Cash and cash equivalents, end of period $ 89,467 $ 59,415 ========= ========= Supplemental disclosures of cash flow information: Cash paid during the year for interest to depositors and interest on debt $ 46,588 $ 36,269 Income taxes paid $ 6,129 $ 506 Non-cash investing activities: Transfers to foreclosed real estate, net $ 132 $ 917 See accompanying Notes to the Unaudited Financial Statements 4 SIS BANCORP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY For The Nine Months Ended September 30, 1998 and 1997 (Dollars In Thousands) Accumulated other comprehensive income: Net unrealized Additional gain (loss) on Common Unearned Paid-In Retained investment securities Stock Compensation Capital Earnings available for sale ---------- ------------ ----------- ---------- --------------------- Balance at December 31, 1997 $ 71 $ (3,123) $ 54,755 $ 75,153 $ 2,133 Net income -- -- -- 12,899 -- Cash dividends declared -- -- -- (3,202) -- Net issuance of common stock in connection with employee and non-employee directors benefit programs 1 (567) 1,475 -- -- Decrease in unearned compensation -- 883 1,029 -- -- Change in unrealized gain on investment securities available for sale -- -- -- -- (2,367) --------- --------- --------- --------- --------- Balance at September 30, 1998 $ 72 $ (2,807) $ 57,259 $ 84,850 $ (234) ========= ========= ========= ========= ========= Balance at December 31, 1996 $ 71 $ (3,693) $ 53,836 $ 67,119 $ 1,453 Net income -- -- -- 10,825 -- Cash dividends declared -- -- -- (2,478) -- Net issuance of common stock in connection with employee and non-employee directors benefit programs -- (98) (68) -- -- Decrease in unearned compensation -- 755 620 -- -- Change in unrealized gain on investment securities available for sale -- -- -- -- 1,165 Treasury stock purchased -- -- -- -- -- --------- --------- --------- --------- --------- Balance at September 30, 1997 $ 71 $ (3,036) $ 54,388 $ 75,466 $ 2,618 ========= ========= ========= ========= ========= Treasury Stock at Cost Total -------------- ----------- Balance at December 31, 1997 $ (3,517) $ 125,472 Net income -- 12,899 Cash dividends declared -- (3,202) Net issuance of common stock in connection with employee and non-employee directors benefit programs 3,517 4,426 Decrease in unearned compensation -- 1,912 Change in unrealized gain on investment securities available for sale -- (2,367) --------- --------- Balance at September 30, 1998 $ -- $ 139,140 ========= ========= Balance at December 31, 1996 $ -- $ 118,786 Net income -- 10,825 Cash dividends declared -- (2,478) Net issuance of common stock in connection with employee and non-employee directors benefit programs 333 167 Decrease in unearned compensation -- 1,375 Change in unrealized gain on investment securities available for sale -- 1,165 Treasury stock purchased (4,193) (4,193) --------- --------- Balance at September 30, 1997 $ (3,860) $ 125,647 ========= ========= See accompanying Notes to the Unaudited Financial Statements 5 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO THE UNAUDITED FINANCIAL STATEMENTS (Dollars in thousands except per share amounts) 1. Condensed Consolidated Financial Statements The Condensed Consolidated Financial Statements of the Company included herein are unaudited, and in the opinion of management all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the financial condition, results of operations and cash flows, as of and for the periods covered herein, have been made. The Company's historical financial statements have been restated to reflect the combination with Glastonbury Bank & Trust Company. Certain information and note disclosures normally included in Condensed Consolidated Financial Statements have been omitted as they are included in the most recent Securities and Exchange Commission ("SEC") Form 10-K and accompanying Notes to the Financial Statements (the "Form 10-K") filed by the Company for the year ended December 31, 1997. Management believes that the disclosures contained herein are adequate to make a fair presentation. These unaudited condensed consolidated financial statements should be read in conjunction with the Form 10-K. The results for the three and nine month interim periods covered hereby are not necessarily indicative of the operating results for a full year. 2. New Accounting Pronouncements In June 1997, the FASB issued SFAS 130 "Reporting Comprehensive Income" which establishes standards for disclosure of comprehensive income. Comprehensive income represents net income for a period plus the change in equity of a business during a period from non-shareholder sources. Excluding net income, the Company's only source of comprehensive income is its unrealized gain (loss) on investment securities available for sale, net of tax. SFAS 130 requires the restatement of prior periods for comparative purposes. The Company adopted SFAS 130 on January 1, 1998. Adoption of this Statement did not have a material impact on the Company's financial position or results of operations. Total comprehensive income for the three and nine months ended September 30, 1998 was $4.3 million and $13.9 million, respectively compared to $5.5 million and $13.9 million, respectively for the three and nine months ended September 30, 1997. In June 1997, the FASB issued SFAS 131 "Disclosures about Segments of an Enterprise and Related Information" which establishes standards for the way that public business enterprises report financial and descriptive information about operating segments. SFAS 131 defines operating segments as components of an enterprise about which separate financial information is available that is evaluated by management in deciding how to allocate resources and in assessing performance. The Company adopted SFAS 131 on January 1, 1998. Adoption of this Statement did not have a material impact on the Company's financial position or results of operations. In February 1998, the FASB issued SFAS 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits - an amendment of FASB Statements No. 87, 88 and 106" (SFAS 132) which revises employers' disclosures about pension and other postretirement benefit plans, though it does not change the measurement or recognition of those plans. The Company adopted SFAS 132 effective January 1, 1998. Adoption of this Statement did not have a material impact on the Company's financial position or results of operations. In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes a new model for accounting for derivatives and hedging activities and supersedes and amends a number of existing standards. SFAS 133 is effective for fiscal years beginning after June 15, 1999, but earlier application is permitted as of the beginning of any fiscal quarter subsequent to June 1998. Upon initial application, all derivatives are required to be recognized in the statement of financial position as either assets or liabilities and measured at fair value. In addition, all hedging relationships must be reassessed and documented pursuant to the provisions of SFAS 133. Management is currently assessing the impact of SFAS 133 on the Company's financial position and results of operations. 6 3. Earnings Per Share Basic and diluted net income per share and weighted average shares outstanding follow (dollars in thousands, except per share amounts): (Unaudited) (Unaudited) Three months ended Nine months ended --------------------------------- --------------------------------- September 30, September 30, September 30, September 30, 1998 1997 1998 1997 ------------ ------------- ------------- ------------- Net income $ 4,598 $ 3,829 $ 12,899 $ 10,825 Weighted average shares outstanding: Basic 6,931,805 6,513,970 6,834,836 6,591,452 Effect of dilutive securities: Stock options 307,085 287,156 328,388 257,093 Restricted stock 17,810 27,822 48,588 43,315 ---------- ---------- ---------- ---------- Diluted 7,256,700 6,828,948 7,211,812 6,891,860 ========== ========== ========== ========== Net income per share: Basic $ 0.66 $ 0.59 $ 1.89 $ 1.64 Diluted $ 0.63 $ 0.56 $ 1.79 $ 1.57 4. Dividend Policy The Company paid a cash dividend in the amount of $0.16 per share on August 24, 1998. On October 20, 1998 the Company declared a dividend of $0.16 per share payable on or about November 23, 1998 to shareholders of record as of the close of business on November 2, 1998. 5. Divestment Related Charges The Company had certain subsidiaries that engaged in various real estate investments, directly or in joint ventures with unaffiliated partners. In accordance with the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), the Company terminated its real estate development activities and has completed the sale of its remaining real estate investments. In the first quarter of 1997, the Company established a reserve of $1.0 million relating to the divestment of its real estate investment and brokerage subsidiaries, Colebrook Inc. and subsidiaries ("Colebrook"). The $1.0 million reserve consisted of $0.7 million in severance and benefit accruals and $0.3 million for professional and other expenses. The Company completed its divestment of Colebrook on July 21, 1998 with the sale of its sole remaining real estate investment for net proceeds of $3.6 million. The Company recognized a gain of $1.1 million related to the sale which is included in net income of real estate operations. Based upon final terms of the divestment, related expenses were $0.6 million, consisting of $0.3 million in severance and benefits and $0.3 million in professional and other expenses. The remaining reserve balance of $0.4 million, primarily related to unused severance, was reversed in June 1998 and is reflected in net income of real estate operations. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (DOLLARS IN THOUSANDS) Overview SIS Bancorp, Inc. (the "Company") is a Massachusetts corporation formed in 1996 and serves as the bank holding company for Springfield Institution for Savings ("SIS Bank"), and Glastonbury Bank & Trust Company ("GBT"). The Company was formed for the purpose of reorganizing SIS Bank into a holding company structure ("the Reorganization"). Upon the effectiveness of the Reorganization, SIS Bank became a wholly-owned subsidiary of the Company and SIS Bank's former stockholders became stockholders of the Company. The Company acquired GBT on December 17, 1997. Established in 1827, SIS Bank is a Massachusetts chartered stock savings bank headquartered in Springfield, Massachusetts. GBT, with its headquarters located in Glastonbury, Connecticut, is a Connecticut chartered commercial bank founded in 1919. Substantially all of the Company's operations are conducted through its subsidiary banks. The Company provides a wide variety of financial services through both SIS Bank and GBT (the "Banks"), including retail and commercial banking, residential mortgage origination and servicing, commercial and consumer lending, and merchant processing. The Banks serve the consumers and businesses located in western Massachusetts and central Connecticut through a network of 33 full service branches. The Company's revenues are derived principally from dividend payments received from the Banks, which in turn derive their revenues principally from interest payments on their loan portfolios and mortgage-backed and other investment securities. The Banks' primary sources of funds are deposits, borrowings and principal and interest payments on loans and mortgage-backed securities. On July 20, 1998, the Company entered into an Agreement and Plan of Merger with Peoples Heritage Financial Group, Inc. ("PHFG"), pursuant to which the Company would be acquired by PHFG, SIS Bank would be merged into PHFG's Massachusetts banking subsidiary and the Company's shareholders would receive, subject to adjustment under certain circumstances, 2.25 shares of PHFG common stock for each outstanding share of the Company's common stock. The Company expects its pending acquisition by PHFG to be completed, subject to the parties' receipt of all necessary approvals from the Board of Governors of the Federal Reserve System ("FRB"), the Office of Thrift Supervision, the Maine Bureau of Banking ("Maine Bureau"), the Massachusetts Board of Bank Incorporation and the Connecticut Commissioner of Banks, prior to December 31, 1998. PHFG has currently received the required approvals of the FRB and the Maine Bureau. The Company's shareholders have approved the pending acquisition at a special meeting held on November 12, 1998. Year 2000 The Year 2000 issue exists because many computer systems and applications (including those in non-information technology equipment and systems) currently use two-digit date fields to designate a year. As the century date change occurs, date-sensitive systems will recognize the Year 2000 as 1900, or not at all. This inability to recognize or properly interpret dates beyond the year 1999 may cause business disruptions as systems process critical financial and operational information incorrectly. During 1997, the Company formed a Year 2000 team to develop and execute the Year 2000 project and has developed an implementation plan to resolve its Year 2000 issues. The Company is addressing this issue in accordance with the guidance set forth in various statements that have been issued by the Federal Financial Institutions Examination Council. The Company is also monitored in its Year 2000 efforts by reports to, and examinations by, various regulators, including the Federal Deposit Insurance Corporation, the Federal Reserve Board, and the Massachusetts and Connecticut Commissioners of Banks. The Year 2000 project has been designated as the highest priority activity of the Company's Information Technology Department. Since 1997, the Company has been reviewing its systems and programs to identify those that contain two-digit year codes, and is in the process of upgrading its infrastructure and corporate facilities to achieve Year 2000 compliance. In addition, the Company is actively working with its major third-party vendors and large commercial borrowers to assess their compliance and remediation efforts. 8 The Company has identified the following phases of the Year 2000 project. In the awareness phase, the Company defined the Year 2000 issue, communicated the Year 2000 issue to all employees and its Board of Directors and obtained executive level support and funding. In the assessment phase, the Company created a comprehensive Year 2000 plan which includes conducting an inventory of all systems which may be affected by the Year 2000 issue including facilities and related non-information technology systems (embedded technology), computer systems, hardware, and services and products provided by third-party vendors, and assessing risk of non-compliance for each identified system. In the renovation phase, the Company renovates or fixes certain systems, while all others are replaced or retired. In the validation phase, the Company conducts testing to ensure all systems, including renovated systems, are Year 2000 compliant for present and future dates. Finally, in the implementation phase, the Company places compliant systems in production. As of September 30, 1998, the Company had completed the remedial phases associated with awareness and assessment and was conducting the procedures associated with the renovation and validation phases. The Company expects to complete all critical renovations by December 31, 1998. The Company had completed test plans as of June 30, 1998 and expects to complete testing of internal systems by December 31, 1998 and external testing of third-party vendor systems by March 31, 1999. The Company's core processing systems, including general ledger, home equity line, commercial loan, investments and deposit applications, have been upgraded to Year 2000 compliant versions, tested, and implemented. The Company is also in the process of verifying that critical third party vendors and large commercial borrowers have adequately addressed their own systems issues. In connection with this verification, the Company will determine whether its loan loss reserves are adequate in light of any additional risk associated with the Company's loan portfolio due to commercial borrowers' Year 2000 issues. The primary costs associated with the Year 2000 issue consist of expenses for the replacement or upgrade of third party systems, the replacement of personal computers and professional services costs. The Company may also incur expenses related to the repair or replacement of non-computer equipment with embedded technology such as elevators and bank vaults. The Company presently estimates that the Company's total direct, out-of-pocket cost relating to the Year 2000 issue to be approximately $0.7 million of which approximately $18 thousand had been incurred through September 30, 1998. With the exception of the Year 2000 project leader, this direct cost does not include salary and overhead expenses of employees from various departments within the Company which devote a portion of their time to the Year 2000 project. These indirect costs are included in the Company's normal operating expenses. It is anticipated that a substantial portion of the total cost will be incurred over the next 15 months and will be expensed as incurred. There are many risks associated with the Year 2000 issue, including the possibility of a failure of the Company's computer and non-information technology systems. Such failures could have a material adverse effect on the Company and may cause system malfunctions, incorrect or incomplete transaction processing, and the inability to reconcile accounting books and records. Even if the Company successfully remediates its Year 2000 issues, it can be materially and adversely affected by failure of third-party vendors or large commercial loan borrowers to remediate their own Year 2000 issues. A timely resolution of the Year 2000 issues depends largely upon the expertise and advice of outside vendors retained by the Company to both modify the Company's existing software and develop new software to address current internal systems deficiencies. The Company is presently unaware of any situation where any vendor or large commercial borrower will not be able to modify its products and systems in a timely manner. If the above mentioned risks are not remedied, the Company may experience business interruption or shutdown, financial loss, regulatory actions, damage to the Company's franchise, and legal liability. The Company intends to document Year 2000 contingency plans during 1999 to address these potential risks. The Company is currently not aware of any Year 2000 problem for which a solution is not available. In addition, the Company is not aware of any obstacles or issues that are presently anticipated in connection with the resolution of Year 2000 issues that are likely to cause significant operational problems or are otherwise expected to have a material adverse effect on the Company's financial condition or results of operations. Results of Operations for the Three Months Ended September 30, 1998 and September 30, 1997 The Company reported net income of $4.6 million, or $0.63 per diluted share for the three months ended September 30, 1998 as compared to net income of $3.8 million, or $0.56 per diluted share for the same period last year. These results primarily reflect increases in net interest income, noninterest income and net income of real estate operations as well as lower provisions for possible loan losses, partially offset by an increase in operating expenses. 9 Net Interest Income Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income is affected by the mix and volume of assets and liabilities, and the movement and level of interest rates. The Company invests in certain assets that have preferential tax treatment. In order to present yields on a comparable basis, net interest income is presented on a fully taxable equivalent basis for purposes of yield and margin analysis. The following table sets forth, for the period indicated, average balances, interest income and expense, and yields earned or rates paid on the major categories of assets and liabilities. Non-accrual loans have been included in the appropriate average balance loan category, but unpaid interest on non-accrual loans has not been included for purposes of determining interest income. In addition, investment securities available for sale are reflected at amortized cost. Three Months Ended September 30, ------------------------------------------------------------------------------------------ 1998 1997 ------------------------------------------- --------------------------------------------- Average Average Average Average Balance (3) Interest (1) Yield/Cost (1) Balance Interest (1) Yield/Cost (1) ------------ -------------- -------------- ------------ ------------ --------------- (Dollars In Thousands) Interest-earning assets: Fed funds sold and short-term investments $ 38,968 $ 505 5.07% $ 27,678 $ 379 5.36% Investment securities held to maturity 245,350 3,901 6.36% 206,573 3,519 6.81% Investment securities available for sale 605,438 9,361 6.18% 541,837 9,053 6.68% Investment securites held for trading -- -- -- 552 4 2.84% Residential real estate loans 237,556 4,707 7.93% 289,915 5,820 8.03% Commercial real estate loans 180,191 4,142 9.19% 177,145 3,957 8.94% Commercial loans 272,881 6,193 8.88% 202,713 4,433 8.56% Home equity loans 175,847 3,638 8.21% 144,958 2,927 8.01% Consumer loans 12,634 306 9.69% 10,125 289 11.42% ---------- ------- ------ ----------- ------- ------ Total interest-earning assets 1,768,865 32,753 7.41% 1,601,496 30,381 7.59% Allowance for loan losses (23,667) (21,624) Non-interest-earning assets 120,373 114,716 ---------- ----------- Total assets $1,865,571 $32,753 $ 1,694,588 $30,381 ========== ======= =========== ======= Interest-bearing liabilities: Deposits Savings accounts $ 221,045 $ 1,109 1.99% $ 264,720 $ 1,561 2.34% NOW accounts (2) 39,863 106 1.05% 49,005 158 1.28% Money manager accounts (2) 44,703 122 1.08% 31,572 85 -- Money market accounts 257,449 2,060 3.17% 206,880 1,736 3.33% Time deposit accounts 586,144 7,868 5.33% 527,828 7,079 5.32% ---------- ------- ------ ----------- ------- ------ Total interest-bearing deposits 1,149,204 11,265 3.89% 1,080,005 10,619 3.90% Borrowed funds 357,596 5,171 5.66% 306,245 4,596 5.87% ---------- ------- ------ ----------- ------- ------ Total interest-bearing liabilities 1,506,800 16,436 4.33% 1,386,250 15,215 4.35% Non-interest-bearing liabilities 224,332 188,216 ---------- ----------- Total liabilities 1,731,132 1,574,466 Total stockholders' equity 134,439 120,122 ---------- ----------- Total liabilities and stockholders's equity $1,865,571 $16,436 $ 1,694,588 $15,215 ========== ======= =========== ======= Net interest income/spread $16,317 3.08% $15,166 3.24% ======= ====== ======= ====== Net interest margin as a % of interest- earning assets 3.69% 3.79% ====== ====== Tax equivalent adjustment $ 323 $ 141 ------- ------- Net interest income/spread per Condensed Consolidated Statement of Operations $15,994 $15,025 ======= ======= <FN> (1) On a fully taxable equivalent basis. Calculated using a Federal income tax rate of 35% for 1998 and 34% for 1997. (2) During July 1997, the Company implemented a program which converted certain NOW accounts to money manager accounts. This program has no effect on the Company's depositors, but has provided additional investable funds to the Company by substantially reducing the reserve balances required to be maintained at the Federal Reserve Bank of Boston. (3) A reclassification of some savings accounts to money market accounts affecting average balance outstanding was made in connection with the GBT acquisition. </FN> Net interest income on a fully taxable equivalent basis for the three months ended September 30, 1998 was $16.3 million compared to $15.2 million for the three months ended September 30, 1997, an increase of $1.1 million or 7.6%. 10 This increase was the result of a $167.4 million increase in interest-earning assets partially offset by a 10 basis point decrease in the net interest margin. Total interest income was $32.8 million on a fully taxable equivalent basis for the three months ended September 30, 1998, an increase of $2.4 million or 7.8% from the same period last year. This increase is attributable to higher levels of interest-earning assets, partially offset by lower yields on interest-earning assets. Average interest-earning assets totaled $1.8 billion in the third quarter of 1998 compared to $1.6 billion in the third quarter of 1997, an increase of $167.4 million or 10.5% and were funded by higher deposit levels and borrowed funds. Average investments increased $101.8 million or 13.6%. Average loans increased $54.3 million as the Company continued to focus on the commercial and home equity market segments, which grew by $70.2 million or 34.6% and $30.9 million or 21.3%, respectively. Average commercial real estate loans increased $3.0 million or 1.7% reflecting growth in commercial construction lending. Average residential real estate loan balances declined $52.4 million or 18.1% for the three months ended September 30, 1998, reflecting amortization and prepayments of the existing loan portfolio, partially offset by new originations of adjustable rate mortgages. The Company continues to actively originate loans secured by first mortgages on one to four family residences, and offers a variety of fixed and adjustable rate mortgage loan products. The Company originates long-term fixed rate mortgages for sale in the secondary market and generally holds adjustable rate mortgages in the Company's loan portfolio. Yields on interest-earning assets declined 18 basis points from the third quarter of 1997 primarily reflecting a lower level of interest rates on the Company's investment securities caused by increased prepayments of mortgage-backed securities which result in accelerated premium amortization. Accelerated prepayment speeds were the result of lower long-term interest rates which significantly increased refinancing activity. Total interest expense was $16.4 million for the three months ended September 30, 1998 compared to $15.2 million during the same period in 1997, an increase of $1.2 million or 8.0%. This increase is attributable to increases in interest-bearing deposits and borrowed funds. Average interest-bearing deposits increased $69.2 million or 6.4%. This growth occurred primarily in time deposits which increased $58.3 million or 11.0% largely due to growth in time deposits of local municipalities. Borrowed funds averaged $357.6 million for the three months ended September 30, 1998 compared to $306.2 million for the same period in 1997. These borrowings were used to match fund fixed rate assets and manage the Company's interest rate risk position. The following table presents the changes in net interest income (on a fully taxable equivalent basis) resulting from changes in interest rates or changes in the volume of interest-earning assets and interest-bearing liabilities during the periods indicated. Changes which are attributable to both rate and volume have been allocated evenly between the change in rate and volume components. 11 Three months ended September 30, 1998 versus 1997 ---------------------------------------------------- Increase (Decrease) Due to ---------------------------------------------------- Volume Rate Net ---------- --------- --------- (Dollars In Thousands) Interest-earning assets: Federal funds sold and interest bearing deposits $ 150 $ (24) $ 126 Investment securities held to maturity 639 (257) 382 Investment securities available for sale 1,023 (715) 308 Investment securities held for trading (2) (2) (4) Residential real estate loans (1,044) (69) (1,113) Commercial real estate loans 69 116 185 Commercial loans 1,563 197 1,760 Home equity loans 631 80 711 Consumer loans 66 (49) 17 ------- ------- ------- Total interest-earning assets 3,095 (723) 2,372 ------- ------- ------- Interest-bearing liabilities: Deposits: Savings accounts (238) (214) (452) NOW accounts (27) (25) (52) Money manager account 36 1 37 Money market accounts 414 (90) 324 Time deposit accounts 782 7 789 ------- ------- ------- Total deposits 967 (321) 646 Borrowed funds 757 (182) 575 ------- ------- ------- Total interest-bearing liabilities 1,724 (503) 1,221 ------- ------- ------- Change in net interest income $ 1,371 $ (220) $ 1,151 ======= ======= ======= Provision for Possible Loan Losses The Company's provision for possible loan losses was $0.3 million for the third quarter of 1998 compared to $0.5 million in the third quarter of 1997. The provision for possible loan losses is based upon management's judgment of the amount necessary to maintain the allowance for possible loan losses at a level which is considered adequate. For further information see "Balance Sheet Analysis - Non-performing Assets" and "- Allowance for Possible Loan Losses". 12 Non-interest Income Non-interest income is composed of fee income for bank services and gains or losses from the sale of assets. The components of non-interest income for the periods presented are as follows: Three months ended September 30, ------------------- 1998 1997 ------ ------ (Dollars in Thousands) Net gain on sale of loans $ 362 $ 136 Net gain on sale of securities 1 17 Net gain on securities held for trading -- 24 Loan charges and fees 733 854 Deposit related fees 2,219 1,962 Merchant processing fees 488 449 Other charges and fees 740 779 ------ ------ $4,543 $4,221 ====== ====== Non-interest income totaled $4.5 million for the third quarter of 1998 compared to $4.2 million for the same period in 1997, an increase of $0.3 million or 7.6%. Net gain on sale of loans increased $0.2 million due to an increase in mortgage production and corresponding sale of loans to the secondary market. Deposit service charges and fees increased $0.3 million due to fees associated with the Company's larger non-interest bearing deposit base. Loan charges and fees decreased $0.1 million reflecting a decline in the Company's mortgage servicing portfolio. Non-interest Expense Salaries and Benefits Expense Salaries and benefits expense totaled $6.9 million for the third quarter of 1998 compared to $6.2 million for the same period in 1997. This increase of $0.7 million reflects increased staffing related to new branch openings, branch-related support as well as support needed to meet increased residential origination volumes. In addition, the Company experienced higher benefit costs associated with restricted stock vesting and the Employee Stock Ownership Plan ("ESOP"). Occupancy Expense of Bank Premises Occupancy expense totaled $1.3 million for the third quarter of 1998 compared to $1.2 million for the same period in 1997, an increase of $0.1 million which is attributed to the expense of new branch openings. Other Operating Expense The components of other operating expense for the periods presented are as follows: Three months ended September 30, ------------------- 1998 1997 ------ ------ (Dollars in Thousands) Marketing $ 884 $ 470 Insurance 162 173 Professional services 906 846 Outside processing 1,418 1,262 Other 1,701 1,561 ------ ------ $5,071 $4,312 ====== ====== 13 Other operating expenses totaled $5.1 million for the third quarter of 1998 compared to $4.3 million for the third quarter of 1997, an increase of $0.8 million. Marketing expense increased $0.4 million due to additional radio and print advertisement as well as branch displays and brochures for GBT. Outside processing expenses increased $0.2 million and other operating expenses increased $0.1 million from the comparable period, reflecting costs associated with higher transaction and account volume resulting from the Company's consumer strategy. Professional services increased $0.1 million due to an increase in consulting fees partially offset by lower levels of home equity closing cost expense. Net Expense of Real Estate Operations The Company's former real estate investment and brokerage subsidiary, Colebrook, engaged in various real estate investments, directly or in joint ventures with unaffiliated partners. In accordance with FDICIA, the Company terminated its real estate development activities and has completed the sale of its remaining real estate investments. At September 30, 1998 the divestment of Colebrook was complete. Net income of real estate operations for the third quarter of 1998 was $1.1 million compared to $0.1 million for the same period in 1997. Results for the third quarter of 1998 reflect a $1.1 million gain on the sale of a real estate investment. Income Taxes For the three months ended September 30, 1998 the Company recorded income tax expense of $2.8 million compared to expense of $2.3 million for the three months ended September 30, 1997. This increase is attributable to a 20.5% increase in pre-tax earnings. Results of Operations for the Nine Months Ended September 30, 1998 and September 30, 1997 The Company reported net income of $12.9 million, or $1.79 per diluted share for the nine months ended September 30, 1998 as compared to net income of $10.8 million, or $1.57 per diluted share for the same period last year. These results reflect increases in net interest income, noninterest income and net income of real estate operations, as well as lower provisions for possible loan losses, partially offset by increases in operating expenses and income tax expense. Net Interest Income Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income is affected by the mix and volume of assets and liabilities, and the movement and level of interest rates. The Company invests in certain assets that have preferential tax treatment. In order to present yields on a comparable basis, net interest income is presented on a fully taxable equivalent basis for purposes of yield and margin analysis. The following table sets forth, for the period indicated, average balances, interest income and expense, and yields earned or rates paid on the major categories of assets and liabilities. Non-accrual loans have been included in the appropriate average balance loan category, but unpaid interest on non-accrual loans has not been included for purposes of determining interest income. In addition, investment securities available for sale are reflected at amortized cost. 14 Nine Months Ended September 30, ------------------------------------------------------------------------------------------ 1998 1997 ------------------------------------------- --------------------------------------------- Average Average Average Average Balance (3) Interest (1) Yield/Cost (1) Balance Interest (1) Yield/Cost (1) ------------ -------------- -------------- ------------ ------------ --------------- (Dollars In Thousands) Interest-earning assets: Fed funds sold and short-term investments $ 41,428 $ 1,596 5.08% $ 20,198 $ 808 5.28% Investment securities held to maturity 226,026 11,067 6.53% 217,066 10,988 6.75% Investment securities available for sale 576,993 26,750 6.18% 529,507 26,992 6.80% Investment securities held for trading -- -- -- 505 12 3.13% Residential real estate loans 254,861 15,246 7.98% 290,164 17,351 7.97% Commercial real estate loans 183,596 12,403 9.01% 171,327 11,574 9.01% Commercial loans 241,922 16,037 8.74% 196,451 12,893 8.65% Home equity loans 167,370 10,445 8.34% 131,231 7,855 8.00% Consumer loans 12,489 914 9.76% 9,504 779 10.93% ----------- -------- ----- ---------- ----------- ----- Total interest-earning assets 1,704,685 94,458 7.39% 1,565,953 89,252 7.60% Allowance for loan losses (23,336) (20,755) Non-interest-earning assets 123,942 113,301 ----------- ---------- Total assets $ 1,805,291 $ 94,458 $1,658,499 $ 89,252 =========== ======== ========== =========== Interest-bearing liabilities: Deposits Savings accounts $ 227,040 $ 3,439 2.03% $ 263,041 $ 4,600 2.34% NOW accounts (2) 40,961 398 1.30% 69,811 623 1.19% Money manager accounts (2) 47,463 406 1.14% 10,640 85 -- Money market accounts 249,594 6,065 3.25% 205,972 5,116 3.32% Time deposit accounts 564,453 22,526 5.34% 518,460 20,545 5.30% ----------- -------- ----- ---------- ----------- ----- Total interest-bearing deposits 1,129,511 32,834 3.89% 1,067,924 30,969 3.88% Borrowed funds 327,595 14,193 5.71% 294,972 12,800 5.72% ----------- -------- ----- ---------- ----------- ----- Total interest-bearing liabilities 1,457,106 47,027 4.32% 1,362,896 43,769 4.29% Non-interest-bearing liabilities 219,432 176,595 ----------- ---------- Total liabilities 1,676,538 1,539,491 Total stockholders' equity 128,753 119,008 ----------- ---------- Total liabilities and stockholders' equity $ 1,805,291 $ 47,027 $1,658,499 $ 43,769 =========== ======== ========== =========== Net interest income/spread $ 47,431 3.07% $ 45,483 3.31% ======== ===== =========== ===== Net interest margin as a % of interest- earning assets 3.71% 3.87% ===== ===== Tax equivalent adjustment $ 801 $ 480 -------- ---------- Net interest income/spread per Condensed Consolidated Statement of Operations $ 46,630 $ 45,003 ======== ========== <FN> (1) On a fully taxable equivalent basis. Calculated using a Federal income tax rate of 35% for 1998 and 34% for 1997. (2) During July 1997, the Company implemented a program which converted certain NOW accounts to money manager accounts. This program has no effect on the Company's depositors, but has provided additional investable funds to the Company by substantially reducing the reserve balances required to be maintained at the Federal Reserve Bank of Boston. (3) A reclassification of some savings accounts to money market accounts affecting average balance outstanding was made in connection with the GBT acquisition. </FN> Net interest income on a fully taxable equivalent basis for the nine months ended September 30, 1998 was $47.4 million compared to $45.5 million for the nine months ended September 30, 1997, an increase of $1.9 million or 4.3%. This increase was the result of a $138.7 million increase in interest-earning assets partially offset by a 16 basis point decrease in the net interest margin. Total interest income was $94.5 million on a fully taxable equivalent basis for the nine months ended September 30, 1998, an increase of $5.2 million or 5.8% from the same period last year. This increase is attributable to higher levels of interest-earning assets, partially offset by lower yields on interest-earning assets. Average interest-earning assets totaled $1.7 billion for the nine months ended September 30, 1998 compared to $1.6 billion for the nine months ended September 30, 1997, an increase of $138.7 million or 8.9% and were funded by higher deposit levels and borrowed funds. Average investments increased $55.9 million or 7.5%. Average loans increased $61.6 million as the Company continued to focus on the commercial and home equity market segments, which grew by $45.5 million or 23.1% and $36.1 million or 27.5%, respectively. Average commercial real estate loans increased $12.3 million or 7.2% reflecting growth in commercial construction lending. Average residential real estate loan balances declined $35.3 million or 12.2% for the nine months ended September 30, 1998, reflecting amortization and prepayments of the existing loan portfolio, partially offset by the origination of adjustable rate mortgages. The Company continues to actively originate loans secured by first mortgages on one to four family residences, and offers a variety of fixed and adjustable rate 15 mortgage loan products. The Company originates long-term fixed rate mortgages for sale in the secondary market and generally holds adjustable rate mortgages in the Company's loan portfolio. Yields on interest-earning assets declined 21 basis points from the nine months ended September 30, 1997 primarily reflecting a lower level of interest rates on the Company's investment securities caused by increased prepayments of mortgage-backed securities which result in accelerated premium amortization. Accelerated prepayment speeds were the result of lower long-term interest rates which significantly increased refinancing activity. Total interest expense was $47.0 million for the nine months ended September 30, 1998 compared to $43.8 million during the same period in 1997, an increase of $3.2 million or 7.4%. This increase is attributable to increases in interest-bearing deposits and borrowed funds. Average interest-bearing deposits increased $61.6 million or 5.8%. This growth occurred primarily in time deposits which increased $46.0 million or 8.9% largely due to growth in deposits of local municipalities. Borrowed funds averaged $327.6 million for the nine months ended September 30, 1998 compared to $295.0 million for the same period in 1997. These borrowings were used to match fund fixed rate assets and manage the Company's interest rate risk position. The following table presents the changes in net interest income (on a fully taxable equivalent basis) resulting from changes in interest rates or changes in the volume of interest-earning assets and interest-bearing liabilities during the periods indicated. Changes which are attributable to both rate and volume have been allocated evenly between the change in rate and volume components. Nine Months Ended September 30, 1998 versus 1997 ---------------------------------------- Increase (Decrease) Due to ---------------------------------------- Volume Rate Net ---------- ----------- --------- (Dollars In Thousands) Interest-earning assets: Federal funds sold and short term investments $ 834 $ (46) $ 788 Investment securities held to maturity 446 (367) 79 Investment securities available for sale 2,310 (2,552) (242) Investment securities held for trading (6) (6) (12) Residential real estate loans (2,111) 6 (2,105) Commercial real estate loans 829 -- 829 Commercial loans 2,999 145 3,144 Home equity loans 2,209 381 2,590 Consumer loans 232 (97) 135 ------- ------- ------- Total interest-earning assets 7,742 (2,536) 5,206 ------- ------- ------- Interest-bearing liabilities: Deposits: Savings accounts (587) (574) (1,161) NOW accounts (269) 44 (225) Money manager accounts 305 16 321 Money market accounts 1,072 (123) 949 Time deposit accounts 1,828 152 1,981 ------- ------- ------- Total deposits 2,349 (484) 1,865 Borrowed funds 1,415 (22) 1,393 ------- ------- ------- Total interest-bearing liabilities 3,764 (506) 3,258 ------- ------- ------- Change in net interest income $ 3,978 $(2,030) $ 1,948 ======= ======= ======= 16 Provision for Possible Loan Losses The Company's provision for possible loan losses was $0.8 million for the nine months ended September 30, 1998 compared to $1.4 million for the same period in 1997. The provision for possible loan losses is based upon management's judgment of the amount necessary to maintain the allowance for possible loan losses at a level which is considered adequate. For further information see "Balance Sheet Analysis - Non-performing Assets" and "- Allowance for Possible Loan Losses". Non-interest Income Non-interest income is composed of fee income for bank services and gains or losses from the sale of assets. The components of non-interest income for the periods presented are as follows: Nine months ended September 30, ------------------- 1998 1997 ------ ------ (Dollars in Thousands) Net gain on sale of loans $ 986 $ 328 Net gain on sale of securities 3 77 Net gain on securities held for trading -- 43 Loan charges and fees 2,276 2,355 Deposit related fees 6,293 5,564 Merchant processing fees 1,398 1,358 Other charges and fees 2,092 1,761 ------- ------- $13,048 $11,486 ======= ======= Non-interest income totaled $13.0 million for the nine months ended September 30, 1998 compared to $11.5 million for the same period in 1997, an increase of $1.5 million or 13.6%. Deposit service charges and fees increased $0.7 million due to fees associated with the Company's larger non-interest bearing deposit base. Net gain on sale of loans increased $0.7 million due to an increase in mortgage production and corresponding sale of loans to the secondary market. Other charges and fees increased $0.3 million due to increases in brokerage service fees and fees associated with Business Manager, a commercial cash management product introduced by the Company in 1997, which involves the funding and management of accounts receivable for small-to-medium-sized business customers. Loan charges and fees decreased $0.1 million reflecting the decline in the residential mortgage servicing portfolio. Non-interest Expense Salaries and Benefits Expense Salaries and benefits expense totaled $19.7 million for the nine months ended September 30, 1998 compared to $18.3 million for the same period in 1997, an increase of $1.4 million reflecting standard wage increases, increased staffing related to new branch openings, branch-related support, as well as support needed to meet increased residential origination volumes. In addition, the Company experienced higher benefit costs associated with restricted stock vesting and the ESOP. Occupancy Expense of Bank Premises Occupancy expense totaled $3.8 million for the nine months ended September 30, 1998 compared to $3.6 million for the same period in 1997, an increase of $0.2 million which is attributed to the expense of new branch openings. Furniture and Equipment Expense Furniture and equipment expense increased $0.3 million reflecting new branch openings as well as investments in new technology. 17 Other Operating Expense The components of other operating expense for the periods presented are as follows: Nine months ended September 30, ------------------- 1998 1997 ------ ------ (Dollars in Thousands) Marketing $ 2,016 $ 1,568 Insurance 467 547 Professional services 2,030 2,436 Outside processing 4,114 3,650 Other 4,926 4,482 ------- ------- $13,553 $12,683 ======= ======= Other operating expenses totaled $13.6 million for the nine months ended September 30, 1998 compared to $12.7 million for the same period in 1997, an increase of $0.9 million. Outside processing and other operating expenses increased $0.5 million and $0.4 million respectively, from the comparable period reflecting costs associated with higher transaction and account volumes resulting from the Company's consumer strategy. Marketing increased $0.4 million due to additional radio and print advertisement as well as branch displays and brochures for GBT. Professional services decreased $0.4 million due to lower levels of legal expenses. Net Expense of Real Estate Operations The Company's former real estate investment and brokerage subsidiary, Colebrook, engaged in various real estate investments, directly or in joint ventures with unaffiliated partners. In accordance with FDICIA, the Company terminated its real estate development activities and has completed the sale of its remaining real estate investments. At September 30, 1998 the divestment of Colebrook was complete. Net income of real estate operations for the nine months ended September 30, 1998 was $1.7 million compared to net expense of $0.4 million for the same period in 1997. In the first quarter of 1997, the Company established a reserve of $1.0 million relating to the divestment of Colebrook which was partially offset by a $0.6 million gain on the sale of real estate property. Results for the nine months ended September 30, 1998 were influenced by a $1.1 million gain on the sale of a real estate investment in the third quarter, the second quarter reversal of the remaining $0.4 million Colebrook divestment reserve, as well as income of $0.2 million representing normal operating earnings. Income Taxes For the nine months ended September 30, 1998 the Company recorded income tax expense of $7.9 million compared to expense of $6.9 million for the nine months ended September 30, 1997. This increase is attributable to a 17.6% increase in pre-tax earnings, partially offset by a lower overall effective rate resulting from state tax planning strategies. 18 Balance Sheet Analysis - Comparison Of September 30, 1998 To December 31, 1997 Total assets increased from $1.7 billion at December 31, 1997 to $1.9 billion at September 30, 1998. This increase primarily reflects growth in investment securities and loans funded through an increase in deposits and wholesale borrowings. Investments The Company's investment portfolio increased $94.6 million from $769.1 million at December 31, 1997 to $863.7 million at September 30, 1998. The Company engages in investment activities for both investment and liquidity purposes. The Company maintains an investment securities portfolio which consists primarily of U.S. Government and Agency securities, corporate obligations, asset-backed securities, collateralized mortgage obligations, FHLB stock, and marketable equity securities. Other short-term investments held by the Company periodically include interest-bearing deposits and federal funds sold. The Company also maintains a mortgage-backed securities portfolio consisting of securities issued and guaranteed by the Federal National Mortgage Association ("FNMA"), the Federal Home Loan Mortgage Corporation ("FHLMC") and the Government National Mortgage Association ("GNMA") in addition to publicly traded mortgage-backed securities issued by private financial intermediaries which are rated "AA" or higher by rating agencies of national prominence. Securities which the Company has the intent and ability to hold until maturity are classified as held-to-maturity and are carried at amortized cost, while those securities which have been identified as assets that may be sold prior to maturity or assets for which there is not a positive intent to hold to maturity are classified as available-for-sale and are carried at fair value, with unrealized gains and losses excluded from earnings and reported net of tax as accumulated other comprehensive income as a separate component of stockholders' equity. During 1997 GBT held trading securities. However, concurrent with the acquisition of GBT, the Company sold its position in these instruments. At September 30, 1998 and December 31, 1997, the Company held no trading securities. The table below sets forth certain information regarding the amortized cost and fair value of the Company's investment portfolio at the dates indicated. September 30, 1998 ----------------------------------------------------------- Available for Sale Held to Maturity ---------------------------- -------------------------- (Dollars In Thousands) Amortized Amortized Cost Fair Value Cost Fair Value ----------- ------------ ---------- ----------- U.S. Government and Agency obligations $ 17,017 $ 17,119 $ -- $ -- Collateralized mortgage obligations 46,690 46,804 12,854 12,994 Mortgage-backed securities 495,842 493,756 165,705 166,017 Asset-backed securities -- -- 65,349 65,861 Other bonds and short term obligations 8,968 9,591 330 330 Other securities 51,294 52,150 -- -- -------- -------- -------- -------- Total $619,811 $619,420 $244,238 $245,202 ======== ======== ======== ======== December 31, 1997 ----------------------------------------------------------- Available for Sale Held to Maturity ---------------------------- -------------------------- (Dollars In Thousands) Amortized Amortized Cost Fair Value Cost Fair Value ----------- ------------ ---------- ----------- U.S. Government and Agency obligations $ 15,608 $ 15,636 $ 2,400 $ 2,391 Collateralized mortgage obligations 51,273 51,415 2,934 2,953 Mortgage-backed securities 458,659 460,478 141,282 141,563 Asset-backed securities -- -- 46,046 46,143 Other bonds and short term obligations 8,966 9,355 345 346 Other securities 38,128 39,224 -- -- -------- -------- -------- -------- Total $572,634 $576,108 $193,007 $193,396 ======== ======== ======== ======== 19 Loan Portfolio Composition Gross loans comprised $896.2 million or 47.2% of total assets as of September 30, 1998. The following table sets forth information concerning the Company's loan portfolio in dollar amounts and percentages, by type of loan at September 30, 1998 and at December 31, 1997. September 30, 1998 December 31, 1997 -------------------------------- -------------------------------- Percent of Percent of Amount Total Amount Total --------------- ------------- -------------- -------------- (Dollars In Thousands) Residential real estate loans $235,738 26.30% $281,457 33.13% Commercial real estate loans 188,624 21.05% 185,226 21.80% Commercial loans 280,551 31.31% 212,869 25.06% Home equity loans 179,005 19.97% 158,753 18.69% Consumer loans 12,270 1.37% 11,189 1.32% -------- ------ -------- ------ Total loans receivable, gross 896,188 100.00% 849,494 100.00% -------- ------ -------- ------ Less: Unearned income and fees (2,986) (1,991) Allowance for loan losses 23,924 22,724 -------- -------- Total loans receivable, net $875,250 $828,761 ======== ======== The Company continues to actively originate loans secured by first mortgages on one to four family residences, and offers a variety of fixed and adjustable rate mortgage loan products. The Company originates long-term fixed rate mortgages for sale in the secondary market and generally holds adjustable rate mortgages in the Company's loan portfolio. During the nine months ended September 30, 1998, the Company experienced an increase in prepayments in its adjustable rate mortgage portfolio. These prepayments offset new originations and resulted in a $45.7 million decrease in residential real estate balances between December 31, 1997 and September 30, 1998. During the nine months ended September 30, 1998, commercial loan balances increased $67.7 million, reflecting the Company's continued focus on lending activities in the local business market. Home equity loans increased $20.3 million from December 31, 1997 to September 30, 1998 as the Company continues to actively promote home equity products. 20 Non-performing Assets Non-performing assets declined from $8.1 million at December 31, 1997 to $5.0 million at September 30, 1998. The decline is primarily attributed to the movement of non-accrual loans to accrual status. The following table sets forth information regarding the components of non-performing assets for the periods presented: September 30, December 31, 1998 1997 ------------- ------------ (Dollars In Thousands) Non-accrual loans (1): Residential real estate loans $1,132 $1,211 Commercial real estate loans 675 1,542 Commercial loans 1,561 2,414 Home equity loans 282 181 Consumer loans 27 4 ------ ------ Total non-accrual loans 3,677 5,352 ------ ------ Loans past due 90 days still accruing (2) 371 431 ------ ------ Total non-performing loans 4,048 5,783 Foreclosed real estate (3) 679 1,209 Restructured loans on accrual status (4) 275 1,124 ------ ------ Total non-performing assets $5,002 $8,116 ====== ====== Total non-performing loans to total gross loans 0.45% 0.68% Total non-performing assets to total assets 0.26% 0.47% Allowance for possible losses to non-performing loans 591.01% 392.94% (1) Non-accrual loans are loans that are contractually past due in excess of 90 days, for which the Company has stopped the accrual of interest, or loans which are not past due but on which the Company has stopped the accrual of interest based on management's assessment of the circumstances surrounding these loans. (2) Accruing loans past due 90 days or more are loans which have not been placed on non-accrual status as, in management's opinion, the collection of the loan, in full, is not in doubt. (3) Foreclosed real estate includes OREO, defined as real estate acquired through foreclosure or acceptance of a deed in lieu of foreclosure. The Company carries foreclosed real estate at the lower of cost or net realizable value, which approximates fair value less estimated selling costs. (4) Restructured loans are loans for which concessions, including reduction of interest rates or deferral of interest or principal payments, have been granted due to the borrower's financial condition. Restructured loans on non-accrual status are reported in the non-accrual loan category. Restructured loans on accrual status are those loans that have complied with terms of a restructuring agreement for a satisfactory period (generally six months). 21 The principal amount of non-performing loans including non-performing restructured loans aggregated $4.0 million at September 30, 1998 and $5.8 million at December 31, 1997. Interest income that would have been recorded if the loans had been performing in accordance with their original terms aggregated $0.3 million and $0.4 million for the nine months ended September 30, 1998 and 1997, respectively. Interest income recorded on these loans for the nine months ended September 30, 1998 and 1997 was $0.1 million and $0.3 million, respectively. The principal amount of accruing restructured loans aggregated $0.3 million at September 30, 1998 compared to $1.1 million at December 31, 1997, a decrease of $0.8 million. Interest income that would have been recorded if the loans had been performing within their original terms aggregated $18 thousand and $0.2 million for the periods ended September 30, 1998 and 1997, respectively. Interest income recorded on these loans amounted to $21 thousand and $0.1 million for the nine months ended September 30, 1998 and 1997, respectively. Watch List Loans The Company maintains a "watch list" of loans, which represents performing loans that have potential weaknesses that require management's attention. These potential weaknesses may stem from a variety of factors including, among other things, economic or market conditions, adverse conditions in the obligor's operations or financial condition weaknesses. Watch list loans totaled $17.2 million and $24.1 million at September 30, 1998 and December 31, 1997, respectively. Classified Loans The Company's Credit Grade Policy (the "Policy") provides for the classification of loans considered to be of lesser quality as "substandard", "doubtful", or "loss" loans. A loan is considered substandard under the Policy if it is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans include those characterized by the "distinct possibility" that the Company will sustain "some loss" if the deficiencies are not corrected. Loans classified as doubtful, of which the Company has none, have all of the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses present make "collection or liquidation in full" on the basis of currently existing facts, conditions and values, "improbable." Loans characterized as loss, of which the Company has none, are those considered "uncollectible" and of such little value that their continuance as bankable assets is not warranted. Classified loans, all of which are categorized substandard, totaled $9.5 million and $6.2 million at September 30, 1998 and December 31, 1997, respectively. Included in these amounts are $3.7 million and $5.4 million of loans which have been reported as non-performing assets at September 30, 1998 and December 31, 1997, respectively. Allowance for Possible Loan Losses The allowance for possible loan losses reflects an amount that, in management's judgment, is adequate to provide for potential losses in the loan portfolio. In addition, examinations of the adequacy of the loan loss reserve are conducted periodically by various regulatory agencies. The allowance for possible loan losses at September 30, 1998 was $23.9 million, compared to $22.5 million at September 30, 1997. 22 The activity in the allowance for possible loan losses for the nine months ended September 30, 1998 and 1997 was as follows: Nine Months Ended September 30, ---------------------- 1998 1997 --------- --------- (Dollars In Thousands) Balance, beginning of period $ 22,724 $ 19,549 Provision for loan losses 755 1,431 Charge-offs: Residential real estate loans (268) (202) Commercial real estate loans (426) (721) Commercial loans (324) (459) Home equity loans (41) (135) Consumer loans (184) (200) Merchant processing (55) (51) -------- -------- Total charge-offs (1,298) (1,768) Recoveries: Residential real estate loans -- 2 Commercial real estate loans 1,277 2,821 Commercial loans 420 331 Home equity loans 12 80 Consumer loans 34 38 Merchant processing -- -- -------- -------- Total recoveries 1,743 3,272 -------- -------- Net recoveries (charge-offs) 445 1,504 Balance, end of period $ 23,924 $ 22,484 ======== ======== Ratio of net loan recoveries (charge-offs) during the period to average loans outstanding during the period 0.05% 0.19% Ratio of allowance for possible loan losses to total loans at the end of the period 2.67% 2.65% Ratio of allowance for possible loan losses to non-performing loans at the end of the period 591.01% 360.26% At September 30, 1998, the recorded investment in loans that are considered impaired under SFAS 114 "Accounting by Creditors for Impairment of a Loan" was $8.5 million. Included in this amount is $1.4 million of impaired loans for which the related SFAS 114 allowance is $0.5 million and $7.2 million of impaired loans for which the SFAS 114 allowance is zero. The average recorded investment in impaired loans during the three and nine months ended September 30, 1998 was approximately $8.2 million and $8.6 million, respectively. For the three and nine month periods ended September 30, 1998, the Company recognized interest income on these impaired loans of $0.1 million and $0.4 million, respectively. 23 The following table shows the allocation of the allowance for possible loan losses to the various types of loans as well as the percentage of allowance for possible loan losses in each category to total allowance for possible loan loss. September 30, 1998 December 31, 1997 ---------------------------- --------------------------- % of % of Total Total Allowance for Allowance for Amount Loan Losses Amount Loan Losses ----------- ------------- --------- ------------- (Dollars In Thousands) Residential real estate loans $ 2,675 11.18% $ 3,664 16.12% Commercial real estate loans 7,516 31.42% 5,632 24.78% Commercial loans 9,025 37.73% 8,328 36.65% Home equity loans 2,518 10.52% 3,183 14.01% Consumer loans 1,008 4.21% 1,274 5.61% Merchant processing 1,182 4.94% 643 2.83% ------- ------ ------- ------ Total allowance for possible loan losses $23,924 100.00% $22,724 100.00% ======= ====== ======= ====== Deposit Distribution The principal source of funds for the Company are deposits from local consumers and businesses. There were no brokered deposits at September 30, 1998 or December 31, 1997. The Company's deposits consist of demand and NOW accounts, money manager accounts, passbook and statement savings accounts, money market accounts and time deposits. The following table presents the composition of deposits at the dates indicated: September 30, 1998 December 31, 1997 ----------------------- ----------------------- Percent Percent of of Amount Total Amount Total ---------- -------- ---------- --------- (Dollars In Thousands) Demand deposits $ 190,547 14.19% $ 171,343 13.52% NOW accounts 46,312 3.45% 51,412 4.06% Money manager accounts (1) 39,398 2.93% 39,447 3.11% Savings accounts 217,861 16.22% 263,449 20.79% Money market accounts 253,066 18.84% 211,286 16.67% Time deposits 595,879 44.37% 530,361 41.85% ---------- ------ ---------- ------ Total deposits $1,343,063 100.00% $1,267,298 100.00% ========== ====== ========== ====== <FN> (1) Money manager accounts represent NOW account balances which have been transferred to money market accounts to provide additional investable funds to the Company by substantially reducing the reserve balances required to be maintained at the Federal Reserve Bank of Boston. This program has no effect on the Company's depositors. </FN> Total deposits were $1.3 billion at both September 30, 1998 and December 31, 1997. Deposits increased $75.8 million with growth occurring primarily in demand deposits and time deposits. The $45.6 million decrease in savings accounts is offset by a comparable increase in money market accounts, which is attributable to the conversion of some savings accounts in connection with the GBT acquisition. Demand deposits increased $19.2 million reflecting growth in business deposits, as a result of active solicitation of these accounts, and consumer deposits, as customers continue to take advantage of free checking accounts offered as a result of the Company's consumer deposit strategy. The $65.5 million increase in time deposits is primarily attributable to growth in deposits of local municipalities. 24 Borrowings Borrowings consist of FHLB advances, securities sold under agreements to repurchase, and loans payable related to the Company's ESOP. The Company generally uses borrowings to match fund fixed rate assets and manage the Company's interest rate risk position. Borrowings increased $80.7 million from $299.9 million at December 31, 1997 to $380.6 million at September 30, 1998 reflecting a portion of the funding for the growth in loans and investments. Regulatory Capital The Company is 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 adverse effect on the Company's financial statements. Under applicable capital adequacy requirements the Company must meet specific minimum capital requirements that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company'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 to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets and Tier 1 capital to total average assets. Management believes, as of September 30, 1998, that the Company meets all capital adequacy requirements to which it is subject. Under the FDIC's regulatory framework for prompt corrective action, both SIS Bank and GBT are considered well capitalized as of September 30, 1998. To be categorized as well capitalized the Banks must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. As of September 30, 1998 the Company also qualified as well capitalized under the applicable Federal Reserve Board regulations. Capital amounts and ratios are monitored by management for the Company, SIS Bank and GBT to ensure qualification as well capitalized. In connection with maintaining GBT's qualification as well capitalized the Company has discontinued GBT dividend payments to the parent company. 25 The actual capital amounts and ratios for the Company, SIS Bank and GBT are presented in the table below, no deductions were made from capital for interest-rate risk. Minimum Minimum Requirements Requirements For Capital To Qualify As Actual Adequacy Purposes Well Capitalized -------------------- ------------------------ ---------------------- Amount Ratio Amount Ratio Amount Ratio --------- ------- ----------- ---------- --------- ------- (Dollars In Thousands) As of September 30, 1998: Tier I Capital (to Average Assets) Company $139,348 7.5% $ 74,623 4.0% N/A SIS Bank $115,416 7.4% $ 62,821 4.0% $ 78,527 5.0% GBT $ 19,097 6.5% $ 11,805 4.0% $ 14,756 5.0% Tier I Capital (to Risk Weighted Assets) Company $139,348 11.5% $ 48,507 4.0% $ 72,761 6.0% SIS Bank $115,416 11.5% $ 40,291 4.0% $ 60,437 6.0% GBT $ 19,097 9.3% $ 8,220 4.0% $ 12,330 6.0% Total Capital (to Risk Weighted Assets) Company $154,601 12.7% $ 97,014 8.0% $121,268 10.0% SIS Bank $128,095 12.7% $ 80,583 8.0% $100,729 10.0% GBT $ 21,671 10.6% $ 16,439 8.0% $ 20,549 10.0% As of December 31, 1997: Tier I Capital (to Average Assets) Company $123,340 7.2% $ 68,834 4.0% N/A SIS Bank $103,780 7.1% $ 58,358 4.0% $ 72,947 5.0% GBT $ 17,291 6.6% $ 10,422 4.0% $ 13,028 5.0% Tier I Capital (to Risk Weighted Assets) Company $123,340 11.9% $ 41,568 4.0% $ 62,352 6.0% SIS Bank $103,780 11.9% $ 35,044 4.0% $ 52,565 6.0% GBT $ 17,291 10.6% $ 6,507 4.0% $ 9,761 6.0% Total Capital (to Risk Weighted Assets) Company $136,438 13.1% $ 83,137 8.0% $103,921 10.0% SIS Bank $114,825 13.1% $ 70,087 8.0% $ 87,609 10.0% GBT $ 19,344 11.9% $ 13,014 8.0% $ 16,268 10.0% Interest Rate Risk Management Using management's estimates of asset prepayments and core deposit decay in its computation, the Company estimates that its cumulative one-year gap position was liability sensitive by $29.3 million or 1.54% of total assets at September 30, 1998. The following table sets forth the amounts of assets and liabilities outstanding at September 30, 1998, which are anticipated by the Company to mature or reprice in each of the future time periods shown using certain assumptions based on its historical experience, the current interest rate environment, and other data available to management. Management believes that these assumptions approximate actual experience and considers such assumptions reasonable, however, the interest rate sensitivity of the Company's assets and liabilities could vary substantially if different assumptions were used or actual experience differs from the assumptions used. Management periodically reviews and, when appropriate, changes the assumptions used in creating this table. 26 GAP Position At September 30, 1998 ---------------------------------------------------------------------- More than six Less than months less six months than one year 1 - 5 Years Over 5 Yrs TOTAL ------------ -------------- ----------- ----------- ---------- (Dollars In Thousands) Assets: Federal funds sold and interest bearing deposits $ 52,242 $ -- $ -- $ -- $ 52,242 Investment securities 323,351 189,285 287,172 63,850 863,658 Residential real estate loans 55,406 55,362 96,449 27,720 234,937 Commercial real estate loans 45,817 13,147 110,009 18,928 187,901 Commercial loans 105,263 14,893 148,952 10,521 279,629 Home equity loans 112,739 7,296 32,478 28,279 180,792 Consumer loans 6,391 1,027 4,820 -- 12,238 Other assets -- -- -- 89,021 89,021 ---------- ---------- ---------- ---------- ---------- Total assets $ 701,209 $ 281,010 $ 679,880 $ 238,319 $1,900,418 ========== ========== ========== ========== ========== Liabilities & stockholders' equity: Savings accounts $ 32,679 $ 32,679 $ 152,503 $ -- $ 217,861 NOW accounts 12,858 12,857 59,995 -- 85,710 Money market accounts 75,920 75,920 101,226 -- 253,066 Time deposits 406,201 131,077 57,382 1,219 595,879 Borrowed funds 142,242 12,914 188,518 36,936 380,610 Other liabilities & stockholders' equity 38,109 38,109 114,328 176,746 367,292 ---------- ---------- ---------- ---------- ---------- Total liabilities & stockholders' equity $ 708,009 $ 303,556 $ 673,952 $ 214,901 $1,900,418 ========== ========== ========== ========== ========== Period GAP position $ (6,800) $ (22,546) $ 5,928 $ 23,418 Net period GAP as a percentage of total assets (0.35%) (1.19%) 0.31% 1.23% Cumulative GAP $ (6,800) $ (29,346) $ (23,418) -- Cumulative GAP as a percentage of total assets (0.35%) (1.54%) (1.23%) -- Cumulative GAP as a percentage of total interest-earning assets (0.38%) (1.62%) (1.29%) -- Cumulative interest-earning assets as a percentage of cumulative interest-bearing 104.67% 105.01% 111.18% 118.15% liabilities <FN> For purposes of the above interest sensitivity analysis: Residential loans held for sale at September 30, 1998 totaling $10.4 million are in the less than six month interest sensitivity period. Fixed rate assets are scheduled by contractual maturity and adjustable rate assets are scheduled by their next repricing date. In both cases, assets that have prepayment optionality are adjusted for the Company's estimate of prepayments. Loans do not include non-accrual loans of $3.7 million. Loans do not include the allowance for loan loss of $23.9 million. In certain deposit categories where there is no contractual maturity, Management assumed the sensitivity characteristics listed below based on the current interest rate environment and the Company's historical experience. Management reviews these assumptions on a quarterly basis and may modify them as circumstances dictate. - Savings accounts are assumed to decay at an annual rate of 30%. - NOW accounts are assumed to decay at an annual rate of 30%. - Money market accounts are assumed to decay at an annual rate of 60%. - Non-interest bearing accounts of $190.5 million are included in other liabilities and are assumed to decay at an annual rate of 40%. </FN> 27 Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, while certain assets and liabilities may have similar contractual maturities or periods to repricing, they may react in different ways to changes in market interest rates. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Additionally, certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Finally, the ability of borrowers to service their adjustable rate mortgages may decrease in the event of an interest rate increase. To offset these inherent weaknesses the Company also utilizes income simulation modeling in measuring its interest rate risk and managing its interest rate sensitivity. Income simulation not only considers the impact of changing market interest rates on forecasted net interest income, but also takes into consideration other factors such as yield curve relationships, the volume and mix of assets and liabilities, customer preferences and general market conditions. In addition, the Company utilizes duration analysis and calculates the Company's market value of portfolio equity under various interest rate scenarios. Liquidity Liquidity measures the ability of the Company to meet its maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund its operations and to provide for customer credit needs. If the Company requires funds beyond its ability to generate them internally, it has additional borrowing capacity with the FHLB and collateral eligible for repurchase agreements. Because the Company has a stable retail deposit base, management believes that significant borrowings will not be necessary to maintain its current liquidity position. Management intends to continue seeking opportunities for expansion and believes that the Company's liquidity, capital resources and borrowing capabilities are adequate for its current and intended operations. Market Risk As a financial institution, the Company's chief market risk is interest rate risk. The Company has no exposure to foreign currency or commodity prices. Its exposure to equity prices is limited to marketable equity securities contained within its available for sale investment portfolio. At September 30, 1998 the Company did not have a trading portfolio. Interest rate risk is the sensitivity of income to variations in interest rates over defined time horizons. The primary goal of interest rate risk management is to control this risk within limits and guidelines approved by the Company's Board of Directors. These limits and guidelines reflect the Company's tolerance for interest rate risk. The Company attempts to control interest rate risk by identifying exposures, quantifying them, and identifying their impact on income. The Company quantifies its interest rate risk exposures using simulation models as well as gap analyses. The Company manages its interest rate exposures using a combination of on-balance sheet instruments, consisting principally of fixed and variable rate securities, deposit pricing and FHLB borrowings. See the GAP Position analysis under this Item 2 and the notes to the Consolidated Financial Statements under Item 8 in the Company's Form 10-K for the year ended December 31, 1997 for further information regarding market risk of these instruments. At September 30, 1998 and December 31, 1997, the Company had no outstanding exposures to off-balance sheet interest rate instruments such as swaps, forwards or futures. GBT held derivative financial instruments during 1997. However, in December, 1997 concurrent with the acquisition of GBT, the Company sold its position in these instruments. At September 30, 1998 the Company held no derivative financial instruments. 28 Part II. OTHER INFORMATION Item 1. Legal Proceedings Not applicable Item 2. Changes in Securities Not applicable Item 3. Default upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders (a) On November 12, 1998,a Special Meeting of the Stockholders of SIS Bancorp, Inc. was held at the headquarters of SIS Bancorp, Inc., 1441 Main Street, Springfield, Massachusetts. (b) N/A (c) The only proposal presented at the meeting was to "Consider and vote upon a proposal to adopt the Agreement and Plan of Merger dated as of July 20, 1998, as amended (the "Merger Agreement") among Peoples Heritage Financial Group, Inc. ("PHFG"), Peoples Heritage Merger Corp., a wholly-owned subsidiary of Peoples Heritage Financial Group, Inc., and SIS Bancorp, Inc. ("SIS"), which provides, among other things, for (i) the merger of SIS with and into Peoples Heritage Merger Corp., and (ii) the conversion of each share of SIS common stock outstanding immediately prior to the merger (other than any dissenting shares under Massachusetts law and certain other shares) into the right to receive 2.25 shares of Peoples Heritage Financial Group, Inc. common stock, subject to possible adjustments under certain circumstances, plus cash in lieu of any fractional shares" as more fully described in the Proxy statement for the meeting. Votes For (shares) Votes Against (shares) Votes Abstained (shares) Broker Non-Votes ------------------ ---------------------- ------------------------ ---------------- 4,991,614 96,729 19,030 None Item 5. Other Information Not applicable Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: None (b) Reports on Form 8-K On July 21, 1998, the Company filed a Form 8-K reporting the signing of a definitive Agreement and Plan for Merger dated July 20, 1998 between the Company and People's Heritage Financial Group, Inc. 29 SIGNATURES Under the requirements of the Securities Exchange Act of 1934, as amended, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SIS BANCORP, INC. (Registrant) November 13, 1998 /s/ F. William Marshall, Jr. Date F. William Marshall, Jr. President and Chief Executive Officer November 13, 1998 /s/ John F. Treanor Date John F. Treanor Executive Vice President, Chief Operating Officer and Chief Financial Officer 30