1 Table of Contents Financial Highlights............................................1 Letter to Stockholders........................................2-3 Business - Westbank Corporation and Subsidiaries ..............4 Selected Consolidated Financial Data.................... .......5 Management's Discussion and Analysis - Financial Results.....6-21 Consolidated Balance Sheets....................................22 Consolidated Statements of Income..............................23 Consolidated Statements of Comprehensive Income................24 Consolidated Statements of Stockholders' Equity................25 Consolidated Statements of Cash Flows..........................26 Notes to Consolidated Financial Statements..................27-47 Independent Auditors' Report................................48-49 Corporate Directory............................................50 Corporate Information..........................................50 2 FINANCIAL HIGHLIGHTS Westbank Corporation and Subsidiaries FOR THE YEAR ENDED DECEMBER 31 (Dollars in Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------- Net income $ 3,377 $ 3,384 $ 2,137 Net interest income 15,339 14,633 13,535 Non-interest income 2,427 2,529 2,340 Non-interest expense 12,200 11,066 11,278 Provision for loan losses 41 306 944 YEAR END DECEMBER 31 (Dollars in Thousands) - - -------------------------------------------------------------------------------------- Investment and mortgage-backed securities $ 84,328 $ 60,213 $ 39,764 Loans, net 293,113 268,254 254,948 Allowance for loan losses 2,665 3,057 2,699 Total assets 402,623 355,567 331,803 Total deposits 342,266 314,679 298,014 Total stockholders' equity 30,490 26,918 22,717 COMMON SHARE INFORMATION Basic weighted average shares outstanding 4,143,009 3,845,698 3,643,270 Basic net earnings per share $.82 $.88 $.59 1 3 CHAIRMAN'S AND PRESIDENT'S LETTER Westbank Corporation and Subsidiaries Dear Shareholder: The past year was especially rewarding because we have achieved our topmost objectives, record earnings and measured growth. Our growth strategy is based on the premise: Succeeding today and investing for tomorrow. We seek to grow at a measured, orderly pace by nurturing our core banking operations, deepening our market penetration by providing more banking services to our present customers, by acquisitions of other banks and opening new offices in selected areas. We are proud to report that net income for the year ended December 31, 1998 totaled $3.3 million or $0.84 per diluted share, compared to $3.2 million or $0.89 per diluted share for the same period a year ago. Included in the results of operations during the fourth quarter of 1998 were $400 thousand of merger costs associated with the acquisition of Cargill Bancorp, Inc., of Putnam, Connecticut, which was consummated on January 29, 1999. We look forward to the opportunity to work with the Cargill shareholders, staff and customers. The affiliation will allow Cargill to offer a wider range of products and services, while at the same time Westbank will achieve its corporate objective of expanding its market into Connecticut. Westbank is presently positioned and has sufficient resources and infrastructure to expand through acquisition. We will pursue opportunities for growth in our defined market area as well as in markets that are contiguous to our present market area, which include Connecticut, Rhode Island and Central Massachusetts. Consistent with our corporate strategies of building market share, we have expanded our geographical reach into Ludlow and Southwick, Massachusetts. These new full-service banking offices have exceeded all expectations by generating a combined total of $11 million in new deposits last year. At year-end assets totaled $355 million, an increase of $46.7 million or 15% compared to the same period in 1997. Deposits increased by $27.5 million or 10% and totaled $299.1 million. The Corporation's capital was $27.3 million at year end, representing a capital ratio of 7.69% while the Corporation's book value totaled $7.19 versus $6.63 for the same period in the prior year. Particularly gratifying was the fact that we were able to expand our loan portfolio last year while continuing to maintain our disciplined loan criteria, ample evidence that loans can be increased substantially while maintaining high credit standards. During 1998 loans increased by $26.9 million or 12% and totaled $259.3 million. At Westbank, profitability is achieved through hard work and a clear focus on what we do well. We reinvest in growth businesses and emphasize our core competencies, which include credit and service quality, both of which are absolutely essential to compete effectively. Banks cannot consistently generate exceptional profits without being top-flight credit underwriters. Westbank is recognized industry-wide for our relentless focus on maintaining superior credit quality. Customer's needs seldom fall into neat categories, and usually cross from one type of banking product to another. A clear competitive advantage for Westbank is the fact that we organize around our customers and their needs, not around products. To be focused on the customer, we have to know what the customer wants, therefore, we listen to them and hear what they really need. Through our local decision-making process in our banking offices our employees are empowered to deliver customer solutions. We've helped many businesses grow from the spare bedroom to the oak boardroom. Technology helps us offer services in a more timely manner. However, sometimes customers want the personal touch. Westbank offers both. This is the essence of Westbank and the basis of the Westbank Advantage: Our products; our people; our entire company is focused on meeting the needs of the customer. Large bank mergers have negatively impacted small and medium sized businesses, which indicates that there is and will be a growing need for a community bank that offers not only a broad range of products both to businesses and consumers but also provides exceptional service. The Residential Mortgage Department continued its strong record of growth and significantly exceeded 1998 goals. Westbank assisted six hundred families in terms of purchasing a home, building their dream home or lowering their existing payments by closing on $61,000,000 in residential loans. Park West Bank and Trust Company also added an additional satellite mortgage correspondent bank, which has an excellent reputation in the Franklin County area of Western Massachusetts. We converted a portion of our mortgages into mortgage-backed securities for sale on Wall Street, providing the Bank with excellent investment grade securities and immediate liquidity. This enables Westbank to realize additional income without relinquishing its relationship with the borrower. With activity remaining strong at the end of 1998, we anticipate another strong year in 1999. Westbank's relatively new Indirect Lending Program has had a very positive impact on loan originations. Through this program Westbank receives consumer loan applications from Bank-approved automobile and recreational vehicle dealerships whose customers wish to finance their purchases. These applications are then processed according to the Bank's normal consumer loan underwriting criteria. In 1998, indirect consumer loans accounted for approximately 28.5% of the Bank's total consumer loan originations excluding mortgages. 2 4 As wealth grows, so do the opportunities for those of us who manage and invest that wealth. Customer needs change as they marry, purchase homes, have children or retire. These lifestyle changes, coupled with changing market conditions, make understanding all the more difficult. Our Trust Department has a well-diversified line of services that is able to meet the changing needs of our customers throughout each phase of their life cycle. Their "job" is building long-term relationships with customers through all market conditions. That means consistently providing the capabilities and capacity to serve customers as their needs and situations change. During 1998, the Trust Department made significant strides. They have built high quality customer relationships based on the trust their customers place in them. At year-end, fiduciary accounts totaled in excess of $119 million. There is, of course, a lot of work that goes on behind the scenes that improves our ability to compete effectively. For example, we are testing and changing systems to be certain that we will cross the threshold into the next millennium. Work on Year 2000 compliance is well advanced. Credit for this accomplishment can be placed squarely on the shoulders of our Y2K Committee that is comprised of executive officers in charge of each functional area of the bank. The Committee is responsible for implementing our Year 2000 plan, and reporting its progress monthly to the board of directors. Our success is attributable to an exceptional team of employees, many of whom are shareholders. They work hard every day to meet and exceed the expectations of their customers and are determined that Westbank be recognized as a leader in the financial services industry. The critical link between customer satisfaction and shareholder value has always been the quality of our employees. Westbank is focused on a growth momentum. However, size is not a strategy. It is a statistic; i.e. growth only for the sake of getting bigger cannot be an objective. Westbank will grow but only in ways that lead to a stronger and more profitable company. CORPORATE VISION IS NOTHING WITHOUT FOCUS. Our focus will be on three strategic initiatives: Revenue Growth, Cost Control and Asset Management. Westbank will continue to emphasize the growth of its core business this year. We expect to build lending and deposit relationships with local customers in a very competitive market. Westbank has the advantage of being a reliable community bank that has a well-earned reputation for knowledgeable service by its experienced staff. Nineteen Hundred and Ninety-Nine will be a challenging year for us as we strive to enhance the environment necessary to support and expand a diversified and profitable financial services company. We will remain intently focused not only on growth, but also on operational integrity and the effectiveness required to achieve a predictable, sustainable financial performance. We are confident in the strategic direction we have chosen and where we expect it to take us throughout 1999 and beyond. Westbank Corporation and its shareholders have been fortunate over the years to be well served by a strong management team and Board of Directors. After thirty-eight years of dedicated service to the Company, Alfred C. Whitaker and Paul J. McKenna, DMD, will retire from the Board of Directors in April of 1999. Their dedication to Westbank and its shareholders is as strong today as it was when they, along with a small group of other businessmen, founded the Bank in 1961. We would like to take this opportunity to thank them for their leadership and loyalty. We wish them well in their retirement. We welcome to the Board of Directors G. Wayne McCary, President and Chief Executive Officer of Eastern States Exposition, the sixth largest fair in North America located in West Springfield, Massachusetts. We appreciate your loyalty, confidence and support of Westbank Corporation. Your investment in our Company is foremost in our minds as we plan for the future. We look forward to the ever-present challenges and the accompanying opportunities of the twenty-first century. We are optimistic that with your continued support we will continue to focus on growth and earnings. Sincerely, Alfred C. Whitaker Donald R. Chase Chairman of the Board President and Chief Executive Officer 3 5 BUSINESS Westbank Corporation and Subsidiaries CORPORATE ORGANIZATION Westbank Corporation (hereinafter sometimes referred to as "Westbank" or the "Corporation") is a registered Bank Holding Company organized to facilitate the expansion and diversification of the business of Park West Bank and Trust Company (hereinafter sometimes referred to as "Park West" or the "Bank") into additional financial services related to banking. PARK WEST BANK AND TRUST COMPANY As of December 31, 1998, substantially all operating income and net income of the Corporation are presently accounted for by Park West. Park West is chartered as a state bank and trust company by the Commonwealth of Massachusetts, is a member of the Federal Deposit Insurance Corporation ("FDIC"), and is subject to regulation by the Massachusetts Commissioner of Banks and the FDIC. A full range of retail banking services is furnished to individuals, businesses, and nonprofit organizations through thirteen banking offices located in Hampden County. Such services include a wide range of checking and savings accounts, loans, safe deposit facilities, and automated teller machines at selected branch locations. Park West also provides lending, depository and related financial services to commercial, industrial, financial and governmental customers. In the lending area, these include short- and long-term loans and revolving credit arrangements, letters of credit, inventory and accounts receivable financing, real estate construction lending, and mortgage loans. Park West also operates a Trust Department providing services normally associated with holding property in a fiduciary or agency capacity. The value of the property held by the Trust Department at December 31, 1998 amounted to $119,797,000 and is not included in the accompanying financial statements since such items are not assets of the Bank. EMPLOYEES As of December 31, 1998, the Corporation and its subsidiaries had the equivalent of 125 full-time officers and staff. COMPETITION Westbank's banking, real estate activity and trust services are competitive with other Massachusetts financial institutions. Its service area is in Western Massachusetts, primarily Hampden County. Westbank's competitors include other commercial banks, mutual savings banks, savings and loan associations, credit unions, consumer finance companies, loan offices, money market funds, and other financing organizations. Competition for trust services by major commercial banks is high, with continuing efforts by those banks to solicit new business. The Trust Department prides itself as one of the few remaining corporate fiduciaries providing personal services locally. Insurance companies, mutual savings banks, investment counseling firms, and other business firms and individuals also offer active competition for such business. ACQUISITION OF CARGILL BANCORP, INC. On July 15, 1998, the Corporation entered into an agreement to acquire Cargill Bancorp, Inc., which is a Delaware corporation and the holding company for Cargill Bank, a $47.0 million asset Connecticut chartered stock savings and loan association headquartered in Putnam, Connecticut. Under the terms of the agreement, Cargill Bancorp will be merged into Westbank Corporation. Cargill Bank will retain its local identity and remain a separate subsidiary of Westbank Corporation. Each share of Cargill Bancorp common stock will be exchanged for 1.3655 shares of Westbank common stock. On November 3, 1998, the Corporation filed a registration statement to register approximately 565,096 shares of common stock in order to facilitate this merger. Cargill shareholders approved the merger at a shareholders meeting held on December 16, 1998, and final regulatory approval was received on January 14, 1999. 4 6 SELECTED CONSOLIDATED FINANCIAL DATA Westbank Corporation and Subsidiaries Year ended December 31, (Dollars in Thousands Except Share Amounts) 1998 1997 1996 1995 1994 - - ------------------------------------------------------------------------------------------------------------------------------- Interest and dividend income $28,631 $26,724 $24,059 $23,475 $19,647 Interest expense 13,292 12,091 10,524 10,145 7,481 - - ------------------------------------------------------------------------------------------------------------------------------- Net interest income 15,339 14,633 13,535 13,330 12,166 Provision for loan losses 41 306 944 2,907 1,528 Non-interest income 2,427 2,529 2,340 3,104 2,641 Non-interest expense 12,200 11,066 11,278 9,969 11,234 - - ------------------------------------------------------------------------------------------------------------------------------- Income before income taxes 5,525 5,790 3,653 3,558 2,045 Income taxes (benefit) 2,148 2,406 1,516 1,132 (307) - - ------------------------------------------------------------------------------------------------------------------------------- Income before cumulative effect of changes in accounting principle 3,377 3,384 2,137 2,426 2,352 Cumulative effect of changes in accounting principle for income taxes (22) - - ------------------------------------------------------------------------------------------------------------------------------- Net income $3,377 $3,384 $2,137 $2,426 $2,330 =============================================================================================================================== Common share data: Earnings per share: Basic $.82 $.88 $.59 $.69 $.67 Diluted $.79 $.85 $.57 $.67 $.65 Cash dividends declared $.40 $.30 $.24 $.20 Ending book value $7.26 $6.84 $6.19 $5.80 $5.25 AT DECEMBER 31: Total loans -- net $293,113 $268,254 $254,948 $233,527 $225,193 Total assets 402,623 355,567 331,803 299,590 284,814 Total non-performing assets 1,494 2,025 3,791 8,655 8,313 Total deposits 342,266 314,679 298,014 269,478 256,668 Total borrowings 27,807 11,884 9,269 7,677 8,625 Total stockholders' equity 30,490 26,918 22,717 20,786 17,355 AVERAGE FOR YEAR: Loans 284,629 270,066 246,366 232,422 214,846 Assets 382,924 348,561 313,063 297,676 273,214 Deposits 335,110 312,725 280,855 269,105 246,845 Stockholders' equity 29,229 24,638 21,777 19,741 17,655 Weighted shares outstanding - basic 4,143,009 3,845,698 3,643,270 3,539,919 3,491,111 - diluted 4,272,682 4,003,015 3,762,419 3,630,052 3,562,162 SELECTED RATIOS: Rate of return on average total assets .88% .97% .68% .81% .86% Rate of return on average stockholders' equity 11.55% 13.73% 9.81% 12.29% 13.20% Stockholders' equity to total assets at year end 7.57% 7.57% 6.85% 6.93% 6.09% Average total stockholders' equity to average total assets 7.63% 7.07% 6.96% 6.63% 6.46% Allowance for loan losses to total loans at year end .90% 1.13% 1.05% 1.65% 1.49% Non-performing loans as a percentage of total loans at year end .37% .68% 1.23% 2.89% 2.57% Net charge-offs as a percentage of average loans .15% .02% .88% 1.03% .76% Other real estate owned as a percentage of total assets .12% .10% .19% .53% .61% 5 7 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS Westbank Corporation and Subsidiaries Management's discussion of operations and financial position is based on the selected consolidated financial data and should be read in conjunction with the consolidated financial statements and notes thereto. Effective January 29, 1999, Cargill Bancorp, Inc., and its subsidiary ("Cargill") were merged with and into Westbank Corporation ("Westbank"), pursuant to a plan of merger dated July 15, 1998. Each share of Cargill common stock was converted into 1.3655 shares of the Corporation's common stock. Approximately 400,164 of Westbank common shares were issued for the outstanding common stock of Cargill. The transaction was accounted for using the pooling-of-interests method and, accordingly, all historical financial data has been restated to include both entities for all periods presented. Westbank's fiscal year ends December 31 and Cargill's fiscal year ends September 30. For 1998, the Corporation reported net income of $3,377,000, or $.82 per share basic and $.79 diluted, after providing $41,000 for loan losses. This compares to net income for 1997 of $3,384,000, or $.88 per share basic and $.85 diluted. The Corporation's 1997 earnings reflected a provision for loan losses of $306,000. Net interest income increased $706,000 from 1997 to 1998. Non-interest expense amounted to $12,200,000 in 1998 compared to $11,066,000 in 1997, an increase of $1,134,000, or 10%. The increase in operating expenses for 1998 is a direct result of reflecting $595,000 for merger costs related to the acquisition of Cargill Bancorp, Inc., and the remaining increase is a result of the overall growth of the Corporation. Non-interest income declined by $102,000 compared to 1997. During 1998, Trust Department earnings increased by $33,000 over 1997. Gains on sale of investments and other real estate declined by $142,000, gains on sale of mortgages totaled $120,000, while service charges on deposit accounts and other non-interest income declined by $108,000 compared to 1997. Income taxes in 1998 totaled $2,148,000, a decrease of $258,000 versus 1997. At December 31, 1998, the Corporation's total assets were $402,623,000, an increase of $47,056,000 or 13%, from $355,567,000 at year-end 1997. The higher level of assets resulted primarily from an increase in net loans and investments totaling $48,875,000 funded by the growth in deposits. Non-performing assets amounted to $1,494,000 or .37% of total assets at December 31, 1998, compared with $2,025,000 or .68% at the end of 1997. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") imposes significant regulatory restrictions and requirements on banking institutions insured by the FDIC and their holding companies. FDICIA established capital categories into which financial institutions are placed based on capital level. Each capital category establishes different degrees of regulatory restrictions which can apply to a financial institution. As of December 31, 1998, Park West's and Cargill's capital was at a level that placed each Bank in the "well capitalized" category as defined by FDICIA. 6 8 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries FDICIA imposes a variety of other restrictions and requirements on insured banks. These include significant regulatory reporting requirements such as insuring that a system of risk-based deposit insurance premiums and civil money penalties for inaccurate deposit reporting exists. In addition, FDICIA imposes a system of regulatory standards for bank and bank holding company operations, detailed truth in savings disclosure requirements, and restrictions on activities authorized by state law but not authorized for national banks. COMPONENTS OF CAPITAL The following table presents the Corporation's components of capital as of December 31. The table also presents the ratio of capital to total assets. (Dollars in Thousands) 1998 1997 1996 - - ---------------------------------------------------------------------------------------------------------------- Stockholders' Equity Common stock $8,397 $7,865 $7,343 Additional paid-in-capital 11,076 9,711 8,386 Retained earnings 10,803 9,282 7,087 Accumulated other comprehensive income (loss) 214 60 (99) - - ---------------------------------------------------------------------------------------------------------------- Total Capital $30,490 $26,918 $22,717 ================================================================================================================ Ratio of capital to average total assets 7.53% 7.44% 7.00% Regulatory risk-based capital requirements take into account the different risk categories of banking organizations by assigning risk weights to assets and the credit equivalent amounts of off-balance sheet exposures. In addition, capital is divided into two tiers. In this Corporation, Tier 1 includes the common stockholders' equity; total risk-based, or supplementary, capital includes not only the equity but also a portion of the allowance for loan losses. The following are the Corporation's risk-based capital ratios at December 31: 1998 1997 1996 Tier 1 risk-based capital (minimum required 4%) 11.94% 11.57% 10.58% Total risk-based capital (minimum required 8%) 13.00% 12.77% 11.76% ================================================================================================================ DISCUSSION OF MARKET RISK Market risk is the risk of loss due to adverse changes in market prices and rates. The management of this risk, coupled with directives to build shareholder value and profitability, is an integral part of the Corporation's overall operating strategy. The Corporation's approach to risk management, primarily interest rate risk management, is quite basic and concentrates on fundamental strategies to restructure the balance sheet and composition of assets and liabilities. Since the Corporation does not utilize interest rate futures, swaps or options transactions, its asset/liability profile is not complex. It reflects a simple approach to managing risk through the use of fixed and adjustable rate loans and investments, rate-insensitive checking accounts as well as a combination of fixed and variable rate deposit products and borrowed funds. Bank policy includes required limits on the sensitivity of net interest income under various interest rate scenarios. The Bank seeks to control its interest rate risk exposure in a manner that will allow for adequate levels of earnings and capital over a range of possible interest rate environments. The Bank has adopted formal policies and practices to monitor and manage interest rate risk exposure. As part of this effort, the Bank actively manages interest rate risk through the use of a simulation model that measures the sensitivity of future net interest income to changes in interest rates. In addition, the Bank regularly monitors interest rate sensitivity through gap analysis, which measures the terms to maturity or next repricing date of interest-earning assets and interest-bearing liabilities. 7 9 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries On a quarterly basis, an interest rate risk exposure compliance report is prepared and presented to the Bank's Board of Directors. This report presents an analysis of the change in net interest income resulting from an increase or decrease in the level of interest rates. All changes are measured as percentage changes from the projected net interest income in the flat rate scenario. The calculated estimates of change in net interest income are compared to current limits established by management and approved by the Board of Directors. The following is a summary of the interest rate exposure report as of December 31, 1998 and 1997: Percentage Change in Change in Interest Rates Net Interest Income (In Basis Points) 1998 1997 - - ------------------------------------------------------------------------------------------------------------------------- +200 (5.21)% (1.41)% Level 0% 0% -200 (0.71)% 1.40% The change in net interest income between 1998 and 1997 when rates decline 200 basis points is primarily the result of the current low interest rate environment. In the current year, many deposit rates were not able to be decreased by the full 200 basis points. The inability to reduce deposit rates would cause net interest income to decline during a falling interest rate environment despite the Corporation being liability-sensitive. The model utilized to create the results presented above makes various estimates at each level of interest rate change regarding cash flows from principal repayments on loans and mortgage-backed securities and/or call activity on investment securities. Actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change. In order to reduce the exposure to interest rate fluctuations, the Corporation has developed strategies to manage its liquidity, shorten the effective maturities of certain interest-earning assets and increase the effective maturities of certain interest-bearing liabilities. The Bank has focused its residential lending on a combination of fixed and adjustable rate mortgages. Commercial loans, commercial mortgages and consumer lending focus on adjustable and short term loans. The Bank also attempts to maintain and/or increase its savings and transaction accounts, which are considered relatively insensitive to changes in interest rates. The Corporation also measures sensitivity to changes in interest rates using interest rate sensitivity gap analysis which is the difference between the cash flow amounts of interest-sensitive assets and liabilities that will be refinanced (or repriced) during a given period. For example, if the asset amount to be repriced exceeds the corresponding liability amount for a certain day, month, year, or longer period, the institution is in an asset-sensitive gap position. In this situation, net interest income would increase if market interest rates rose or decrease if market interest rates fell. If, alternatively, more liabilities than assets will reprice, the institution is in a liability-sensitive position. Accordingly, net interest income would decline when rates rise and increase when rates fall. Also, these examples assume that interest-rate changes for assets and liabilities are of the same magnitude, whereas actual interest-rate changes generally differ in magnitude for assets and liabilities. The following table sets forth the distribution of the repricing of the Corporation's earning assets and interest-bearing liabilities as of December 31, 1998, the interest rate sensitivity gap, (i.e., interest rate sensitive assets less interest rate sensitive liabilities), the cumulative interest rate sensitivity gap, the interest rate sensitivity gap ratio and the cumulative interest rate sensitivity gap ratio. The table also sets forth the time periods in which earning assets and interest-bearing liabilities will mature or may reprice in accordance with their contractual terms. However, the table does not necessarily indicate the impact of general interest rate movements on the net interest margin since the repricing of various categories of assets and liabilities is subject to competitive pressures and the needs of the Bank's customers. In addition, various assets and liabilities indicated as repricing within the same period may, in fact, reprice at different times within such period and at different rates. 8 10 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries Three Over Three Over One Over Months Months to Year to Five (Dollars in Thousands) or Less A Year Five Years Years Total - - ------------------------------------------------------------------------------------------------------------------------------ EARNING ASSETS Securities including mortgage-backed securities $3,174 $1,549 $6,380 $ 73,225 $84,328 Interest bearing cash 391 595 894 1,880 Loans 50,916 45,162 97,771 101,929 295,778 Federal funds sold 1,069 1,069 - - ------------------------------------------------------------------------------------------------------------------------------ 55,550 47,306 105,045 175,154 383,055 INTEREST BEARING LIABILITIES Savings deposits 5,369 48,320 53,689 NOW Accounts 2,600 23,393 25,993 Money market accounts 29,659 29,659 Negotiated rate certificates 13,299 8,439 3,373 25,111 Other time deposits 39,198 78,436 38,786 156,420 Borrowed funds 20,309 510 6,988 27,807 - - ------------------------------------------------------------------------------------------------------------------------------ $102,465 $95,354 $ 120,860 $318,679 ============================================================================================================================== Interest Rate Sensitivity Gap $(46,915) $(48,048) $(15,815) $175,154 $64,376 Cumulative Interest Rate Sensitivity Gap $(46,915) $(94,963) $(110,778) $64,376 Interest Rate Sensitivity Gap Ratio (12.24%) (12.54%) (4.15%) 45.68% 16.75% Cumulative Interest Rate Sensitivity Gap Ratio (12.24%) (24.79%) (28.93%) 16.75% The presentation of a run off and repricing of savings accounts and NOW accounts is based on the Corporation's historical experience with $5,369,000 and $2,600,000, respectively, included in the three-month to one-year category and the remainder placed in the one to five year category of the interest-bearing liabilities. Westbank seeks to manage the mix of asset and liability maturities to control the effect of changes in the general level of interest rates on net interest income. In periods of rising interest rates, Westbank's negative interest rate sensitivity gap as to earning assets and interest-bearing liabilities maturing in less than one year may cause a diminution of Westbank's income; correspondingly, in periods of declining interest rates, a negative interest rate sensitivity gap may provide additional income. Except for its effect on the general level of interest rates, inflation does not have a material impact on Westbank's earnings due to the rate of variability and short-term maturities of its earning assets. DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY - INTEREST RATES AND INTEREST DIFFERENTIAL The following table presents the condensed average balance sheets for 1998, 1997 and 1996. The total dollar amount of interest income from earning assets and the resultant yields are calculated on a taxable equivalent basis. The interest paid on interest-bearing liabilities, expressed both in dollars and rates, is shown in the table: 9 11 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries 1998 1997 1996 Average Average Average Interest Yield/ Interest Yield/ Interest Yield/ Average Income/ Rate Average Income/ Rate Average Income/ Rate (Dollars in Thousands) Balance Expense Paid Balance Expense Paid Balance Expense Paid - - ----------------------------------------------------------------------------------------------------------------------------------- ASSETS Securities: U.S. Treasury $3,663 $221 6.03% $6,978 $430 6.16% $9,150 $591 6.46% Federal agencies 61,856 3,994 6.46 42,072 2,833 6.73 26,044 1,768 6.79 Other securities 4,969 304 6.12 3,835 240 6.26 4,158 279 6.71 - - ----------------------------------------------------------------------------------------------------------------------------------- Total securities 70,488 4,519 6.41 52,885 3,503 6.62 39,352 2,638 6.70 - - ----------------------------------------------------------------------------------------------------------------------------------- Interest-bearing cash and temporary investments 792 29 3.66 1,340 73 5.45 2,592 163 6.29 - - ----------------------------------------------------------------------------------------------------------------------------------- Loans: (a) Commercial 41,129 3,810 9.26 38,058 3,640 9.56 35,558 3,351 9.42 Real estate 213,377 17,400 8.15 205,984 17,153 8.33 190,235 15,871 8.34 Consumer 30,123 2,435 8.08 26,024 2,100 8.07 20,573 1,789 8.70 - - ----------------------------------------------------------------------------------------------------------------------------------- Total loans 284,629 23,645 8.31 270,066 22,893 8.48 246,366 21,011 8.53 Federal funds sold 7,761 438 5.64 4,800 255 5.31 4,845 247 5.10 - - ----------------------------------------------------------------------------------------------------------------------------------- Total earning assets 363,670 $28,631 7.87% 329,091 $26,724 8.12% 293,155 $24,059 8.21% - - ----------------------------------------------------------------------------------------------------------------------------------- Allowance for loan losses (2,920) (2,840) (3,383) Cash and due from banks 11,120 10,888 10,704 Other assets 11,054 11,422 12,587 - - ----------------------------------------------------------------------------------------------------------------------------------- Total assets $382,924 $348,561 $313,063 =================================================================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing deposits: Savings $50,588 $1,382 2.73% $47,020 $1,160 2.47% $43,932 $978 2.23% Money market 31,663 1,195 3.77 17,132 572 3.34 14,172 373 2.63 Negotiated rate certificates 22,977 1,118 4.87 18,528 922 4.98 16,621 829 4.99 Other time deposits 181,085 8,967 4.95 184,165 9,146 4.97 162,154 8,083 4.98 - - ----------------------------------------------------------------------------------------------------------------------------------- Total time deposits 286,313 12,662 4.42 266,845 11,800 4.42 236,879 10,263 4.33 Borrowed funds 16,906 630 3.73 9,065 291 3.21 8,714 261 3.00 - - ----------------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 303,219 13,292 4.38 275,910 12,091 4.38 245,593 10,524 4.29 Demand deposits 48,797 45,880 43,976 Other liabilities 1,679 2,133 1,717 Stockholders' equity 29,229 24,638 21,777 - - ----------------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $382,924 $348,561 $313,063 =================================================================================================================================== Net interest income $15,339 $14,633 $13,535 Yield spread 3.49% 3.74% 3.92% Net Yield on earning assets 4.22% 4.45% 4.62% =================================================================================================================================== (a) Average loan balances above include non-accrual loans. When a loan is placed in non-accrual status, interest income is recorded to the extent actually received in cash or is applied to reduce principal. During 1998, the yield spread declined to 3.49% from 3.74% in 1997, down 25 basis points. The Corporation's net interest margin decreased during 1998 to 4.22% from 4.45% in 1997, a decrease of 23 basis points During 1997, the yield spread declined to 3.74% from 3.92% in 1996, down 18 basis points. The Corporation's net interest margin decreased during 1997 to 4.45% from 4.62% in 1996, a decrease of 17 basis points. The section titled Rate/Volume Analysis further describes the change in yields. 10 12 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries RATE/VOLUME ANALYSIS OF INTEREST MARGIN ON EARNING ASSETS The following table sets forth, for each major category of interest-earning assets and interest-bearing liabilities, the dollar amounts of interest income (calculated on a taxable equivalent basis) and interest expense and changes therein for 1998 as compared with 1997 and 1997 compared with 1996. 1998 Compared With 1997 1997 Compared With 1996 - - ----------------------------------------------------------------------------------------------------------------------------------- Increase Due to* Increase Due to* (Dollars in Thousands) 1998 1997 (Decrease) Volume Rate 1997 1996 (Decrease) Volume Rate - - ----------------------------------------------------------------------------------------------------------------------------------- Interest earned: Securities: U.S. Treasury $221 $430 $(209) $(200) $(9) $430 $591 $(161) $(140) $(21) Federal agencies 3,994 2,833 1,161 1,281 (120) 2,833 1,768 1,065 1,058 7 Other securities 304 240 64 69 (5) 240 279 (39) (18) (21) Interest-bearing cash 29 73 (44) (24) (20) 73 163 (90) (86) (4) Loans: Commercial 3,810 3,640 170 286 (116) 3,640 3,351 289 239 50 Real estate 17,400 17,153 247 600 (353) 17,153 15,871 1,282 1,314 (32) Consumer 2,435 2,100 335 332 3 2,100 1,789 311 446 (135) Federal funds sold 438 255 183 166 17 255 247 8 (2) 10 - - ----------------------------------------------------------------------------------------------------------------------------------- 28,631 26,724 1,907 2,510 (603) 26,724 24,059 2,665 2,811 (146) - - ----------------------------------------------------------------------------------------------------------------------------------- Interest expense: Savings 1,382 1,160 222 93 129 1,160 978 182 73 109 Money market 1,195 572 623 540 83 572 373 199 87 112 Negotiated rate certificates 1,118 922 196 218 (22) 922 829 93 96 (3) ` Other time deposits 8,967 9,146 (179) (142) (37) 9,146 8,083 1,063 1,109 (46) Borrowed funds 630 291 339 285 54 291 261 30 11 19 - - ----------------------------------------------------------------------------------------------------------------------------------- 13,292 12,091 1,201 994 207 12,091 10,524 1,567 1,376 191 - - ----------------------------------------------------------------------------------------------------------------------------------- Net interest income $15,339 $14,633 $706 $1,516 $(810) $14,633 $13,535 $1,098 $1,435 $(337) =================================================================================================================================== * The dollar amount of changes in interest income and interest expense attributable to changes in rate and volume has been allocated between rate and volume based on changes in rates times the prior year's volume and the changes in volume times the prior year's rate. Net interest income for 1998 increased to $15,339,000, up 5% from $14,633,000 in 1997. An 11% increase in average earning assets and a 25 basis point decline in average rate of return resulted in an increase in volume of $2,510,000 and a decrease in rate of $603,000. An increase of 10% in average interest-bearing liabilities and a 1 basis point increase in average rate of interest paid contributed to an increase in volume of $994,000 and an increase in rate of $207,000. Net interest income for 1997 increased to $14,633,000, up 8% from $13,535,000 in 1996. A 16% increase in average earning assets and a 9 basis point decline in average rate of return resulted in an increase in volume of $2,811,000 and a decrease in rate of $146,000. An increase of 12% in average interest-bearing liabilities and a 9 basis point increase in average rate of interest paid contributed to an increase in volume of $1,376,000 and an increase in rate of $191,000. LIQUIDITY Liquidity management requires close scrutiny of the mix and maturity of deposits and borrowings and short-term investments. Cash and due from banks, federal funds sold, investment securities and mortgage-backed securities, as compared to deposits, are used by Westbank to compute its liquidity on a daily basis as adjusted for regulatory purposes. In addition, Westbank is subject to Regulation D of the Federal Reserve Bank (FRB), which requires depository institutions to maintain reserve balances on deposit with the FRB based on certain average depositor balances. Westbank is in compliance with Regulation D. Management of Westbank believes that its current liquidity is sufficient to meet current and anticipated funding needs. Refer to Note 7 in the Notes To Consolidated Financial Statements for a discussion of the Corporation's external sources of liquidity. 11 13 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries INVESTMENT PORTFOLIO Refer to Note 2 in the Notes to Consolidated Financial Statements of this report which covers the maturity distribution and market values at December 31, 1998 of the securities portfolio. The following table shows the amortized cost (in thousands) of the Corporation's securities held to maturity at December 31: 1998 1997 1996 - - ---------------------------------------------------------------------- U. S. Government obligations $ 998 $ 4,246 $ 7,296 Federal agency obligations 26,890 32,927 13,827 Mortgage-backed securities 2,728 2,330 1,814 Other debt securities 99 2,440 - - ---------------------------------------------------------------------- Amortized cost $30,616 $39,602 $25,377 ====================================================================== The following table shows the fair value (in thousands) of the Corporation's securities available for sale at December 31: 1998 1997 1996 - - -------------------------------------------------------------------------------- U. S. Government obligations $ 928 $ 2,058 $ 1,990 Federal agency obligations 26,667 3,486 2,465 Mortgage-backed securities 24,372 13,502 8,807 Equity securities 1,745 1,664 1,125 - - -------------------------------------------------------------------------------- 53,712 20,710 14,387 Gross unrealized (gain) loss on securities available for sale (352) (104) 170 - - -------------------------------------------------------------------------------- Amortized cost $ 53,360 $ 20,606 $ 14,557 ================================================================================ The following table shows weighted average yields and maturity distribution of debt securities at December 31, 1998: Within 1 Year 1 to 5 Years 5 to 10 Years After 10 Years Total Average Amortized Average Amortized Average Amortized Average Amortized Average Amortized Yield Cost Yield Cost Yield Cost Yield Cost Yield Cost - - ------------------------------------------------------------------------------------------------------------------------------- U. S. Government obligations 5.61% $ 1,428 6.25% $ 498 5.78% $ 1,926 Federal agency obligations 5.19 1,499 6.43 4,442 6.21% $44,477 6.49% $ 3,400 6.22% 53,818 Mortgage-backed securities 5.50 56 6.26 1,440 6.48 1,004 6.58 23,987 6.56 26,487 - - ------------------------------------------------------------------------------------------------------------------------------ Total debt Securities 5.40% $ 2,983 6.37% $ 6,380 6.22% $45,481 6.57% $27,387 6.32% $82,231 ============================================================================================================================== The weighted average yield has been computed by dividing annualized interest income, including the accretion of discount and the amortization of premiums, by the book value of securities outstanding. 12 14 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries LOAN PORTFOLIO The following table sets forth the classification (in thousands) of the Corporation's loans by major category at December 31: 1998 1997 1996 1995 1994 - - ------------------------------------------------------------------------------------------- Commercial $ 41,760 $ 41,661 $ 36,153 $ 36,080 $ 35,156 - - ------------------------------------------------------------------------------------------- Real Estate: Construction 5,998 5,302 6,662 8,526 8,900 Residential (1-4 family) 168,744 152,896 153,781 132,530 113,327 Commercial properties 60,348 55,127 45,506 51,059 61,311 - - ------------------------------------------------------------------------------------------- Total Real Estate 235,090 213,325 205,949 192,115 183,538 - - ------------------------------------------------------------------------------------------- Consumer 19,277 16,648 15,943 9,701 10,240 - - ------------------------------------------------------------------------------------------- Gross loans 296,127 271,634 258,045 237,896 228,934 Deferred loan origination fees-net of costs (349) (323) (398) (445) (339) - - ------------------------------------------------------------------------------------------- Total Loans 295,778 271,311 257,647 237,451 228,595 Allowance for loan losses (2,665) (3,057) (2,699) (3,924) (3,402) - - ------------------------------------------------------------------------------------------- Net loans $ 293,113 $ 268,254 $ 254,948 $ 233,527 $ 225,193 =========================================================================================== The Corporation's loan portfolio is not concentrated within a single industry or a group of related industries; however, underlying collateral values are dependent upon market fluctuations in the Western Massachusetts and Northeastern Connecticut areas. The aggregate amount of loans to executive officers, directors and organizations with which they are associated amounted to $3,041,000 or 7.8% of stockholders' equity as of December 31, 1998, compared to $2,386,000 or 8.9% as of December 31, 1997. The following table provides the maturity distribution and sensitivity to changes in interest rates of commercial loans and commercial real estate construction loans at December 31, 1998: 12 Months 1 - 5 After (Dollars in Thousands) or Less Years 5 Years Total - - ------------------------------------------------------------------------------- Commercial $32,576 $ 7,457 $ 1,727 $41,760 Commercial real estate-construction 5,998 5,998 - - ------------------------------------------------------------------------------- Totals $38,574 $ 7,457 $ 1,727 $47,758 =============================================================================== Of the commercial loans which mature beyond one year, approximately $4,291,000 have fixed rates and the remaining $4,893,000 are floating rate loans. In the normal course of business, various commitments and contingent liabilities are outstanding, such as guarantees, standby letters of credit, commitments to extend credit and various financial instruments with off-balance-sheet risk that are not reflected in the financial statements. The most significant of these are commitments to grant loans and commitments to advance funds under existing loan agreements which were $9,281,000 and $31,457,000, respectively, at December 31, 1998 and $10,257,000 and $29,533,000, respectively, in 1997. See further discussion in Note 13 to the Consolidated Financial Statements. 13 15 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries LOAN LOSS EXPERIENCE The provision for loan losses is an amount added to the allowance against which loan losses are charged. The provision for losses is dependent on actual net write-offs and an evaluation of the collectibility of the loan portfolio, taking into consideration such factors as the financial condition of individual borrowers, historical loss experience with respect to various portfolio segments, current and near-term economic conditions, and the size of the portfolio. Based on these reviews, the allowance for loan losses at December 31, 1998, is deemed to be adequate by management. In the determination of the allowance for loan losses, management obtains independent appraisals for a significant number of properties. Management has also retained an independent loan review consultant to provide advice on the adequacy of the loan loss allowance. The following table sets forth the historical relationship among the average amount of loans outstanding, the allowance for loan losses, provision for loan losses charged to operating expenses, losses charged off, recoveries and selected ratios: Year Ended December 31, (Dollars in Thousands) 1998 1997 1996 1995 1994 - - -------------------------------------------------------------------------------------------------------------------------- Balance at beginning of year $ 3,057 $ 2,699 $ 3,924 $ 3,402 $ 3,511 Provision charged to expense 41 306 944 2,907 1,528 - - -------------------------------------------------------------------------------------------------------------------------- 3,098 3,005 4,868 6,309 5,039 - - -------------------------------------------------------------------------------------------------------------------------- Charge-offs: Loans secured by real estate 318 394 1,745 2,180 1,305 Construction/land development 190 12 Commercial and industrial loans 153 250 510 246 487 Consumer loans 47 116 94 122 96 - - -------------------------------------------------------------------------------------------------------------------------- 518 760 2,539 2,560 1,888 - - -------------------------------------------------------------------------------------------------------------------------- Recoveries: Loans secured by real estate 42 354 324 24 25 Construction/land developing 14 75 Commercial and industrial loans 30 445 12 51 210 Consumer loans 13 13 20 25 16 - - -------------------------------------------------------------------------------------------------------------------------- 85 812 370 175 251 - - -------------------------------------------------------------------------------------------------------------------------- Net charge-offs (recoveries) 433 (52) 2,169 2,385 1,637 - - -------------------------------------------------------------------------------------------------------------------------- Balance at end of year $ 2,665 $ 3,057 $ 2,699 $ 3,924 $ 3,402 Average loans outstanding $ 284,629 $ 270,066 $ 246,366 $ 232,423 $ 214,846 ========================================================================================================================== Net charge-offs (recoveries) as a percentage of average loans 0.15% (0.02)% 0.88% 1.03% 0.76% Net charge-offs (recoveries) as a percentage of the allowance at January 1 14.16 (1.93) 55.28 70.11 46.62 Allowance as a percentage of total loans at December 31 0.90 1.13 1.05 1.65 1.49 Allowance as a percentage of non-performing loans at December 31 259.24 166.87 85.41 55.42 51.70 14 16 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries Allocation of the balance as of December 31 of the allowance for loan losses applicable to: (Dollars in Thousands) 1998 1997 1996 1995 1994 - - ----------------------------------------------------------------------------------------------------------------------------------- % of % of % of % of % of Total Total Total Total Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans - - ----------------------------------------------------------------------------------------------------------------------------------- Loans secured by real estate $1,764 77.38% $2,083 76.55% $1,763 77.23% $2,898 77.17% $2,626 76.28% Construction/land development 70 2.03 83 1.97 94 2.58 156 3.58 127 3.89 Commercial and industrial loans 628 14.10 697 15.35 685 14.01 776 15.17 522 15.36 Consumer loans 203 6.49 194 6.13 157 6.18 94 4.08 127 4.47 - - ----------------------------------------------------------------------------------------------------------------------------------- $2,665 100% $3,057 100% $2,699 100% $3,924 100% $3,402 100% =================================================================================================================================== The approach the Corporation uses in determining the adequacy of the allowance for loan losses is the combination of a target reserve and general reserve allocation. Quarterly, based on an internal review of the loan portfolio, the Corporation identifies required reserve allocations targeted to recognized problem loans that, in the opinion of management, have potential loss exposure or questions relative to the adequacy of the collateral on these same loans. In addition, the Corporation allocates a general reserve against the remainder of the loan portfolio. The decline in the allowance for loan losses from 1997 to 1998 is a result of the improved credit quality of the loan portfolio, in combination with the continued improvement in the local economy. NON-PERFORMING ASSETS LOANS Loans on which interest and principal payments are 90 days or more past due are placed on a non-accrual basis (earlier, if deemed appropriate) and interest is reversed unless management determines that the collectibility of principal and interest is not reasonably considered in doubt. The following table sets forth information with regard to non-performing loans as of the end of each year indicated: (Dollars in Thousands) 1998 1997 1996 1995 1994 - - ------------------------------------------------------------------------------------------------------ Loans on a non-accrual basis $ 797 $ 1,648 $ 2,878 $ 6,578 $ 5,378 - - ------------------------------------------------------------------------------------------------------ Non-accrual loans as a percentage of total net loans outstanding 0.27% 0.61% 1.13% 2.82% 2.39% Non-accrual loans as a percentage of total assets 0.20% 0.46% 0.87% 2.20% 1.89% Loans contractually past due 90 days or more and still accruing $ 231 $ 184 $ 282 $ 503 $ 1,202 The gross amount of interest that would have been accrued at the original contract rate on loans on a non-accrual basis (in thousands) was $35,000, $79,000, $240,000, $331,000 and $408,000 for 1998, 1997, 1996, 1995 and 1994, respectively. Interest income included in the results of operations relating to these loans was $20,000 in 1994. The decrease in non-accrual loans from 1997 is attributable to the continued resolution of non-performing loans throughout 1998. During the second quarter of 1998, the Corporation sold a pool of non-performing loans. The decrease in the allowance for loan losses is attributable to charging off previously-reserved amounts directly related to the sale of non-performing loans referred to above. 15 17 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries The Bank evaluates each impaired loan to determine the appropriate income recognition practice. Generally, income is recorded only on a cash basis for impaired loans. Interest income recognized during 1998 and 1997 on impaired loans was not significant. At December 31, 1998 and 1997, the recorded investment in impaired loans was $1,419,000 and $1,809,000 respectively, for which no additional specific allowance for loan losses was recorded. For the twelve months ended December 31, 1998, the average recorded investment in impaired loans was $1,366,000 compared to $2,080,000 for 1997. RESTRUCTURED LOANS A restructured loan is one for which the Corporation has modified the contractual terms to provide a reduction in the rate of interest and, in most instances, an extension of payments of principal or interest or both because of a deterioration in the financial position of the borrower. Restructured loans modified prior to January 1, 1995, which are performing in accordance with their new terms are not included in non-accrual loans, unless concern exists as to the ultimate collection of principal or interest, and are not considered to be impaired. Those entered into after January 1, 1995, are considered to be impaired as described in Note 1 to the financial statements Restructured loans, which are classified as accruing loans, amounted to $773,000 in 1995 and $681,000 in 1994. Interest income reduction because of restructuring was not significant for 1995 and 1994. OTHER REAL ESTATE OWNED The following table sets forth information regarding other real estate owned at December 31: (Dollars in Thousands) 1998 1997 1996 1995 1994 - - -------------------------------------------------------------------------------------------------- Other real estate owned - net $ 466 $ 353 $ 631 $ 1,574 $ 1,733 Other real estate owned as a percentage of total assets .12% .10% .19% .53% .61% DEPOSITS The following table sets forth the average amounts of various classifications of deposits: 1998 1997 1996 (Dollars in Thousands) Amount Rate Amount Rate Amount Rate - - ------------------------------------------------------------------------------------------------------------------------------ Savings $50,588 2.73% $47,020 2.47% $43,932 2.23% Money market 31,663 3.77 17,132 3.34 14,172 2.63 Negotiated rate certificates 22,977 4.87 18,528 4.98 16,621 4.99 Other time deposits 181,085 4.95 184,165 4.97 162,154 4.98 - - ------------------------------------------------------------------------------------------------------------------------------ 286,313 4.42% 266,845 4.42% 236,879 4.33% Demand deposits 48,797 45,880 43,976 - - ------------------------------------------------------------------------------------------------------------------------------ $335,110 $312,725 $280,855 ============================================================================================================================== 16 18 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries Certificates of deposits of $100,000 and over at December 31, 1998 had the following maturities: 3 Months 3 to 6 6 to 12 1 Year to (Dollars in Thousands) or Less Months Months 5 Years Total Totals $13,298 $4,349 $4,090 $3,374 $26,880 ============================================================================================================================= RETURN ON EQUITY AND ASSETS The Corporation's return on average equity and assets for each of the years ended December 31, were as follows: 1998 1997 1996 - - ---------------------------------------------------------------------------------------------- Return on average total assets .88% .97% .68% Return on average stockholders' equity 11.55 13.73 9.81 Average stockholders' equity to average total assets 7.57 7.07 6.96 Dividend payout ratio 44.54 30.76 36.78 BORROWINGS The following table summarizes borrowings. Average interest rates during each year were computed by dividing total interest expense by the average amount borrowed: (Dollars in Thousands) 1998 1997 1996 Balance at year end $27,807 $11,884 $ 9,269 Average amount outstanding 16,442 9,065 8,714 Maximum amount outstanding at any month-end 28,307 14,036 12,794 Average interest rate for the year 3.83% 3.20% 2.99% Average interest rate on year-end balance 3.85 3.15 3.03 STATEMENTS OF INCOME In the following sections of Management's Discussion and Analysis of the Statements of Income, the comparative results of 1998, 1997 and 1996 will be covered in greater detail. As of December 31, 1998, the principal earning assets of the holding company consist of a commercial bank, Park West Bank and Trust Company, and a Connecticut state-chartered savings bank, Cargill Bank. Noteworthy are the effects of sources of income from earning assets and expense of interest-bearing liabilities. Presented below is a comparative summary of percentages of increases and decreases for the three years ended December 31, 1998. The significant changes are discussed in the analysis that follow the summary. Percentage of increase (decrease) 1998 1997 Over Over (Dollars in Thousands) 1998 1997 1996 1997 1996 - - ------------------------------------------------------------------------------------------------------ Net interest income $15,339 $14,633 $13,535 4.82% 8.11% Provision for loan losses 41 306 944 (86.60) (67.58) Non-interest income 2,427 2,529 2,340 (4.03) 8.08 Non-interest expense 12,200 11,066 11,278 10.25 (1.88) Income taxes 2,148 2,406 1,516 (10.72) 58.71 - - ------------------------------------------------------------------------------------------------------ Net Income $ 3,377 $ 3,384 $ 2,137 (0.21%) 58.35% ====================================================================================================== INTEREST INCOME Westbank's earning assets include a diverse portfolio of interest-earning instruments ranging from Westbank's core business of loan extensions to interest-bearing securities issued by federal, state and municipal authorities. These earning assets are financed through a combination of interest-bearing and interest-free sources. Total interest income for 1998 amounted to $28,631,000 as compared to $26,724,000 for 1997 and $24,059,000 for 1996. For 1998 this represents an increase of $1,907,000 or 7% over 1997, while interest income increased by $2,665,000 or 11% in 1997 versus 1996. The increase in 1998 is the result of an increase in average earning assets of $34,579,000 or 11%, offset by a decrease of 25 basis points in average earning interest rate. The increase in 1997 over 1996 is the result of an increase in average earning assets of $35,936,000 offset by a 9 basis point decrease in average earning interest rate. 17 19 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries INTEREST EXPENSE Interest expense for 1998 on deposits and borrowings amounted to $13,292,000 as compared to $12,091,000 in 1997 and $10,524,000 for 1996. Interest expense increased by $1,201,000 or 10% during 1998 compared to 1997 and 1997 interest expense increased by $1,567,000 or 15% versus 1996. The 1998 increase is the result of an increase in average interest-bearing liabilities of $27,309,000 and a 1 basis point increase in the average rate of interest paid compared to 1997. The increase in interest expense during 1997 versus 1996 is the result of an increase of average interest-bearing liabilities of $30,614,000 combined with a 9 basis point increase in average interest rate paid. NET INTEREST INCOME Net interest income, the most significant component of earnings, is the amount by which the interest generated by assets exceeds the interest expense on liabilities. Westbank's management analyzes its performance by utilizing the concepts of interest rate spread and net yield on earning assets. The interest rate spread represents the difference between the yield on earning assets and interest paid on interest-bearing liabilities. The net yield on earning assets is the difference between the rate of interest on earning assets and the effective rate paid on all funds, interest-bearing liabilities, as well as interest-free sources (primarily demand deposits and stockholders' equity). The following table sets forth Westbank's net interest income: (Dollars in Thousands) 1998 1997 1996 - - ---------------------------------------------------------------------------------------------------------------- Total interest income $28,631 $26,724 $24,059 Total interest expense 13,292 12,091 10,524 - - ---------------------------------------------------------------------------------------------------------------- Net interest income $15,339 $14,633 $13,535 ================================================================================================================ The RATE/VOLUME ANALYSIS OF INTEREST MARGIN ON EARNING ASSETS section includes and sets forth each major category of interest-earning assets and interest-bearing liabilities which result in net interest income. PROVISION FOR LOAN LOSSES The 1998 provision for loan losses totaled $41,000 compared with $306,000 in 1997, a decrease of 87%. During 1997, the provision decreased by $638,000 versus 1996, representing a decrease of 68%. The decrease in the provision for loan losses during 1998 is directly attributable to the decrease in non-performing loans and the overall credit quality of the Bank's loan portfolio. A full discussion appears previously under the headings of LOAN LOSS EXPERIENCE and NON-PERFORMING ASSETS. NON-INTEREST INCOME Income from sources other than interest was $2,427,000 in 1998, a decrease of $102,000 from the prior year and an increase of $189,000 versus 1996. Non-interest income for 1998 reflects an increase in Trust Department earnings of $33,000, a decrease in service charges on deposit accounts and other non-interest income of $42,000 and decreases from the gain on sale of investments, other real estate and mortgages totaling $27,000 compared to 1997. 18 20 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries NON-INTEREST EXPENSE The components of other operating expenses at December 31 are as follows: (Dollars in Thousands) 1998 1997 1996 - - ---------------------------------------------------------------------------- Salaries and benefits $ 5,797 $ 5,461 $ 5,091 Occupancy 855 780 792 Other non-interest expense 5,444 4,604 4,781 Other real estate owned expenses and provision 104 221 614 - - ---------------------------------------------------------------------------- $12,200 $11,066 $11,278 ============================================================================ Overall non-interest expense increased during 1998 by $1,058,000 versus 1997 and by $1,099,000 compared to 1996. During 1998, salaries and benefits increased by $385,000, attributable to overall corporate growth and the staff requirements for the addition of two new branch offices during 1998. Occupancy remained level with 1997. Finally, other non-interest expense and depreciation and amortization expense increased in 1998 by $668,000, the result of the recognition of approximately $595,000 of merger expense related to the acquisition of Cargill Bancorp, Inc., combined with overall corporate growth during 1998. INCOME TAXES For the year ended December 31, 1998 Westbank Corporation recorded a tax expense of $2,148,000 compared to 1997, when the Corporation recorded a tax expense of $2,406,000. The lower tax expense for 1998 was the result of a lower tax rate during 1998. NET INCOME The net income for 1998 of $3,377,000, or $.82 per share basic and $.79 per share diluted, is based on a weighted average of 4,143,009 basic and 4,272,682 diluted shares outstanding, compared with a net income for 1997 of $3,384,000, or $.88 per share basic and $.85 per share diluted based on a weighted average of 3,845,698 basic and 4,003,015 diluted. Net income in 1996 was $2,137,000, or $.59 per share basic and $.57 per share diluted and based on weighted average shares of 3,643,270 basic and 3,762,419 diluted. NEW ACCOUNTING STANDARDS The Corporation adopted two new accounting standards in 1998, Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income, and No. 131, Disclosures about Segments of an Enterprise and Related Information. During 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 134, Accounting for Mortgage-Backed Securities retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. For further discussion, see the Summary of Significant Accounting Policies in the Notes to the Financial Statements. YEAR 2000 The Corporation has taken steps to ensure that all of its computer systems (the "Systems") are ready to operate accurately on and beyond January 1, 2000. In the event that the Corporation's Systems are not Year 2000 compliant as of January 1, 2000, the Corporation would face significant operational difficulties. The Corporation fully understands the need to prevent disruption of computer and technical systems, and the Corporation is committed to providing its customers with high quality services without interruption. While the Corporation has determined that many of the Systems are Year 2000 compliant, the Corporation has prepared an action plan (the "Year 2000 Project") to ensure the continued integrity of its Systems. The Year 2000 Project includes five phases: (1) the awareness phase; (2) the assessment phase; (3) the renovation phase; (4) the validation phase; and (5) the implementation phase. The Corporation is currently in the implementation phase. 19 21 MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL RESULTS (CONTINUED) Westbank Corporation and Subsidiaries YEAR 2000 The Corporation relies on outside providers for the core banking software and data processing portions of the Systems. The Year 2000 Project applies to such vendors. The Year 2000 Project also includes a contingency plan to be implemented in the event that the Year 2000 Project reveals that any of the Systems are not Year 2000 compliant. In addition, in the event that despite the Year 2000 Project the Corporation experiences disruption due to Year 2000 problems, the Corporation is developing a business resumption plan which should be complete by June 30, 1999. As of December 31, 1998, the Corporation has incurred approximately $141,000 in Year 2000-related expenses and has estimated that capital expenditures related to the Year 2000 issue will total approximately $510,000. The Corporation has designed the Year 2000 Project based upon guidance from the Federal Financial Institutions Examining Council. In addition, the FDIC monitors the Corporation's preparation for the Year 2000 on a periodic basis. The information set forth above is designed to be a "Year 2000 Readiness Disclosure," as that term is defined in the Year 2000 Information Readiness and Disclosure Act. This information is forward-looking information, and, as such, it is subject to risks and uncertainties that would cause actual results to differ materially from the projected results discussed in this report. 20 22 CONSOLIDATED BALANCE SHEETS Westbank Corporation and Subsidiaries December 31, (Dollars in Thousands, except share amounts) 1998 1997 - - ----------------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks: Non-interest bearing $11,291 $10,783 Interest bearing 1,880 2,065 - - ----------------------------------------------------------------------------------------------------------------------------- 13,171 12,848 Federal funds sold 1,069 3,678 Total cash and cash equivalents 14,240 16,526 - - ----------------------------------------------------------------------------------------------------------------------------- Securities (Note 2): Investment securities available for sale 53,712 20,710 Investment securities held to maturity (fair value of $30,817 in 1998 and $39,771 in 1997) 30,616 39,602 - - ----------------------------------------------------------------------------------------------------------------------------- Total securities 84,328 60,312 - - ----------------------------------------------------------------------------------------------------------------------------- Loans, net of allowance for loan losses of $2,665 in 1998 and $3,057 in 1997 (Note 3) 290,767 263,808 Mortgage loans held for sale (Note 3) 2,346 4,446 - - ----------------------------------------------------------------------------------------------------------------------------- Total loans 293,113 268,254 - - ----------------------------------------------------------------------------------------------------------------------------- Property and equipment (Note 4) 6,851 5,901 Other real estate owned, net of allowance for losses $200 in 1997 (Note 5) 466 353 Accrued interest receivable 2,457 2,240 Other assets 1,168 1,981 - - ----------------------------------------------------------------------------------------------------------------------------- Total assets $402,623 $355,567 ============================================================================================================================= LIABILITIES AND STOCKHOLDERS' EQUITY Deposits (Note 6): Non-interest bearing $51,395 $50,443 Interest bearing 290,872 264,236 - - ----------------------------------------------------------------------------------------------------------------------------- Total deposits 342,267 314,679 Borrowed funds (Note 7) 27,807 11,884 Interest payable on deposits 429 385 Other liabilities 1,630 1,701 - - ----------------------------------------------------------------------------------------------------------------------------- Total liabilities 372,133 328,649 - - ----------------------------------------------------------------------------------------------------------------------------- Commitments and contingent liabilities (Notes 12 and 13) Stockholders' equity (Notes 10, 11 and 15): Preferred stock, par value $5 per share, authorized 100,000 shares; none issued Common stock, par value $2 per share, authorized 9,000,000 shares; issued and outstanding 4,198,838 shares in 1998 and 3,932,535 shares in 1997 8,397 7,865 Additional paid-in capital 11,076 9,711 Retained earnings 10,803 9,282 Accumulated other comprehensive income 214 60 - - ----------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 30,490 26,918 - - ----------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $402,623 $355,567 ============================================================================================================================= 21 23 CONSOLIDATED STATEMENTS OF INCOME Westbank Corporation and Subsidiaries Years ended December 31, (Dollars in Thousands, except share amounts) 1998 1997 1996 - - ----------------------------------------------------------------------------------------------------------------------------- Interest and dividend income: Interest and fees on loans $23,645 $22,893 $21,011 Interest and dividend income from securities 4,614 3,569 2,773 Interest from interest bearing cash and federal funds sold 372 262 275 - - ----------------------------------------------------------------------------------------------------------------------------- Total interest and dividend income 28,631 26,724 24,059 - - ----------------------------------------------------------------------------------------------------------------------------- Interest expense: Interest on deposits 12,662 11,800 10,263 Interest on borrowed funds 630 291 261 - - ----------------------------------------------------------------------------------------------------------------------------- Total interest expense 13,292 12,091 10,524 - - ----------------------------------------------------------------------------------------------------------------------------- Net interest income 15,339 14,633 13,535 Provision for loan losses (Note 3) 41 306 944 - - ----------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 15,298 14,327 12,591 - - ----------------------------------------------------------------------------------------------------------------------------- Non-interest income: Trust department income 498 465 425 Service charges on deposits 766 808 867 Loan servicing 470 494 505 Gain on sale of securities available for sale 141 259 112 Gain on sale of other real estate owned (Note 5) 43 67 3 Gain on sale of mortgages 120 5 9 Other non-interest income 389 431 419 - - ----------------------------------------------------------------------------------------------------------------------------- Total non-interest income 2,427 2,529 2,340 - - ----------------------------------------------------------------------------------------------------------------------------- Non-interest expense: Compensation and benefits (Note 9) 5,797 5,461 5,091 Depreciation and amortization 851 772 743 Data processing 808 751 652 Occupancy expense 802 794 802 Other real estate owned expenses (Note 5) 104 221 614 Other non-interest expense (Note 14) 3,838 3,067 3,376 - - ----------------------------------------------------------------------------------------------------------------------------- Total non-interest expense 12,200 11,066 11,278 - - ----------------------------------------------------------------------------------------------------------------------------- Income before income taxes 5,525 5,790 3,653 Income taxes (Note 8) 2,148 2,406 1,516 - - ----------------------------------------------------------------------------------------------------------------------------- Net income $ 3,377 $ 3,384 $ 2,137 ============================================================================================================================= Earnings per share (Note 11): - Basic $ .82 $ .88 $ .59 - Diluted .79 .85 .57 ============================================================================================================================= Weighted average shares outstanding (Note 11): - Basic 4,143,009 3,845,698 3,643,270 - Diluted 4,272,682 4,003,015 3,762,419 ============================================================================================================================= See notes to consolidated financial statements. 22 24 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Westbank Corporation and Subsidiaries Years ended December 31, (Dollars in Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------------------------- Net Income $3,377 $3,384 $2,137 - - ------------------------------------------------------------------------------------------------------------------------------- Unrealized gain (loss) on securities available for sale, net of income taxes (benefit) of $150 in 1998, $271 in 1997, and ($71) in 1996. 249 327 (99) Less: reclassification adjustment for gains included in net income, net of income taxes of $49 in 1998, $76 in 1997, and $46 in 1996. 92 168 66 - - ------------------------------------------------------------------------------------------------------------------------------- Other Comprehensive Income (Loss) 157 159 (165) - - ------------------------------------------------------------------------------------------------------------------------------- Comprehensive Income $3,534 $3,543 $1,972 =============================================================================================================================== See notes to consolidated financial statements. 23 25 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Westbank Corporation and Subsidiaries Accumulated Common Stock Additional Other Par paid-in Retained Comprehensive (Dollars in Thousands, except share amounts) Shares Value capital earnings Income/(Loss) Total - - ------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1995 3,530,981 $7,062 $7,816 $5,842 $66 $20,786 Net income 2,137 2,137 Cash dividends declared ($.24 per share) (784) (784) Stock dividend (1% on Cargill Bancorp shares) 15,248 30 78 (108) Shares issued: Stock option plan 30,584 61 25 86 Dividend reinvestment and stock purchase plan 94,615 190 467 657 Change in unrealized gain (loss) on securities available for sale (165) (165) - - ------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1996 3,671,428 7,343 8,386 7,087 (99) 22,717 Net income 3,384 3,384 Cash dividends declared ($.30 per share) (1,040) (1,040) Stock dividend (1% on Cargill Bancorp shares) 16,076 32 117 (149) Shares issued: Stock option plan 98,612 197 116 313 Dividend reinvestment and stock purchase plan 146,419 293 1,092 1,385 Changes in unrealized gain (loss) on securities available for sale 159 159 - - ------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1997 3,932,535 7,865 9,711 9,282 60 26,918 Net income 3,377 3,377 Cash dividends declared ($.40 per share) (1,503) (1,503) Stock dividend (1% on Cargill Bancorp shares) 17,389 35 93 (129) (1) Shares issued: Stock option plan 199,799 399 742 1,141 Dividend reinvestment and stock purchase plan 49,115 98 530 628 Cargill interim loss for the quarter ended December 31, 1998 (Note 1) (224) (224) Changes in unrealized gain (loss) on securities available for sale 154 154 - - ------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1998 4,198,838 $8,397 $11,076 $10,803 $214 $30,490 ============================================================================================================================== See notes to consolidated financial statements. 24 26 CONSOLIDATED STATEMENTS OF CASH FLOWS Westbank Corporation and Subsidiaries Years ended December 31, (Dollars in Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------------------------ Operating activities: Net income $ 3,377 $ 3,384 $ 2,137 Adjustments to reconcile net income to net cash provided (used) by operating activities: Cargill interim loss for period ended December 31, 1998 (224) Provision for loan losses 41 306 944 Provision for other real estate owned 22 109 501 Depreciation and amortization 851 772 743 Realized gain on sale of securities (141) (259) (112) Realized gain on sale of other real estate owned (43) (67) (3) Realized gain on miscellaneous assets (83) Realized gain on sale of mortgages (120) (5) (9) Deferred income taxes (107) 164 368 Change in: (Increase)/Decrease in loans held for sale 2,100 (8,099) 1,313 (Increase)/Decrease in accrued interest receivable (217) (314) 13 Other assets 814 90 431 Interest payable on deposits 44 51 19 Increase/(Decrease)Other liabilities 36 147 272 - - ------------------------------------------------------------------------------------------------------------------------------ Net cash provided (used) by operating activities 6,433 (3,721) 6,534 ============================================================================================================================== Investing activities: Securities: Held to maturity: Purchases (21,473) (28,920) (14,373) Proceeds from maturities 30,459 15,557 10,467 Available for sale: Purchases (41,210) (8,748) (3,013) Proceeds from sales 8,607 10,019 2,857 Proceeds from maturities 5,164 2,484 6,858 Proceeds on sale of miscellaneous assets 296 Purchases of premises and equipment (1,801) (835) (1,099) Net increase in loans (32,987) (15,210) (29,076) Proceeds from sale of other real estate owned 618 791 1,182 - - ------------------------------------------------------------------------------------------------------------------------------ Net cash used in investing activities (52,623) (24,862) (25,901) ============================================================================================================================== Financing activities: Net increase in deposits 27,588 16,660 28,493 Net increase in short-term borrowings 8,923 2,615 1,592 Increase in long-term borrowings 7,000 Proceeds from exercise of stock options and stock purchase plan 1,897 1,699 743 Dividends paid (1,504) (1,041) (785) - - ------------------------------------------------------------------------------------------------------------------------------ Net cash used by financing activities 43,904 19,933 30,043 - - ------------------------------------------------------------------------------------------------------------------------------ Increase (decrease) in cash and cash equivalents (2,286) (8,650) 10,676 Cash and cash equivalents at beginning of year 16,526 25,176 14,500 - - ------------------------------------------------------------------------------------------------------------------------------ Cash and cash equivalents at end of year $14,240 $16,526 $25,176 ============================================================================================================================== Cash paid during the year: Interest on deposits and other borrowings $13,075 $11,754 $10,506 Income taxes 2,103 1,990 1,287 Supplemental disclosure of cash flow information: Securitization of loans into mortgage-backed securities 5,067 9,314 3,639 Transfers of loans to other real estate owned 701 806 1,280 Transfer of miscellaneous asset from other real estate owned to premises and equipment 291 Loans to facilitate the sale of other real estate owned 618 120 667 See notes to consolidated financial statements. 25 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Westbank Corporation and Subsidiaries YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Westbank Corporation (the "Corporation") and its subsidiaries are in conformity with generally accepted accounting principles and general practices within the banking industry. The following is a description of the more significant policies. NATURE OF BUSINESS As of December 31, 1998, the Corporation operates two banking subsidiaries (the "Banks"), Park West Bank and Trust Company ("Park West") with thirteen banking offices and a trust department located in Hampden County, Massachusetts, and Cargill Bank ("Cargill") with three offices in Windham County, Connecticut. A full range of retail banking services are furnished to individuals, businesses and non-profit organizations. The Corporation's primary source of revenue is derived from providing loans to customers, predominately located in Western Massachusetts and Northeast Connecticut. MERGER Effective January 29, 1999, Cargill Bancorp, Inc., and its subsidiary ("Cargill") were merged with and into Westbank Corporation ("Westbank"), pursuant to a plan of merger dated July 15, 1998. Each share of Cargill common stock was converted into 1.3655 shares of the Corporation's common stock. A total of 400,164 Westbank common shares were issued for the outstanding common stock of Cargill. The transaction was accounted for using the pooling-of-interests method and, accordingly, all historical financial data has been restated to include both entities for all periods presented. Directs costs of mergers accounted for by the pooling-of-interests method are expensed as incurred. Merger-related costs expensed in 1998 aggregated $595,000. These merger expenses included legal, accounting, regulatory and severance costs, as well as integration costs such as conversions, abandonments and relocations, etc. The restatement of the historical financial data is based on Westbank's fiscal year end December 31 and Cargill's fiscal year end September 30. The Cargill loss of $224,000 for the quarter ended December 31, 1998, has been included directly in stockholders' equity in order to conform Cargill's reporting periods to the Corporation's as of December 31, 1998. For the quarter ended December 31, 1998, Cargill had net interest income of $456,000 and a net loss of $224,000. Included in operating expenses were $346,000 of merger and related costs that were primarily the cause of their loss. The following table presents summary results of operations for the companies for the immediate years prior to the merger: (Dollar amounts in thousands) Westbank Cargill Combined -------- ------- -------- 1998: Net interest income $13,442 $1,897 $15,339 Net income 3,256 121 3,377 1997: Net interest income $12,784 $1,849 $14,633 Net income 3,231 153 3,384 1996: Net interest income $11,842 $1,693 $13,535 Net income (loss) 2,248 (111) 2,137 BASIS OF PRESENTATION The consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiaries, Park West Bank and Trust Company, its subsidiaries, Lorac Leasing Corp., Park West Securities Corporation and PWB&T Inc., and Cargill Bank. All material intercompany balances and transactions have been eliminated upon consolidation. Certain amounts in the 1997 and 1996 financial statements have been reclassified to conform to the 1998 presentation. The Corporation operates two community banks offering different products and services. Since the Corporation derives a significant portion of its revenue and expense from the Banks, no meaningful allocation of its resources is possible. 26 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries USE OF ESTIMATES The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and affect the reported amounts of income and expenses for each year. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan losses and other real estate owned, management obtains independent appraisals for significant properties. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation's allowances for losses on loans and other real estate owned. Such agencies may require the Corporation to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. NEW ACCOUNTING STANDARDS As of January 1, 1998, the Corporation adopted a Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income, which establishes standards for reporting and displaying of comprehensive income and SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, which establishes standards for the way public companies report information about operating segments in both interim and annual financial statements and related disclosures. Adoption of these statements did not impact the Corporation's consolidated balance sheets, statements of income or cash flows and was limited to the form and content of its disclosures. Both statements were effective for fiscal years beginning after December 31, 1997, and required restatement of all prior periods presented to conform to the provisions of these statements. In June 1998, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement established accounting and reporting standards for derivative instruments including derivative activities. This statement will be effective for the Corporation's fiscal 2001 financial statements. In October 1998, the FASB issued SFAS No. 134, Accounting for Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. This statement further amends SFAS No. 65 to require that, after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability and intent to sell or hold these investments. This statement will be effective for the Corporation's 1999 financial statements. Management is currently evaluating the future impact of these standards. CASH AND CASH EQUIVALENTS The Corporation defines cash and due from banks and federal funds sold to be cash and cash equivalents. The Bank is required to maintain average reserve balances with the Federal Reserve Bank. These balances can be in the form of either vault cash or funds left on deposit with the Federal Reserve Bank. The average amount of these balances was $3,049,000 for 1998. SECURITIES Securities that management has the positive intent and ability to hold until maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts. Those securities which have been identified as assets for which there is not a positive intent to hold to maturity, including all marketable equity securities, are classified as available for sale with unrealized gains (losses), net of income taxes, reported as a separate component of stockholders' equity. The Corporation determines if securities will be classified as held to maturity or available for sale at the time of purchase. In addition, any mortgage-backed securities created out of the Corporation's own inventory of residential real estate loans are also considered available for sale. Gains and losses on sales of securities are recognized in other income at the time of sale on a specific identification basis. Securities which have experienced an other than temporary decline in value are written down to estimated fair value, establishing a new cost basis with the amount of the write-down expensed as a realized loss. The Corporation does not engage in trading activities. Mortgage-backed securities held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts determined by a method that approximates the level-yield method. Management has the positive ability and the intent to hold these assets until maturity. 27 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries LOANS Loans have been reduced by deferred loan fees and the allowance for loan losses. Interest on commercial and real estate loans is accrued on the principal amount of loans outstanding. Interest on installment and other loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. Loan origination fees, net of certain direct loan origination costs, are deferred and recognized as income over the life of the related loan as an adjustment to the loan's yield. Non-accrual loans are loans on which the accrual of interest ceases when the collection of principal or interest payments is determined to be doubtful by management. It is the general policy of the Corporation to discontinue the accrual of interest when principal or interest payments are delinquent 90 days, unless the loan principal and interest are determined by management to be fully collectible. Any unpaid amounts previously accrued on these loans are reversed from income. Interest received on a loan in non-accrual status is applied to reduce principal or, if management determines that the principal is collectible, applied to interest on a cash basis. A loan is returned to accrual status after the borrower has brought the loan current and has demonstrated compliance with the loan terms for a sufficient period, and management's doubts concerning collectibility have been removed. The Corporation measures impairment of commercial loans by using the present value of expected future cash flows discounted at the loan's effective interest rate. Commercial real estate loans are generally measured based on the fair value of the underlying collateral. Smaller balance homogenous loans, including residential real estate and consumer loans, are collectively evaluated for impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral-dependent. The Corporation evaluates each impaired loan to determine the appropriate income recognition practice. Generally, income is recorded only on a cash basis for impaired loans. The adequacy of the allowance for loan losses is evaluated regularly by management. Factors considered in evaluating the adequacy of the allowance include the size of the portfolio, previous loss experience, current economic conditions and their effect on borrowers, the financial condition of individual borrowers and the related performance of individual loans in relation to contract terms. The provision for loan losses charged to operating expense is based upon management's judgment of the amount necessary to maintain the allowance at a level adequate to absorb losses. Loan losses are charged against the allowance for loan losses when management believes the collectibility of the principal is unlikely. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate. Net unrealized losses are recognized through a valuation allowance charged to income. PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method. Amortization of leasehold improvements is charged over the terms of the respective leases, including option periods or the estimated useful lives of the improvements, whichever is shorter. Gains and losses are recognized upon disposal of assets. The cost of maintenance and repairs is charged to income as incurred, whereas significant renewals are capitalized. OTHER REAL ESTATE OWNED Other real estate owned ("OREO") includes properties the Corporation has acquired through foreclosure. OREO is recorded at the lower of cost or fair value at the date of acquisition, less estimated selling costs. At the time of foreclosure, the excess, if any, of the loan amount over the fair value of the asset acquired is charged off against the allowance for loan losses. Operating expenses to administer OREO properties are charged directly to operating expenses. Valuation allowances are established subsequent to acquisition, as necessary, based upon management's continuing assessment of the fair values of the properties. Loans granted in conjunction with sales of OREO are required to comply with the Corporation's standard underwriting criteria, including receipt of an adequate down payment. 28 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries LOAN SALES AND SERVICING RIGHTS The Corporation sells loans in the secondary market and retains the related servicing rights. Mortgage servicing rights are recognized as an asset when loans are sold with servicing retained, by allocating the cost of an originated mortgage loan between the loan and the servicing right based on estimated relative fair values. The cost allocated to the servicing right is capitalized as a separate asset and amortized in proportion to, and over the period of, estimated net servicing income. Capitalized mortgage servicing rights are evaluated for impairment by comparing the asset's unamortized cost to its current estimated fair value. Fair values are estimated using a discounted cash flow approach, which considers future servicing income and costs, current market interest rates, and anticipated prepayment and default rates. In making impairment evaluations, mortgage servicing rights are stratified based on one or more of the predominant risk characteristics of the underlying loans. The Corporation has stratified its servicing portfolio for this purpose between fixed and adjustable rate loans. Impairment losses, if any, are recognized through a valuation allowance for each impaired stratum. Adjustments to the valuation allowance are charged or credited to income. INCOME TAXES The asset and liability method of accounting for income taxes is utilized. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. To the extent that current available evidence about the future raises doubt about the realization of a deferred tax asset, a valuation allowance will be established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. PENSION PLAN The Corporation has a trusteed defined contribution pension plan covering substantially all employees. The Corporation's policy is to fund accrued pension cost. STOCK OPTIONS The Corporation measures compensation cost of stock options on the intrinsic value of the common stock options granted. Intrinsic value is the excess of the market value of the common stock over the exercise price at the date of grant. Because stock options are granted with fixed terms and with an exercise price equal to the market price of the common stock at the date of grant, there is no measured compensation cost of stock options. The pro forma disclosures for net income and earnings per share as if a fair value-based method of accounting had been applied are contained in these Notes to the Consolidated Financial Statements. TRUST DEPARTMENT Assets held by the Corporation for customers in a fiduciary or agency capacity are not included in the consolidated financial statements, as such items are not assets of the Corporation. Such assets totaled approximately $119,797,000 and $117,234,000 at December 31, 1998 and 1997, respectively. Trust income is recognized on a cash basis. The amounts recognized under this method are not materially different from amounts that would be recognized on the accrual basis. EARNINGS PER SHARE Basic earnings per share is the result of dividing earnings available to common stockholders by the weighted average number of common shares outstanding during the year. Diluted earnings per share gives effect to all potentially dilutive common shares that were outstanding during the year. 29 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries 2 - SECURITIES Investment securities held to maturity at December 31 are as follows: 1998 Gross Gross Net Amortized unrealized unrealized Fair unrealized (Dollars in Thousands) cost gains losses value gain - - ------------------------------------------------------------------------------------------------------------------------------ U.S. Government obligations $ 998 $ 28 $ 1,026 $ 28 Federal agency obligations 26,890 145 27,035 145 Mortgage-backed securities 2,728 30 $2 2,756 28 - - ------------------------------------------------------------------------------------------------------------------------------ $30,616 $203 $2 $30,817 $201 ============================================================================================================================= 1997 Gross Gross Net Amortized unrealized unrealized Fair unrealized (Dollars in Thousands) cost gains losses value gain - - ------------------------------------------------------------------------------------------------------------------------------ U.S. Government obligations $ 4,246 $ 35 $ 1 $ 4,280 $ 34 Federal agency obligations 32,927 121 20 33,028 101 Mortgage-backed securities 2,330 43 9 2,364 34 Certificates of deposit 99 99 - - ----------------------------------------------------------------------------------------------------------------------------- $39,602 $199 $30 $39,771 $169 ============================================================================================================================= During 1998 and 1997 there were no sales of investment securities classified as held to maturity. Investment securities available for sale at December 31 are as follows: 1998 Gross Gross Net Amortized unrealized unrealized Fair unrealized (Dollars in Thousands) cost gains losses value gain/(loss) - - ------------------------------------------------------------------------------------------------------------------------------ U.S. Government obligations $ 928 $ 928 Federal agency obligations 26,629 $124 $ 86 26,667 $ 38 Equity securities 1,716 29 1,745 29 Mortgage-backed securities 24,087 299 14 24,372 285 - - ----------------------------------------------------------------------------------------------------------------------------- $53,360 $452 $100 $ 53,712 $ 352 ============================================================================================================================= 1997 Gross Gross Net Amortized unrealized unrealized Fair unrealized (Dollars in Thousands) cost gains losses value gain/(loss) - - ------------------------------------------------------------------------------------------------------------------------------ U.S. Government obligations $ 2,058 $ 2,058 Federal agency obligations 3,500 $ 3 $ 17 3,486 $(14) Equity securities 1,642 22 1,664 22 Mortgage-backed securities 13,406 97 1 13,502 96 - - ------------------------------------------------------------------------------------------------------------------------------ $20,606 $122 $18 $20,710 $104 ============================================================================================================================== During 1998 and 1997, the Corporation recognized gross gains on securities available for sale totaling $141,000 and $259,000, respectively. The contractual maturities of held-to-maturity and available-for-sale securities, other than equity securities, as of December 31, 1998, are summarized in the following tables. Actual maturities may differ from contractual maturities because certain issuers have the right to call or prepay obligations. For the purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the contractual maturities of underlying collateral. The mortgage-backed securities may mature earlier than their contractual maturities because of principal repayments. 30 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries Amortized Fair (Dollars in Thousands) cost value - - ----------------------------------------------------------------------------------------------------------------------------- Held to Maturity: Within 1 year $ 499 $ 505 Over 1 year to 5 years 5,821 5,901 Over 5 years to 10 years 23,346 23,458 Over 10 years 950 953 - - ----------------------------------------------------------------------------------------------------------------------------- Total bond and debt obligations $30,616 $ 30,817 ============================================================================================================================= Amortized Fair (Dollars in Thousands) cost value - - ----------------------------------------------------------------------------------------------------------------------------- Available for Sale: Within 1 year $ 2,484 $ 2,479 Over 1 year to 5 years 558 565 Over 5 years to 10 years 22,475 22,226 Over 10 years 26,454 26,696 - - ----------------------------------------------------------------------------------------------------------------------------- Total bond and debt obligations $51,971 $ 51,966 ============================================================================================================================= At December 31, 1998 securities with a book value and fair value of $17,998,000 and $18,092,000, respectively, were pledged to secure public deposits, repurchase agreements and for other purposes as required by law. 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES Loans consisted of the following at December 31: (Dollars in Thousands) 1998 1997 - - ---------------------------------------------------------------------------------------------------------------------------- Commercial $ 41,760 $ 41,661 Real estate construction 5,998 5,302 Real estate 229,092 208,023 Consumer 19,277 16,648 - - ---------------------------------------------------------------------------------------------------------------------------- 296,127 271,634 Allowance for loan losses (2,665) (3,057) Deferred loan origination fees (349) (323) - - ---------------------------------------------------------------------------------------------------------------------------- $293,113 $268,254 ============================================================================================================================= Changes in the allowance for loan losses are summarized as follows: (Dollars in Thousands) 1998 1997 1996 - - ----------------------------------------------------------------------------------------------------------------------------- Balance, beginning of year $ 3,057 $2,699 $3,924 Provision for loan losses 41 306 944 Loans charged off (518) (760) (2,539) Recoveries 85 812 370 - - ----------------------------------------------------------------------------------------------------------------------------- $ 2,665 $3,057 $2,699 ============================================================================================================================= The aggregate principal balance of non-accrual loans was $797,000 and $1,648,000 at December 31, 1998 and 1997 respectively. Contractual interest income that was not recognized on such non-accrual loans was $35,000, $79,000 and $240,000 for 1998, 1997 and 1996, respectively. 31 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries The Corporation did not sell any loans with recourse during 1998 or 1997. The remaining recourse exposure on prior sales was $2,007,000 at December 31, 1998. Management does not believe that its recourse obligations subject the Corporation to any material risk of loss in the future. The Corporation has suffered no losses as a result of these recourse obligations. Of the $229,077,000 in real estate loans at December 31, 1998, $168,744,000 are collateralized by 1-4 family dwellings. The majority of the collateral for these loans is located in the Corporation's market area of Western Massachusetts and Northeast Connecticut. Commercial real estate and real estate construction loans represented $60,348,000 in outstanding principal at December 31, 1998. These loans encompass a wider region extending throughout Massachusetts and Southern New England. Most are collateralized by commercial real estate developments. Commercial loans both collateralized and uncollateralized of $41,760,000 at December 31, 1998, represent loans made to businesses primarily in Western Massachusetts. The Corporation has had, and expects to have in the future, banking transactions in the ordinary course of business with its directors and officers. Such loans, in the opinion of management, do not include more than the normal risk of collectibility nor other unfavorable features. The following summarizes the activity with respect to indebtedness, both direct and indirect, for directors, policy-making officers and major stockholders during the years ended December 31: (Dollars in Thousands) 1998 1997 - - ---------------------------------------------------------------------------------------------------------------------------- Balance at beginning of year $2,386 $1,552 New loans granted 886 2,936 Repayments of principal (231) (2,102) - - ----------------------------------------------------------------------------------------------------------------------------- Balance at end of year $3,041 $2,386 ============================================================================================================================= At December 31, 1998 and 1997, the recorded investment in impaired loans was $1,419,000 and $1,809,000, respectively, for which no additional specific allowance for loan losses was recorded. For the years ended December 31, 1998, 1997 and 1996, the average recorded investment in impaired loans was $1,366,000, $2,080,000 and $3,890,000, respectively. Interest income recognized during 1998, 1997 and 1996 on impaired loans was not significant. The Corporation had no commitments to lend additional funds to borrowers having loans that are on non-accrual status, impaired or restructured. The Corporation services loans for others which are not included in the consolidated balance sheets. The unpaid balances of these loans totaled $115,391,000 and $133,359,000 at December 31, 1998 and 1997, respectively. 4 - PROPERTY AND EQUIPMENT Major classes of property and equipment at December 31 are summarized as follows: Estimated (Dollars in Thousands) 1998 1997 Lives - - ----------------------------------------------------------------------------------------------------------------------------- Property (including land of $1,546 in 1998 and $1,187 in 1997) $5,214 $4,305 15-40 years Capital lease building 263 263 15 years Furniture and equipment 4,167 3,181 3-10 years Leasehold and building improvements 2,825 3,246 5-15 years Motor vehicles 114 105 3 years - - ----------------------------------------------------------------------------------------------------------------------------- 12,583 11,100 Accumulated depreciation 5,732 5,199 - - ----------------------------------------------------------------------------------------------------------------------------- Property and Equipment $6,851 $5,901 ============================================================================================================================= 32 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries 5 - OTHER REAL ESTATE OWNED At December 31, other real estate owned consisted of properties acquired through foreclosure as follows: (Dollars in Thousands) 1998 1997 Real estate acquired through foreclosure - net of OREO provision 466 353 ============================================================================================================================= Changes in the allowance for other real estate owned losses are summarized as follows: (Dollars in Thousands) 1998 1997 1996 ============================================================================================================================= Balance, beginning of year $200 $195 $65 Provision for other real estate owned charged to operations 22 29 390 Write-downs (net of payments) (222) (24) (260) - - ----------------------------------------------------------------------------------------------------------------------------- Balance, end of year $ $200 $195 ============================================================================================================================= 6 - DEPOSITS Deposit accounts by type as of December 31 are summarized as follows: (Dollars in Thousands) 1998 1997 ============================================================================================================================= Demand deposit 51,395 50,443 Savings 53,689 45,902 N.O.W. 25,993 23,027 Money market deposits 29,659 25,677 Other time deposits 181,531 169,630 ============================================================================================================================= 342,267 314,679 ============================================================================================================================= At December 31, 1998, the scheduled maturities of other time deposits and IRA deposits with a fixed maturity are as follows: (Dollars in Thousands) =========================================================================================================== 1999 130,174 2000 27,394 2001 10,219 2002 3,359 2003 and after 1,172 - - ----------------------------------------------------------------------------------------------------------- 172,318 Certificates of deposit with balances greater than or equal to $100,000 amounted to $26,880,000 and $22,621,000 as of December 31, 1998 and 1997, respectively. Interest paid on these deposits totaled approximately $1,250,000 and $1,046,000, respectively. 33 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries 7 - BORROWED FUNDS Short-term borrowings as of December 31 are as follows: (Dollars in Thousands) 1998 1997 ============================================================================================================================= Securities sold under agreements to repurchase $11,953 $8,020 Purchased federal funds 270 270 FHLB Advance 7,310 Treasury tax and loan notes 1,274 3,594 - - ----------------------------------------------------------------------------------------------------------------------------- Total short term borrowings $20,807 $11,884 ============================================================================================================================= The above short-term borrowings generally mature daily. The following information relates to long-term debt as of December 31, 1998: (Dollars in Thousands) ============================================================================================================================= FHLB Term advance 5.87% due May 12, 2003 $7,000 The following table summarizes borrowings. Average interest rates during each year were computed by dividing total interest expense by the average amount borrowed: (Dollars in Thousands) 1998 1997 1996 ============================================================================================================================= Balance at year end $27,807 $11,884 $ 9,269 Average amount outstanding 16,442 9,065 8,714 Maximum amount outstanding at any month-end 28,307 14,036 12,794 Average interest rate for the year 3.83% 3.20% 2.99% Average interest rate on year-end balance 3.85% 3.15% 3.03% The Corporation maintains lines of credit with the Fleet Bank of Massachusetts for $3,000,000 and the Bank of Boston for $1,500,000. Both are revolving lines of credit that are renewed on an annual basis. There were no amounts outstanding against either line as of December 31, 1998 or 1997. The Corporation had additional short term borrowing capacity through the Federal Home Loan Bank of $7,244,000 through its Ideal Way program that was unused at year-end 1998. Advances from the Federal Home Loan Bank of Boston (FHLB) are collateralized by the Company's holdings of FHLB stock and residential real estate loans. 34 36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries 8 - INCOME TAXES The income taxes (benefits) were as follows: (Dollars in Thousands) 1998 1997 1996 ============================================================================================================================= Current tax: Federal $1,943 $1,836 $921 State 312 408 328 Total current 2,255 2,244 1,249 - - ----------------------------------------------------------------------------------------------------------------------------- Deferred tax: Deferred taxes (107) 164 368 Change in valuation allowance for deferred tax assets (2) (101) Total deferred (107) 162 267 - - ----------------------------------------------------------------------------------------------------------------------------- Total income taxes $2,148 $2,406 $1,516 ============================================================================================================================= The differences between the effective tax rate and the federal statutory tax rate on income before taxes are reconciled as follows: 1998 1997 1996 - - ----------------------------------------------------------------------------------------------------------------------------- Federal statutory rate 34.0% 34.0% 34.0% Change in valuation allowance for deferred tax asset 1.0 State income taxes, net of federal benefit 4.4 6.1 6.9 Other .5 .5 .6 - - ----------------------------------------------------------------------------------------------------------------------------- 38.9% 41.6% 41.5% ============================================================================================================================= 35 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31 are presented below: (Dollars in Thousands) 1998 1997 ============================================================================================================================= Deferred tax assets: Other real estate owned $ 84 Deferred loan fees $ 122 112 Reserve for loan losses 96 86 Deferred income 17 22 Accrued expenses not deducted for tax 176 52 State tax net operating loss carryforward 99 Non-accrual interest 11 48 Amortization 12 Other 95 39 - - ----------------------------------------------------------------------------------------------------------------------------- Total gross deferred tax assets 529 542 Valuation allowance (99) - - ----------------------------------------------------------------------------------------------------------------------------- Net deferred tax assets 529 443 - - ----------------------------------------------------------------------------------------------------------------------------- Deferred tax liabilities: Bond accretion 8 17 Unrealized gain on securities 151 44 Depreciation 345 314 Allowance for loan losses 193 249 Deferred FNMA premium 4 5 Prepaid pension 26 Earned income not yet taxed 141 112 Other 37 31 - - ----------------------------------------------------------------------------------------------------------------------------- Total gross deferred tax liabilities 879 798 - - ----------------------------------------------------------------------------------------------------------------------------- Net deferred tax liability $(350) $(355) ============================================================================================================================= In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax assets and liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Corporation will realize the benefits of these deductible differences, net of the recorded valuation allowance. 9 - PENSION PLAN The Corporation has a defined contribution pension plan (money purchase), covering substantially all of its employees at Park West and a defined benefit plan for its employees at Cargill Bank. Contributions to the money purchase plan are a percentage of individual employees' salary. Total pension expense for 1998, 1997 and 1996 amounted to $212,000, $204,000 and $213,000, respectively. At May 31, 1998, the most recent plan year end of the money purchase plan, total plan assets were $3,671,379 and the vested balance was $3,568,546. The money purchase plan assets are invested in money market funds, government bonds, corporate and government agency bonds and marketable securities. The defined benefit plan is a multi-employer plan. 10 - STOCK OPTIONS The Corporation has four fixed-option plans which reserve shares of common stock for issuance to executives, key employees and directors. During 1998, 1997 and 1996, no compensation cost was required to be recognized for the stock option plans. Had compensation costs for the Corporation's four stock option plans been determined based on the fair value at the grant date for awards in 1998, 1997 and 1996 consistent with the provisions of SFAS No. 123, the Corporation's net earnings and earnings per share would have been as follows: 36 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries (Dollars in Thousands, except per share data) 1998 1997 1996 ============================================================================================================================== Net earnings - as reported $3,377 $3,384 $2,137 Net earnings - pro forma 2,709 3,003 1,649 Earnings per share - as reported - Basic .82 .88 .59 - Diluted .79 .85 .57 Earnings per share - pro forma - Basic .65 .78 .45 - Diluted .63 .75 .44 The Corporation offers shares of common stock to officers and key employees pursuant to the 1985 Incentive Stock Option Plan. As of December 31, 1998, all options granted are exercisable. The following is a summary of the changes in options outstanding: 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------------------------ Options granted and exercisable at the beginning of the year 191,466 277,122 307,706 Options exercised: at $2.00 (27,741) (16,268) at $2.50 (350) (27,450) (9,200) at $3.50 (20,302) (5,116) at $6.00 (146,832) (10,163) - - ------------------------------------------------------------------------------------------------------------------------------ Options granted and exercisable at the end of the year 44,284 191,466 277,122 ============================================================================================================================== Unless exercised the options will expire ten years after granting. No options are available for future grants. The Corporation adopted a Cargill Directors and Officers Stock Option Plan during 1992. The following is a summary of the changes in options outstanding under the Cargill Directors and Officers Stock Option Plan: 1998 1997 1996 ============================================================================================================================== Options granted and exercisable at the beginning of the year 113,657 124,113 133,685 Options exercised or expired (9,572) Options exercised at $4.02 31,617 10,456 - - ----------------------------------------------------------------------------------------------------------------------------- Options granted and exercisable at the end of the year 82,040 113,657 124,113 ============================================================================================================================== Unless exercised the options will expire twenty years after granting. No options are available for future grants. The Corporation adopted a Directors Stock Option Plan during 1995. The following is a summary of the changes in options outstanding under the Directors Stock Option Plan: 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------------------------ - - ------------------------------------------------------------------------------------------------------------------------------ Options granted and exercisable at the beginning of the year 53,000 44,000 33,000 Options granted and exercisable: at $7.125 11,000 at $9.375 11,000 at $12.875 9,000 at $14.75 3,000 Options exercised at $6.00 (15,000) (2,000) at $7.125 (2,000) at $9.375 (2,000) - - ----------------------------------------------------------------------------------------------------------------------------- Options granted and exercisable at the end of the year 46,000 53,000 44,000 - - ----------------------------------------------------------------------------------------------------------------------------- Options available for future grants 58,000 70,000 81,000 - - ----------------------------------------------------------------------------------------------------------------------------- Unless exercised, the options will expire twenty years after granting. 37 39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries The Corporation adopted an incentive stock option plan during 1996 for directors and employees. At the 1998 Annual Meeting of Shareholders, the 1996 Incentive Stock Option Plan was amended to increase the number of shares reserved for issuance by 200,000 shares. The following is a summary of the changes in the 1996 Incentive Stock Option Plan: 1998 1997 1996 ============================================================================================================================= Options outstanding at the beginning of the year 36,500 45,500 Options authorized 200,000 178,500 ============================================================================================================================= Options granted and exercisable at the beginning of the year 141,500 133,000 - - ----------------------------------------------------------------------------------------------------------------------------- Options granted and exercisable to directors at $8.00 11,000 Options granted and exercisable to employees at $8.125 122,500 Options granted and exercisable to directors at $9.00 9,000 Options granted and exercisable to directors at $15.25 10,000 Options granted and exercisable to employees at $13.375 107,000 Options exercised at $8.125 (500) Options exercised at $8.00 (2,000) Options terminated (500) Options granted and exercisable at the end of the year 256,500 141,500 133,000 - - ----------------------------------------------------------------------------------------------------------------------------- Options available for future grants 119,500 36,500 45,500 ============================================================================================================================= 11 - EARNINGS PER SHARE The following is a reconciliation of the shares and earnings per share utilized for the basic and diluted earnings per share computations. Shares Per Share =========================================================================================== Basic Earnings Per Share: 1998 4,143,009 $.82 1997 3,845,698 .88 1996 3,643,270 .59 Effect of Dilutive Option Shares: 1998 129,673 .03 1997 157,317 .03 1996 119,149 .02 Diluted Earnings Per Share: 1998 4,272,682 .79 1997 4,003,015 .85 1996 3,762,419 .57 12 - LEASES The Corporation leases certain facilities under long-term operating lease agreements. The following is a schedule of future minimum lease payments for such operating leases as of December 31, 1998: (Dollars in Thousands) ========================================================================================= 1999 $ 298 2000 297 2001 196 2002 183 2003 117 After 2003 438 - - ----------------------------------------------------------------------------------------- Total minimum lease payments $1,529 ========================================================================================= Rent expense for 1998, 1997 and 1996 amounted to $274,000, $273,000 and $261,000, respectively. 38 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries 13 - COMMITMENTS, CONTINGENT LIABILITIES AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK In the normal course of business, various commitments and contingent liabilities are outstanding, such as guarantees, standby letters of credit, commitments to extend credit and various financial instruments with off-balance-sheet risk that are not reflected in the financial statements. Financial instruments with off-balance-sheet risk involve elements of credit risk, interest rate risk, liquidity risk and market risk. Management does not anticipate any significant losses as a result of these transactions. The following table summarizes the contractual value of financial instruments and other commitments at December 31: (Dollars in Thousands) 1998 1997 =========================================================================================================== Commitments to grant loans $ 9,281 $10,257 Stand-by letters of credit and financial guarantees 1,012 1,022 Commitments to advance funds under existing loan agreements 31,457 29,533 The Corporation uses the same credit policies in making commitment and conditional obligations as it does for on-balance-sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since commitments may be expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. In the normal course of business, certain litigation is pending against the Corporation. Management, after consultation with legal counsel, does not anticipate that any ultimate liability arising out of such litigation will have a material effect on the Corporation's financial condition or results of operations. 14 - OTHER NON-INTEREST EXPENSE The components of other non-interest expense, which are in excess of 1% of the aggregate of total non-interest expense and not shown separately on the consolidated statements of income, are as follows: Years Ended December 31, (Dollars in Thousands) 1998 1997 1996 ====================================================================================== Merger related expenses $595 Professional fees $322 Advertising 385 $350 358 Supplies 324 277 40 15 - STOCKHOLDERS' EQUITY AND REGULATORY MATTERS The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") addresses the legal and regulatory environment for insured depository institutions, including reductions in insurance coverage for certain kinds of deposits, increased supervision by the federal regulatory agencies, increased reporting requirements for insured institutions, and new regulations concerning internal controls, accounting, and operations. Both the Corporation and the Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation's or banking 39 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries subsidiaries' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, a bank must meet specific capital guidelines that involve quantitative measures of a bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. A bank'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 a bank to maintain minimum amounts and ratios (as defined in the regulations) of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. Management believes, as of December 31, 1998, that the Corporation meets all capital adequacy requirements to which it is subject. As of December 31, 1998, the most recent notification from the Federal Deposit Insurance Corporation categorized both Park West and Cargill as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, a bank must maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratios. There are no conditions or events since that notification that management believes have changed the institution's category. The Corporation's, Park West's and Cargill's actual capital amounts and ratios are also presented in the following table: Minimum Capital to be considered well capitalized under Prompt Minimum Capital Corrective Action Actual Adequacy Purposes Provisions (Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio ============================================================================================================================= December 31, 1998 Total Capital (To risk-weighted assets): Park West $27,890 12.20% $18,291 8.00% $22,864 10.00% Cargill 3,475 14.93 1,862 8.00 2,327 10.00 Holding Company 32,946 13.00 20,281 8.00 N/A N/A Tier I Capital (To risk-weighted assets): Park West 25,510 11.16 9,146 4.00 13,718 6.00 Cargill 3,189 13.70 931 4.00 1,396 6.00 Holding Company 30,281 11.94 10,141 4.00 N/A N/A Tier I Capital (To average assets): Park West 25,510 7.24 14,102 4.00 17,628 5.00 Cargill 3,189 6.69 1,907 4.00 2,364 5.00 Holding Company 30,281 7.53 16,092 4.00 N/A N/A December 31, 1997 Total Capital (To risk weighted-assets): Park West 24,535 11.97 16,397 8.00 20,496 10.00 Cargill 3,317 13.10 2,022 8.00 2,528 10.00 Holding Company 29,654 12.77 18,570 8.00 N/A N/A Tier I Capital (To risk weighted-assets) Park West 21,969 10.70 8,198 4.00 12,298 6.00 Cargill 3,108 12.70 1,011 4.00 1,517 6.00 Holding Company 26,858 11.57 9,285 4.00 N/A N/A Tier I Capital (To average assets): Park West 21,969 7.04 12,493 4.00 15,617 5.00 Cargill 3,108 6.60 1,880 4.00 2,350 5.00 Holding Company 26,858 7.44 16,092 4.00 N/A N/A 40 42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries On November 19, 1997, the Board of Directors of the Corporation adopted an Amended and Restated Shareholder Rights Plan (the "Rights Plan"). Pursuant to the terms of the Rights Plan, the Board of Directors declared a dividend distribution to stockholders of record as of the close of business on December 4, 1997 (the "Record Date") of one Preferred Stock Purchase Right (a "Right") for each outstanding share of Common Stock of the Corporation. In addition, one Right automatically attaches to each share of Common Stock issued subsequent to the Record Date, until November 19, 2007. Each Right entitles the registered holder to purchase from the Corporation a unit of one ten-thousandths of a share (a "Unit") of Series A Junior Participating Cumulative Preferred Stock, par value $5.00 per share ("Preferred Stock"), at a cash exercise price of $60.00 per share of Common Stock, subject to adjustment. The Corporation has reserved 12,000 shares of Preferred Stock for issuance upon exercise of the Rights. Currently, the Rights are not exercisable and are attached to and trade with the outstanding shares of Common Stock. The Rights will separate from the Common Stock and become exercisable upon the earliest to occur of (i) the close of business on the tenth calendar day following the first public announcement that a person or group of affiliated or associated persons has acquired beneficial ownership of 15% or more of the outstanding shares of the Corporation's Common Stock (an "Acquiring Person"), (ii) the close of business on the tenth business day (or such date as the Board of Directors may determine) following the commencement of a tender offer or exchange offer that would result upon its consummation in a person or a group becoming the beneficial owner of 15% of the outstanding shares of the Corporation's Common Stock, (iii) the determination by the Board of Directors that any person is an "Adverse Person." Upon the occurrence of any one of the above events, each holder of a Right (other than the Acquiring Person or the Adverse Person, as the case may be) is entitled to acquire such number of Units of the Preferred Stock of the Corporation as are equivalent to such number of shares of Common Stock having a value twice the current exercise price of the Right. If the Corporation is acquired in a merger or other business combination transaction, after any such event each holder of a Right is then entitled to purchase, at the then current exercise price, shares of the acquiring company's common stock having a value of twice the exercise price of the Right. Until a Right is exercised, the holder has no rights as a stockholder of the Corporation (beyond those rights as an existing stockholder), including the right to vote or to receive dividends. While the distribution of the Rights is not taxable to stockholders or to the Corporation, stockholders may, depending upon the circumstances, recognize taxable income in the event the Rights become exercisable for Units, other securities of the Corporation, other consideration or for shares of common stock of an acquiring company. The Rights may be redeemed in whole by the Corporation, under certain circumstances, at a price of $.001 per Right. The Rights and the Rights Plan expire on November 19, 2007. Retained earnings at September 30, 1998, include $458,000 which is set aside in accordance with existing provisions of the Internal Revenue Code to absorb losses on loans. If, in the future, this amount were used for any other purposes, a tax liability could be incurred. It is not anticipated that such amount will be made available for dividends or that a tax thereon will be imposed. Cargill previously converted from a state chartered mutual savings and loan association to a state chartered stock savings and loan association. At the time of conversion, Cargill established a liquidation account in an amount equal to Cargill's net worth. In the event of a complete liquidation of Cargill (and only in such event), each eligible account holder will be entitled to receive a liquidation distribution from the liquidation account before any liquidation distribution may be made with respect to capital stock. The balance in the liquidation account at September 30, 1998, was $85,000. Cargill may not declare or pay a cash dividend on or purchase any of its stock if the effect would be to reduce the net worth of Cargill below either the amount of the liquidation account or the capital requirements of its regulators. 41 43 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries 16 - EMPLOYEE STOCK OWNERSHIP PLAN The Corporation established an Employees' Stock Ownership Plan ("ESOP"). The ESOP has been funded by a $100 contribution from the Corporation. At December 31, 1998 and 1997, the ESOP held no shares of the Corporation's stock. 17 - FAIR VALUE OF FINANCIAL INSTRUMENTS Fair value estimates, methods, and assumptions are set forth below for the Corporation's financial instruments. The following table represents the carrying amount and estimated fair value of the Corporation's financial instruments at December 31: 1998 1997 ========================================================================================================================= Carrying Estimated Carrying Estimated (Dollars in Thousands) Amount Fair Value Amount Fair Value - - -------------------------------------------------------------------------------------------------------------------------- Assets: Cash and due from banks $ 13,171 $ 13,171 $ 12,848 $ 12,848 Federal funds sold 1,069 1,069 3,678 3,678 Investment securities held to maturity 30,616 30,817 39,602 39,771 Investment securities available for sale 53,712 53,712 20,710 20,710 Loans 293,113 301,442 268,254 269,665 Liabilities: Deposits 342,267 343,814 314,679 315,577 Borrowed funds 27,807 27,807 11,884 11,884 CASH AND DUE FROM BANKS AND FEDERAL FUNDS SOLD The carrying amount for cash and due from banks and for federal funds sold approximates fair value and matures in 90 days or less. INVESTMENT SECURITIES The fair value of securities, except certain state and municipal securities, is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. LOANS Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type, such as commercial, commercial real estate, residential mortgage and other consumer. Each loan category is further segmented into fixed and adjustable rate interest terms, and by performing and non-performing categories. The fair value of performing loans, except residential mortgages, is calculated by discounting scheduled cash flows through the estimated maturity, using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Corporation's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. For performing residential mortgage loans, including loans held for sale, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates, using discount rates based on secondary market sources adjusted to reflect differences in servicing and credit costs. Fair value for significant non-performing loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined, using available market information and specific borrower information. DEPOSITS The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, regular savings, NOW accounts and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. 42 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries BORROWED FUNDS The fair value of such borrowings was estimated by utilizing future cash flows discounted using current borrowing rates for similar instruments. For short-term borrowings, the carrying amount approximates the fair value due to their short-term nature. COMMITMENTS TO EXTEND CREDIT The stated value of commitments to extend credit approximates fair value, as the current fees charged for similar commitments does not differ significantly from quoted fees. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. Such differences are not considered significant. 43 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries 18 - SUMMARY OF UNAUDITED QUARTERLY FINANCIAL INFORMATION (Dollars in thousands, except per share amounts) 1998 ---- Q1 (1) Q2 (1) ----------------------------------------- ----------------------------------------- Westbank Cargill Restated Westbank Cargill Restated -------- ------- -------- -------- ------- -------- Interest income $5,842 $880 $6,722 $6,264 $892 $7,156 Interest expense 2,579 419 2,998 2,982 401 3,383 -------------------------------------------------------------------------------------------- Net interest income 3,263 461 3,724 3,282 491 3,773 Provision for losses 19 9 28 12 12 1 Non-interest income 608 8 616 598 43 641 Non-interest expense 2,455 381 2,836 2,458 399 2,857 -------------------------------------------------------------------------------------------- Income before income taxes 1,397 79 1,476 1,422 123 1,545 Income taxes 558 35 593 537 52 589 Net income $ 839 $ 44 $ 883 $ 885 $ 71 $ 956 ============================================================================================ Earnings per share - Basic $ .22 $ .21 $ .24 $ .23 - Diluted .22 .21 .23 .22 ============================================================================================ 1998 ---- Q3 (1) Q4 (1) ----------------------------------------- ------------------------------------------- Westbank Cargill Restated Westbank Cargill Restated -------- ------- -------- -------- ------- -------- Interest income $6,561 $889 $7,450 $6,418 $ 885 $7,303 Interest expense 3,161 416 3,577 2,921 413 3,334 -------------------------------------------------------------------------------------------- Net interest income 3,400 473 3,873 3,497 472 3,969 Provision for losses 1 Non-interest income 542 47 589 496 85 581 Non-interest expense 2,483 355 2,838 2,975 694 3,669 -------------------------------------------------------------------------------------------- Income before income taxes 1,459 165 1,624 1,018 (138) 880 Income taxes 549 70 619 396 (49) 347 -------------------------------------------------------------------------------------------- Net income $ 910 $ 95 $1,005 $ 622 $ (89) $ 533 ============================================================================================ Earnings per share - Basic $ .24 $ .24 $ .16 $ .13 - Diluted .24 .24 .16 .12 ============================================================================================ 1997 ---- Q1 (1) Q2 (1) ----------------------------------------- ----------------------------------------- Westbank Cargill Restated Westbank Cargill Restated -------- ------- -------- -------- ------- -------- Interest income $5,428 $854 $6,282 $5,698 $891 $6,589 Interest expense 2,411 424 2,835 2,534 436 2,970 -------------------------------------------------------------------------------------------- Net interest income 3,017 430 3,447 3,164 455 3,619 Provision for losses 150 31 181 40 10 50 Non-interest income 506 109 615 485 53 538 Non-interest expense 2,293 407 2,700 2,323 437 2,760 -------------------------------------------------------------------------------------------- Income before income taxes 1,080 101 1,181 1,286 61 1,347 Income taxes 443 30 473 549 20 569 -------------------------------------------------------------------------------------------- Net income $ 637 $ 71 $ 708 $ 737 $ 41 $ 778 ============================================================================================ Earnings per share - Basic $ .19 $ .19 $ .22 $ .21 - Diluted .18 .18 .21 .20 ============================================================================================ 1997 ---- Q3 (1) Q4 (1) ----------------------------------------- ------------------------------------------- Westbank Cargill Restated Westbank Cargill Restated -------- ------- -------- -------- ------- -------- Interest income $5,979 $916 $6,895 $6,051 $ 907 $6,958 Interest expense 2,740 429 3,169 2,687 430 3,117 -------------------------------------------------------------------------------------------- Net interest income 3,239 487 3,726 3,364 477 3,841 Provision for losses 75 75 Non-interest income 565 54 619 705 52 757 Non-interest expense 2,397 461 2,858 2,300 448 2,748 -------------------------------------------------------------------------------------------- Income before income taxes 1,407 5 1,412 1,769 81 1,850 Income taxes 589 5 594 730 40 770 ============================================================================================ Net income $ 818 $818 $1,039 $ 41 $1,080 Earnings per share - Basic $ .23 $ .21 $ .29 $ .27 - Diluted .24 .20 .28 .26 ============================================================================================ (1) Previously reported balances of the merged companies have been reclassified to conform to the Corporation's presentation and restated to give effect to the combination. 44 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Westbank Corporation and Subsidiaries 19 - CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS December 31, (Dollars in Thousands) 1998 1997 ==================================================================================== BALANCE SHEETS Assets Cash $ 66 $ 87 Investment in subsidiaries 28,912 25,136 Other investments 922 1,372 Other assets 762 344 - - ------------------------------------------------------------------------------------ Total assets $30,662 $26,939 ==================================================================================== Liabilities $ 172 $ 21 - - ------------------------------------------------------------------------------------ Stockholders' equity Preferred stock - none Common stock, par value $2 per share 8,397 7,865 Additional paid-in capital 11,076 9,711 Retained earnings 10,803 9,282 Accumulated other comprehensive income 214 60 - - ------------------------------------------------------------------------------------ Stockholders' equity 30,490 26,918 - - ------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $30,662 $26,939 1998 1997 1996 ========================================================================================================================== STATEMENTS OF INCOME Dividend from subsidiary $ 100 $ 550 $ 550 Interest income 85 38 19 Other income (expense) - net (735) (144) (143) - - -------------------------------------------------------------------------------------------------------------------------- Income (loss) before taxes and undistributed income of subsidiaries (550) 444 426 Income tax benefit 215 2 26 Undistributed income of subsidiaries 3,712 2,938 1,685 - - -------------------------------------------------------------------------------------------------------------------------- Net income $ 3,377 $ 3,384 $ 2,137 ========================================================================================================================== STATEMENTS OF CASH FLOWS Cash flows from operating activities: Net income $ 3,377 $ 3,384 $ 2,137 Cargill interim loss for quarter ended 12/31/98 (224) Operating activities: Equity in income of subsidiaries (3,622) (2,938) (1,685) Increase in other assets (418) (33) (302) Increase in other liabilities 151 2 19 - - -------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities (736) 415 169 - - -------------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Investment securities (purchases) maturities 450 (1,039) (88) - - -------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Proceeds from stock options exercised 1,141 314 86 Proceeds from dividend reinvestment and optional stock purchases 628 1,385 657 Dividends paid (1,504) (1,041) (786) - - -------------------------------------------------------------------------------------------------------------------------- Net cash (used in) provided by financing activities 265 658 (43) - - -------------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (21) 34 38 Cash and cash equivalents at the beginning of the year 87 53 15 - - -------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at the end of the year $ 66 $ 87 $ 53 ========================================================================================================================== 45 47 INDEPENDENT AUDITORS' REPORT Westbank Corporation and Subsidiaries Shareholders and Board of Directors, Westbank Corporation We have audited the consolidated balance sheets of Westbank Corporation and subsidiaries (the "Corporation") as of December 31, 1998 and 1997 and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements give retroactive effect to the merger on January 29, 1999 of Cargill Bancorp, Inc., and subsidiary and Westbank Corporation and subsidiaries, which has been accounted for as a pooling of interests as described in Note 1 to the consolidated financial statements. We did not audit the consolidated balance sheets of Cargill Bancorp, Inc., as of September 30, 1998 and 1997, or the related statements of income, comprehensive income, stockholders' equity and cash flows of Cargill Bancorp, Inc., for each of the three years in the period ended September 30, 1998, which statements reflect total assets of $48,241,000 and $47,302,000 as of September 30, 1998 and 1997, and net interest income of $1,897,000, 1,849,000 and $1,693,000 for the years ended September 30, 1998, 1997 and 1996, respectively. Those statements were audited by other auditors whose report dated October 30, 1998 has been furnished to us and our opinion, insofar as it relates to the amounts included for Cargill Bancorp, Inc., and subsidiary for 1998, 1997 and 1996 is based solely on the report of such other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, such consolidated financial statements present fairly, in all material respects, the financial position of Westbank Corporation and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Hartford, Connecticut January 29, 1999 (July 30, 1999 as to effects of the merger described in Note 1) 46 48 INDEPENDENT AUDITORS' REPORT Westbank Corporation and Subsidiaries Shareholders and Board of Directors, Cargill Bancorp, Inc. We have audited the consolidated statements of financial condition of Cargill Bancorp, Inc., and subsidiary as of September 30, 1998 and 1997, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity and cash flows for the years ended September 3, 1998, 1997 and 1996. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements, based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used, and significant estimates made, by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cargill Bancorp, Inc., and subsidiary as of September 30, 1998 and 1997, and the results of its operations and its cash flows for the years ended September 30, 1998, 1997 and 1996, in conformity with generally accepted accounting principles. SNYDER & HALLER Hartford, Connecticut October 30, 1998 47 49 CORPORATE DIRECTORY AND INFORMATION Westbank Corporation and Subsidiaries DIRECTORS WESTBANK CORPORATION AND PARK WEST BANK AND TRUST COMPANY ERNEST N. LAFLAMME, JR. Chairman of the Board Westbank Corporation Treasurer City of Chicopee ROLAND O. ARCHAMBAULT Owner Park Supply Company MARK A. BEAUREGARD Attorney at Law Resnic, Beauregard, Waite & Driscoll DAVID R. CHAMBERLAND President Chicopee Building Supply, Inc. DONALD R. CHASE President and Chief Executive Officer Westbank Corporation President and Chief Executive Officer Park West Bank and Trust Company LEROY F. JARRETT President and Treasurer (Retired) New England Church Interiors G. WAYNE MCCARY President & CEO Eastern States Exposition ROBERT J. PERLAK Private Investor GEORGE R. SULLIVAN Executive Vice President Sullivan Paper Company, Inc. JAMES E. TREMBLE President Valley Cinema, Inc. OFFICERS WESTBANK CORPORATION ERNEST N. LAFLAMME, JR. Chairman of the Board DONALD R. CHASE President and Chief Executive Officer JOHN M. LILLY Treasurer and Chief Financial Officer ROBERT J. PERLAK Corporate Clerk PARK WEST BANK AND TRUST COMPANY DONALD R. CHASE President and Chief Executive Officer ROBERT J. PERLAK Corporate Clerk FINANCE DIVISION JOHN M. LILLY Executive Vice President and Treasurer IRVING M. WALKER, JR., CMA Accounting Officer LOAN DIVISION GARY L. BRIGGS Executive Vice President PAUL M. ACCORSI Senior Vice President DAVID M. BARSZCZ Vice President CLIFFORD R. BORDEAUX Assistant Vice President GERARD E. DRAPEAU VICE President RICHARD N. HANCHETT Vice President MICHAEL M. LEFEBVRE Vice President JOSEPH S. LEMAY Assistant Vice President JOHN E. O'BRIEN Loan Operations Officer RESIDENTIAL REAL ESTATE STANLEY F. OSOWSKI Senior Vice President WOLFGANG A. ADAMETZ Vice President LOAN CREDIT & COLLECTION TRENTON E. TAYLOR Senior Vice President PATRICIA A. NABOSKY Assistant Vice President EDP/OPERATIONS S. STEVE KONIECKI Senior Vice President MARKETING JOSEPH L. ROLAK Director of Marketing and Vice President COMPLIANCE JANE M. KNAPP Vice President BRANCH ADMINISTRATION/ HUMAN RESOURCES KATHLEEN A. JALBERT Senior Vice President DEBORAH A. KUMIEGA Assistant Vice President GARY B. SZYMANIAK COMMUNITY BANKING OFFICER AUDITING DIVISION LLOYD S. HALL, CBA Director of Auditing TRUST DIVISION ROBERT A. GIBOWICZ Senior Trust Officer Westbank Corporation Westbank Tower, 225 Park Avenue West Springfield, MA 01089-3310 (413) 747-1400 48 50 Annual Meeting The Annual Meeting of Stockholders of Westbank Corporation will be held on Wednesday, April 21, 1999 at nine o'clock in the morning at the Carriage House at Storrowton Tavern, 1305 Memorial Avenue, West Springfield, Massachusetts. TRANSFER AGENT AND REGISTRAR Park West Bank and Trust Company -- Trust Department INDEPENDENT AUDITORS Deloitte & Touche, LLP Hartford, Connecticut CORPORATE COUNSEL Doherty, Wallace, Pillsbury and Murphy, P.C. Springfield, Massachusetts INFORMATION SERVICE Westbank Corporation welcomes stockholder and public interest in our services and activities. Questions pertaining to material presented in this Report and requests for a copy of the Annual Report (Form 10-K) filed with the Securities and Exchange Commission should be directed to John M. Lilly, Treasurer and Chief Financial Officer, at the above address COMMON STOCK - MARKET INFORMATION The table below shows cash dividend data and the range of bid prices by quarter for the Corporation's common stock. The source of the bid ranges is the local newspaper's listing of the NASD regional market quotations: 1998 1997 Bid Bid High Low Dividend High Low Dividend - - ------------------------------------------------------------------------------------ First $17 1/4 $12 $0.10 $10 $8 3/4 $0.075 Second 16 5/8 13 7/8 0.10 9 1/2 8 -1/2 0.075 Third 14 3/4 10 3/8 0.10 11 8 5/8 0.075 Fourth 13 9 3/8 0.10 13 5/8 10 5/8 0.075 The above quotations of the Corporation's common stock represent prices between dealers. They do not include retail markup, markdown or commissions. At January 31, 1999 the Corporation had 1,202 stockholders. Westbank Corporation's common stock is traded on the NASDAQ National Market Exchange, the trading symbol is "WBKC". For information on the Westbank Corporation Dividend Reinvestment and Stock Purchase Plan, call: Park West Bank and Trust Company, Trust Department (413) 747-1482. The following firms make a market in Westbank Corporation's Common Stock: Advest, Inc. First Albany Corporation McConnell, Budd & Downes, Inc. Keefe, Bruyette & Woods, Inc. CORPORATE COUNSEL EQUAL OPPORTUNITY EMPLOYER The Corporation has maintained its commitment to equal opportunity and affirmative action in employment and personnel policies and pledges to recruit, hire, train and promote persons in all job classifications without regard to race, color, religion, sex, national origin, veterans status, age or handicap. 49