- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [XAnnual]report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 1997 or [_Transition]report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 COMMISSION FILE NUMBER: 000-20809 ---------------- SIS BANCORP, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) ---------------- MASSACHUSETTS 04-3303264 (I.R.S. EMPLOYER IDENTIFICATION NO.) (STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) 1441 MAIN STREET 01102 SPRINGFIELD, MASSACHUSETTS (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (413) 748-8000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $0.01 PER SHARE TITLE OF EACH CLASS Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant, based on the closing sale price of March 6, 1998, as reported by NASDAQ, was $267,882,500. Indicate the number of shares outstanding of the registrant's common stock, as of the latest practicable date: 6,957,987 shares as of March 6, 1998. DOCUMENTS INCORPORATED BY REFERENCE Portions of the SIS Bancorp, Inc. Proxy Statement for the Annual Meeting of Stockholders to be held on May 7, 1998 are incorporated by reference into Part III of this Form 10-K. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- CAUTIONARY STATEMENT FOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This Report contains certain "forward-looking statements" including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact. SIS Bancorp, Inc. and its subsidiaries (the "Company") wishes to caution readers that the following important factors, among others, may have affected and could in the future affect the Company's actual results and could cause the Company's actual results for subsequent periods to differ materially from those expressed in any forward-looking statement made by or on behalf of the Company herein: (i) the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which the Company must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board; (iii) the effect on the Company's competitive position within its market area of the increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as nonbank providers of various financial services; (iv) the effect of changes in interest rates; (v) the effect of changes in the business cycle and downturns in the local, regional or national economies; (vi) the effect of the "year 2000" issue (i.e. that current computer programs use only two digits to identify a year in the date field and cannot reflect a change in the century) on the Company's financial condition or results of operations; and (vii) the impact of pending litigation on the Company's financial condition or results of operations. 2 PART I ITEM 1: BUSINESS OVERVIEW SIS Bancorp, Inc. (the "Company") is a Massachusetts corporation formed in 1996 and serves as the bank holding company for Springfield Institution for Savings ("SIS Bank"), and Glastonbury Bank and Trust Company ("GBT"). The Company was formed for the purpose of reorganizing SIS Bank into a holding company structure ("the Reorganization"). Upon the effectiveness of the Reorganization, SIS Bank became the wholly owned subsidiary of the Company and SIS Bank's former stockholders became stockholders of the Company. The Company acquired GBT on December 17, 1997. Established in 1827, SIS Bank is a Massachusetts chartered stock savings bank headquartered in Springfield, Massachusetts. GBT, with its headquarters located in Glastonbury, Connecticut, is a Connecticut chartered commercial bank founded in 1919. Substantially all of the Company's operations are conducted through its subsidiary banks. The Company provides a wide variety of financial services through both SIS Bank and GBT (the "Banks"), including retail and commercial banking, residential mortgage origination and servicing, commercial and consumer lending, merchant processing and insurance sales. The Banks serve the consumers and businesses located in western Massachusetts and central Connecticut through a network of 34 full service branches. The Company's revenues are derived principally from dividend payments received from the Banks, which in turn derive their revenues principally from interest payments on their loan portfolios and mortgage-backed and other investment securities. The Banks' primary sources of funds are deposits, borrowings and principal and interest payments on loans and mortgage-backed securities. RECENT DEVELOPMENTS On August 18, 1997, the Company and GBT signed an Agreement and Plan of Reorganization, under which the Company acquired all of the outstanding shares of GBT (the "Merger"). The Merger was completed on December 17, 1997. As a result of the Merger, GBT became a wholly owned subsidiary of the Company. The Merger resulted in the exchange of 0.74 of a share of the Company's common stock for each of GBT's 1,829,920 shares of common stock and was treated as a pooling of interests for accounting purposes. Accordingly, the Company's historical financial statements have been restated to reflect the combination with GBT. INVESTMENT ACTIVITIES The Company engages in investment activities for both investment and liquidity purposes. The Company maintains an investment securities portfolio which consists primarily of U.S. Government and agency securities, corporate obligations, asset-backed securities, collateralized mortgage obligations, Federal Home Loan Bank stock, and marketable equity securities. Other short- term investments held by the Company periodically include interest-bearing deposits, money market mutual funds and federal funds sold. The Company also maintains a mortgage-backed securities portfolio consisting of securities issued and guaranteed by the Federal National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC") in addition to publicly traded and rated mortgage-backed securities issued by private financial intermediaries which are rated "AA" or higher by rating agencies of national prominence. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, investment securities which the Company has the intent and ability to hold until maturity are classified as held to maturity and are carried at amortized cost, while those securities which have been identified as assets that may be sold prior to maturity or assets for which there is not a positive intent to hold to maturity are classified as available for sale and are carried at fair value, with unrealized gains and losses excluded from earnings and reported net of tax as a separate component of stockholders' equity. 3 Securities classified as trading represent short-term investments held for sale at GBT. These securities are carried at market value. When sales occur, gains or losses are recognized using market prices at the time of sale. Concurrent with the merger with GBT, the Company liquidated its trading portfolio. Accordingly, the Company has zero and $0.5 million of securities classified as trading at December 31, 1997 and 1996, respectively. The following table sets forth certain information regarding the amortized cost and fair value of the Company's investment portfolio at the dates indicated. DECEMBER 31, 1997 ----------------------------------------- AVAILABLE FOR SALE HELD TO MATURITY -------------------- -------------------- (DOLLARS IN THOUSANDS) AMORTIZED AMORTIZED COST FAIR VALUE COST FAIR VALUE --------- ---------- --------- ---------- U.S. government and agency obligations........................ $ 15,608 $ 15,636 $ 2,400 $ 2,391 Collateralized mortgage obligations........................ 51,273 51,415 2,934 2,953 Mortgage-backed securities.......... 458,659 460,478 141,282 141,563 Asset backed securities............. -- -- 46,046 46,143 State and Municipal bonds........... 8,966 9,355 -- -- Other bonds and short term obligations........................ -- -- 345 346 Federal Home Loan Bank and other stock.............................. 38,128 39,224 -- -- -------- -------- -------- -------- Total............................. $572,634 $576,108 $193,007 $193,396 ======== ======== ======== ======== DECEMBER 31, 1996 ----------------------------------------- AVAILABLE FOR SALE HELD TO MATURITY -------------------- -------------------- (DOLLARS IN THOUSANDS) AMORTIZED AMORTIZED COST FAIR VALUE COST FAIR VALUE --------- ---------- --------- ---------- U.S. government and agency obligations........................ $ 31,458 $ 31,460 $ 7,932 $ 7,827 Collateralized mortgage obligations........................ 43,337 43,220 5,062 5,206 Mortgage-backed securities.......... 387,467 389,597 164,934 164,111 Asset backed securities............. -- -- 42,118 42,165 State and Municipal bonds........... 855 857 185 185 Other bonds and short term obligations........................ 1,681 1,681 415 417 Federal Home Loan Bank and other stock.............................. 16,601 16,799 -- -- -------- -------- -------- -------- Total............................. $481,399 $483,614 $220,646 $219,911 ======== ======== ======== ======== DECEMBER 31, 1995 ----------------------------------------- AVAILABLE FOR SALE HELD TO MATURITY -------------------- -------------------- (DOLLARS IN THOUSANDS) AMORTIZED AMORTIZED COST FAIR VALUE COST FAIR VALUE --------- ---------- --------- ---------- U.S. government and agency obligations........................ $ 15,528 $ 15,527 $ 5,434 $ 5,404 Collateralized mortgage obligations........................ 9,152 9,057 5,160 5,408 Mortgage-backed securities.......... 239,510 240,995 179,122 179,592 State and Municipal bonds........... -- -- 190 190 Other bonds and short term obligations........................ 9,300 9,300 12,156 11,979 Federal Home Loan Bank and other stock.............................. 7,907 7,907 -- -- -------- -------- -------- -------- Total............................. $281,397 $282,786 $202,062 $202,573 ======== ======== ======== ======== The Company's investment portfolio increased $64.8 million from $704.3 million at December 31, 1996 to $769.1 million at December 31, 1997. This increase in investments was funded through an increase in deposits and borrowings. 4 In 1995, the Financial Accounting Standards Board ("FASB") issued a special report, "Implementation of Statement 115," that provided additional guidance related to the application of SFAS 115. In connection with the issuance of this special report, the FASB allowed all organizations to review their portfolio classifications and make a one-time reclassification of securities between categories during the period from November 15, 1995 to December 15, 1995. On December 15, 1995, the Company transferred securities with an amortized cost of $94.7 million and an unrealized loss of $1.1 million from the held to maturity portfolio to the available for sale portfolio. In addition, the Company also transferred securities with an estimated fair value of $47.3 million and an unrealized gain of $0.3 million from the available for sale portfolio to the held to maturity portfolio. The remaining unrealized gain of $0.1 million remains as a separate component of stockholders' equity. Subsequent to the transfer of these securities, the Company sold $82.9 million of available for sale securities in December, 1995 at a net loss of $0.9 million. In December, 1997 in connection with the acquisition of GBT, the Company sold $20.6 million in investments from the held to maturity and available for sale portfolios in order to maintain its existing interest rate position. However, the Company generally intends to hold to maturity its debt and equity securities which are so classified. The Company realized a net loss of $0.3 million related to these sales. The following table sets forth the contractual maturity distribution of the carrying value and the weighted average yields of the investment portfolio at December 31, 1997. Certain of the investments are subject to early repayment at the option of the issuer. Accordingly, changes in interest rates may affect actual maturities. WITHIN ONE YEAR 1--5 YEARS 5--10 YEARS OVER 10 YEARS ------------------ ------------------ ------------------ ------------------ WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AVERAGE COST YIELD COST YIELD COST YIELD COST YIELD TOTAL YIELD --------- -------- --------- -------- --------- -------- --------- -------- -------- -------- AVAILABLE FOR SALE U.S. government and agency obligations..... $-- -- $ 5,507 6.73% $10,101 6.77% $ -- -- $ 15,608 6.76% Collateral mortgage obligations............ -- -- 23,345 6.58% 3,505 6.37% 24,423 6.82% 51,273 6.68% Mortgage-backed securities............. -- -- 1,986 8.20% 1,803 7.52% 454,870 7.17% 458,659 7.18% Asset-backed securities............. -- -- -- -- -- -- -- -- -- -- State and Municipal bonds.................. -- -- -- -- -- -- 8,966 5.28% 8,966 5.28% ---- ------- ------- -------- -------- Total.................. $-- -- $30,838 6.71% $15,409 6.77% $488,259 7.12% $534,506 7.09% Market Value........... $-- $30,962 $15,498 $490,424 $536,884 HELD TO MATURITY U.S. government and agency obligations..... $-- -- $ -- -- $ 2,400 6.67% $ -- -- $ 2,400 6.67% Collateral mortgage obligations............ -- -- -- -- 850 7.26% 2,084 7.14% 2,934 7.17% Mortgage-backed securities............. -- -- 6,493 6.78% 4,218 7.27% 130,571 7.14% 141,282 7.13% Asset-backed securities............. -- -- -- -- 3,295 8.12% 42,751 6.86% 46,046 6.95% State and Municipal bonds.................. 5 5.50% 65 7.51% 75 6.78% -- -- 145 7.06% Other bonds and short term obligations....... 100 5.00% -- -- 100 8.40% -- -- 200 6.70% ---- ------- ------- -------- -------- Total.................. $105 5.02% $ 6,558 6.79% $10,938 7.40% $175,406 7.07% $193,007 7.08% Market Value........... $105 $ 6,561 $10,972 $175,758 $193,396 5 As of December 31, 1997, approximately 95.8% of mortgage-backed securities available for sale and 67.1% of mortgage-backed securities held to maturity were adjustable rate. LENDING ACTIVITIES Gross loans comprised $849.5 million or 49.0% of total assets at December 31, 1997, compared to $774.1 million or 48.5% of total assets at December 31, 1996. The following table sets forth information concerning the Company's loan portfolio in dollar amounts and percentages, by type of loan at December 31, 1997, 1996, 1995, 1994, and 1993, respectively. DECEMBER 31, -------------------------------------------------------------- 1997 1996 1995 -------------------- -------------------- -------------------- PERCENT OF PERCENT OF PERCENT OF AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL -------- ---------- -------- ---------- -------- ---------- (DOLLARS IN THOUSANDS) Residential real estate loans.................. $281,457 33.13% $295,503 38.18% $314,331 43.94% Commercial real estate loans.................. 185,226 21.80% 171,744 22.19% 170,145 23.79% Commercial loans........ 212,869 25.06% 179,705 23.21% 141,215 19.74% Home equity loans....... 158,753 18.69% 118,235 15.27% 78,823 11.02% Consumer loans.......... 11,189 1.32% 8,920 1.15% 10,830 1.51% -------- ------ -------- ------ -------- ------ Total loans receivable, gross.. 849,494 100.00% 774,107 100.00% 715,344 100.00% -------- ------ -------- ------ -------- ------ Less: Unearned income and fees................. (1,991) (820) (270) Allowance for loan losses............... 22,724 19,549 18,612 -------- -------- -------- Total loans receivable, net.... $828,761 $755,378 $697,002 ======== ======== ======== DECEMBER 31, --------------------------------------- 1994 1993 ------------------- ------------------- PERCENT OF PERCENT OF AMOUNT TOTAL AMOUNT TOTAL -------- ---------- -------- ---------- (DOLLARS IN THOUSANDS) Residential real estate loans........... $296,256 45.96% $305,361 38.71% Commercial real estate loans............ 179,007 27.77% 288,336 36.55% Commercial loans........................ 104,220 16.17% 142,422 18.05% Home equity loans....................... 55,071 8.54% 37,332 4.73% Consumer loans.......................... 10,050 1.56% 15,445 1.96% -------- ------ -------- ------ Total loans receivable, gross....... 644,604 100.00% 788,896 100.00% -------- ------ -------- ------ Less: Unearned income and fees.............. 388 1,526 Allowance for loan losses............. 20,918 23,488 -------- -------- Total loans receivable, net......... $623,298 $763,882 ======== ======== 6 MATURITY OF LOAN PORTFOLIO The following table sets forth the Company's loan portfolio, before allowance for loan losses and unearned discounts, based on contractual maturities. The table does not consider prepayment assumptions. Principal amortization is included based on scheduled payments. Demand loans, and loans having no stated schedule of repayment and no stated maturity are reported as due within one year. Actual maturities may be significantly shorter due to changes in interest rates and economic conditions. DECEMBER 31, 1997 --------------------------------------- LESS THAN 1 YEAR MORE THAN 1 YEAR TO 5 YEARS 5 YEARS TOTAL --------- ---------- --------- -------- (DOLLARS IN THOUSANDS) Fixed rate loans (1): Residential real estate............... $ 2,067 $ 3,988 $ 63,096 $ 69,151 Commercial real estate................ 5,146 32,705 23,758 61,609 Commercial............................ 4,101 39,216 23,022 66,339 Home equity........................... 106 7,335 27,500 34,941 Consumer.............................. 4,880 3,888 566 9,334 ------- -------- -------- -------- Total fixed rate loans.............. 16,300 87,132 137,942 241,374 ------- -------- -------- -------- Adjustable rate loans (1): Residential real estate............... 3,003 1,493 207,810 212,306 Commercial real estate................ 14,025 25,997 83,595 123,617 Commercial............................ 43,748 38,876 63,906 146,530 Home equity........................... 398 2,831 120,583 123,812 Consumer.............................. 128 134 1,593 1,855 ------- -------- -------- -------- Total adjustable rate loans......... 61,302 69,331 477,487 608,120 ------- -------- -------- -------- Total amounts due................... $77,602 $156,463 $615,429 $849,494 ======= ======== ======== ======== - -------- (1) Includes non-accrual loans. DELINQUENCY The following table sets forth a summary of the Company's delinquent loans at December 31, 1997, 1996, 1995, 1994, and 1993: DECEMBER 31, 1997 --------------------------------- 60-89 DAYS 90 DAYS OR MORE ---------------- ---------------- NUMBER PRINCIPAL NUMBER PRINCIPAL OF BALANCE OF BALANCE LOANS OF LOANS LOANS OF LOANS ------ --------- ------ --------- Residential real estate loans............. 12 $ 603 34 $1,698 Commercial real estate loans.............. 2 565 2 397 Commercial loans.......................... 8 1,214 9 1,247 Home equity loans......................... 7 192 5 77 Consumer loans............................ 126 103 79 59 --- ------ --- ------ Total delinquent loans................ 155 $2,677 129 $3,478 === ====== === ====== Delinquent loans to total gross loans..... 0.32% 0.41% 7 DECEMBER 31, 1996 --------------------------------- 60-89 DAYS 90 DAYS OR MORE ---------------- ---------------- NUMBER PRINCIPAL NUMBER PRINCIPAL OF BALANCE OF BALANCE LOANS OF LOANS LOANS OF LOANS ------ --------- ------ --------- Residential real estate loans............. 39 $1,782 44 $ 2,773 Commercial real estate loans.............. 1 139 5 1,057 Commercial loans.......................... 7 317 13 1,121 Home equity loans......................... 5 140 7 189 Consumer loans............................ 95 89 68 37 --- ------ --- ------- Total delinquent loans................ 147 $2,467 137 $ 5,177 === ====== === ======= Delinquent loans to total gross loans..... 0.32% 0.67% DECEMBER 31, 1995 --------------------------------- 60-89 DAYS 90 DAYS OR MORE ---------------- ---------------- NUMBER PRINCIPAL NUMBER PRINCIPAL OF BALANCE OF BALANCE LOANS OF LOANS LOANS OF LOANS ------ --------- ------ --------- Residential real estate loans............. 41 $2,603 77 $ 3,184 Commercial real estate loans.............. 3 250 21 2,246 Commercial loans.......................... 9 593 10 419 Home equity loans......................... 6 177 8 73 Consumer loans............................ 25 17 12 14 --- ------ --- ------- Total delinquent loans................ 84 $3,640 128 $ 5,936 === ====== === ======= Delinquent loans to total gross loans..... 0.51% 0.83% DECEMBER 31, 1994 --------------------------------- 60-89 DAYS 90 DAYS OR MORE ---------------- ---------------- NUMBER PRINCIPAL NUMBER PRINCIPAL OF BALANCE OF BALANCE LOANS OF LOANS LOANS OF LOANS ------ --------- ------ --------- Residential real estate loans............. 28 $1,447 70 $ 3,577 Commercial real estate loans.............. 1 129 6 2,150 Commercial loans.......................... 5 368 13 1,577 Home equity loans......................... 10 195 18 419 Consumer loans............................ 45 64 31 65 --- ------ --- ------- Total delinquent loans................ 89 $2,203 138 $ 7,788 === ====== === ======= Delinquent loans to total gross loans..... 0.34% 1.21% DECEMBER 31, 1993 --------------------------------- 60-89 DAYS 90 DAYS OR MORE ---------------- ---------------- NUMBER PRINCIPAL NUMBER PRINCIPAL OF BALANCE OF BALANCE LOANS OF LOANS LOANS OF LOANS ------ --------- ------ --------- Residential real estate loans............. 42 $1,655 111 $ 9,611 Commercial real estate loans.............. 5 5,066 8 5,976 Commercial loans.......................... 30 1,386 52 6,893 Home equity loans......................... 9 183 20 571 Consumer loans............................ 82 131 153 167 --- ------ --- ------- Total delinquent loans................ 168 $8,421 344 $23,218 === ====== === ======= Delinquent loans to total gross loans..... 1.07% 2.94% 8 ALLOWANCE FOR LOAN LOSSES The allowance for possible loan losses reflects an amount that in management's judgment is adequate to provide for potential losses in the loan portfolio. In addition, examinations of the adequacy of the loan loss reserve are conducted periodically by various regulatory agencies. The Company's loan loss reserve methodology emphasizes an evaluation of non- performing loans and those loans that have been identified as having a higher risk of becoming non-performing loans. The overall analysis is a continuing process that gives consideration to such factors as size and risk characteristics of the loan portfolio, the risk rating of individual credits, general economic conditions, historical delinquency and charge-off experience, the borrowers' financial capabilities and the underlying collateral, including, when appropriate, independent appraisals of real estate properties. In addition, management periodically reviews the methodology of allocating reserves to the various loan categories based on similar factors. The Company's allowance for possible loan losses is decreased by loan charge-offs and increased by provisions for possible loan losses and recoveries on loans previously charged-off. When commercial and residential real estate loans are foreclosed, the loan balance is compared with the fair value of the property. If the net carrying value of the loan at the time of foreclosure exceeds the fair value of the property less estimated selling costs, the difference is charged to the allowance for possible loan losses and the fair value of the property becomes the new cost basis of the real estate owned. The Company has or obtains current appraisals on real estate owned at the time it obtains possession of the property. Real estate owned is subsequently carried at the lower of cost or fair value less estimated selling costs with any further adjustments reflected as a charge against operations. The Company assesses the value of real estate owned on a periodic basis. 9 The allowance for possible loan losses at December 31, 1997 was $22.7 million, compared to $19.5 million at December 31, 1996. The activity in the allowance for possible loan losses for the fiscal years ended December 31, 1997, 1996, 1995, 1994, and 1993 is set forth in the following table: FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------ 1997 1996 1995 1994 1993 ------- ------- ------- -------- -------- (DOLLARS IN THOUSANDS) Balance, beginning of period.................... $19,549 $18,612 $20,918 $ 23,488 $ 16,952 Provision for loan losses.. 1,895 3,721 6,262 27,728 19,881 Charge-offs: Residential real estate loans................... (427) (915) (710) (4,661) (2,558) Commercial real estate loans................... (740) (3,220) (4,875) (21,275) (4,946) Commercial loans......... (617) (545) (3,864) (7,137) (6,678) Home equity loans........ (153) (235) (51) (124) (215) Consumer loans........... (266) (144) (225) (314) (484) Merchant processing...... (9) (93) (31) (19) (90) ------- ------- ------- -------- -------- Total charge-offs...... (2,212) (5,152) (9,756) (33,530) (14,971) Recoveries: Residential real estate loans................... 21 742 -- 460 242 Commercial real estate loans................... 2,901 1,119 517 1,317 559 Commercial loans......... 428 349 491 1,274 667 Home equity loans........ 90 106 82 79 47 Consumer loans........... 52 52 98 102 111 Merchant processing...... -- -- -- -- -- ------- ------- ------- -------- -------- Total recoveries....... 3,492 2,368 1,188 3,232 1,626 ------- ------- ------- -------- -------- Net recoveries (charge- offs)..................... 1,280 (2,784) (8,568) (30,298) (13,345) Balance, end of period..... $22,724 $19,549 $18,612 $ 20,918 $ 23,488 ======= ======= ======= ======== ======== Ratio of net loan recoveries (charge-offs) during the period to average loans outstanding during the period......... 0.16% (0.38)% (1.26)% (4.27)% (1.54)% Ratio of allowance for possible loan losses to total loans at the end of the period................ 2.68% 2.53% 2.60% 3.25% 2.98% Ratio of allowance for possible loan losses to non-performing loans at the end of the period..... 392.94% 231.65% 179.70% 111.32% 38.47% Effective January 1, 1995, the Company adopted SFAS No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS 114"). At December 31, 1997, the recorded investment in loans that are considered impaired under SFAS 114 was $5.3 million as compared to $8.0 million at December 31, 1996. Included in this amount as of December 31, 1997 is $2.0 million of impaired loans for which the related SFAS 114 allowance is $0.4 million and $3.3 million of impaired loans for which the SFAS 114 allowance is zero. At December 31, 1996 there were $2.9 million of impaired loans for which the related SFAS 114 allowance was $0.2 million and $5.2 million of impaired loans for which the SFAS 114 allowance was zero. The average recorded investment in impaired loans during the year ended December 31, 1997 was approximately $9.0 million as compared to $9.7 million at December 31, 1996. For the years ended December 31, 1997 and 1996, the Company recognized interest income on these impaired loans of $0.5 million and $0.3 million, respectively. 10 The following table shows the allocation of the allowance for loan losses to various types of loans. DECEMBER 31, ----------------------------------------------------------------- 1997 1996 1995 --------------------- --------------------- --------------------- % OF % OF % OF TOTAL TOTAL TOTAL ALLOWANCE FOR ALLOWANCE FOR ALLOWANCE FOR AMOUNT LOAN LOSSES AMOUNT LOAN LOSSES AMOUNT LOAN LOSSES ------- ------------- ------- ------------- ------- ------------- (DOLLARS IN THOUSANDS) Residential real estate loans.................. $ 3,664 16.12% $ 2,237 11.44% $ 2,499 13.43% Commercial real estate loans.................. 5,632 24.78% 7,729 39.54% 8,540 45.88% Commercial loans........ 8,328 36.65% 7,145 36.55% 5,852 31.44% Home equity loans....... 3,183 14.01% 1,417 7.25% 863 4.64% Consumer loans.......... 1,274 5.61% 421 2.15% 261 1.40% Merchant processing..... 643 2.83% 600 3.07% 597 3.21% ------- ------ ------- ------ ------- ------ Total allowance for loan losses........... $22,724 100.00% $19,549 100.00% $18,612 100.00% ======= ====== ======= ====== ======= ====== DECEMBER 31, ------------------------------------------- 1994 1993 --------------------- --------------------- % OF % OF TOTAL TOTAL ALLOWANCE FOR ALLOWANCE FOR AMOUNT LOAN LOSSES AMOUNT LOAN LOSSES ------- ------------- ------- ------------- (DOLLARS IN THOUSANDS) Residential real estate loans....... $ 5,298 25.33% $ 2,916 12.41% Commercial real estate loans........ 9,860 47.14% 13,317 56.70% Commercial loans.................... 3,656 17.48% 6,189 26.35% Home equity loans................... 1,190 5.69% 418 1.78% Consumer loans...................... 357 1.71% 269 1.15% Merchant processing................. 557 2.65% 379 1.61% ------- ------ ------- ------ Total allowance for loan losses.... $20,918 100.00% $23,488 100.00% ======= ====== ======= ====== DEPOSIT DISTRIBUTION The principal source of funds for the Company are deposits from local consumers and businesses. There were no brokered deposits at December 31, 1997. The Company's deposits consist of demand and NOW accounts, passbook and statement savings accounts, money market accounts and time deposit accounts. Total deposits were $1.3 billion at December 31, 1997 compared to $1.2 billion at December 31, 1996, an increase of $89.7 million. This growth occurred primarily in demand deposits, savings accounts, and time deposits. From December 31, 1996 to December 31, 1997, the Company's consumer demand deposit balances increased by $27.5 million as customers continue to take advantage of free checking accounts offered as part of the Company's consumer deposit strategy to attract and retain core deposits, which is intended to provide the Company with a lower cost source of funds. In addition, the Company's commercial demand deposit balances increased by $7.9 million from December 31, 1996 to December 31, 1997 reflecting growth in the Company's commercial customer base. The Company's savings account balances increased $10.1 million from December 31, 1996 to December 31, 1997 as a result of the consumer deposit strategy. From December 31, 1996 to December 31, 1997, the Company's time deposit balances have increased $33.6 million, largely as the result of the introduction of new CD products as well as growth in time deposits with local municipalities. 11 The following table sets forth the distribution of the Company's deposit accounts for each of the three years ended December 31, 1997, 1996 and 1995. DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 ------------------ ------------------ ------------------ PERCENT PERCENT PERCENT OF OF OF AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL ---------- ------- ---------- ------- ---------- ------- (DOLLARS IN THOUSANDS) Demand deposits......... $ 171,343 13.52% $ 135,965 11.55% $ 104,023 9.67% NOW accounts (1)........ 51,412 4.06% 81,943 6.96% 79,488 7.39% Money manager accounts (1).................... 39,447 3.11% -- 0.00% -- 0.00% Savings accounts........ 263,449 20.79% 253,358 21.52% 236,724 22.01% Money market accounts... 211,286 16.67% 209,523 17.79% 212,560 19.77% Time deposits........... 530,361 41.85% 496,772 42.18% 442,561 41.16% ---------- ------ ---------- ------ ---------- ------ Total deposits......... $1,267,298 100.00% $1,177,561 100.00% $1,075,356 100.00% ========== ====== ========== ====== ========== ====== - -------- (1) During July 1997, the Company implemented a program which converted certain NOW accounts to money manager accounts. This program has no effect on the Company's depositors, but has provided additional investable funds to the Company by substantially reducing the reserve balances required to be maintained at the Federal Reserve Bank of Boston. The Company does not actively solicit Time deposit accounts of $100,000 or more. The following table sets forth the remaining contractual maturities of the Company's portfolio of Time deposits in amounts of $100,000 or greater at December 31, 1997. DECEMBER 31, 1997 ---------------------- (DOLLARS IN THOUSANDS) Three months or less................................ $53,111 Over three through six months....................... 10,554 Over six through 12 months.......................... 15,782 Over 12 months...................................... 7,966 ------- Total........................................... $87,413 ======= BORROWINGS Deposits are the primary source of funds for the Company. However, the Company is able to borrow from the Federal Home Loan Bank ("FHLB") of Boston and can enter into repurchase agreements. At December 31, 1997, the Company's total outstanding FHLB advances were $184.1 million compared to $89.5 million at December 31, 1996. Repurchase agreements were $113.3 million at December 31, 1997 compared to $176.9 million at December 31, 1996. COMPETITION Vigorous competition exists in all areas in which the Company engages in business. The Company faces intense competition in its market areas from major banking and financial institutions, including many which have substantially greater resources or market presence than the Company. Competitors of the Company include commercial banks, savings banks, mutual funds, insurance companies, finance companies, credit unions and mortgage companies. SUPERVISION AND REGULATION The Company is a Massachusetts corporation and is a bank holding company subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") pursuant to the Bank Holding Company Act of 1956, as amended, and files with the Federal Reserve Board an annual 12 report and such additional reports as the Federal Reserve Board may require. The Company is also subject to the jurisdiction of the Massachusetts Board of Bank Incorporation. As a bank holding company, the Company's activities are limited to the business of banking and activities closely related to or incidental to banking. The Company may not directly or indirectly acquire the ownership or control more than 5 percent of any class of voting shares or substantially all of the assets of any company, including a bank, without the prior approval of the Federal Reserve Board. SIS Bank is a Massachusetts chartered stock savings bank subject to regulation and supervision by the Federal Deposit Insurance Corporation ("FDIC") and the Massachusetts Commissioner of Banks. GBT is a Connecticut chartered commercial bank, subject to regulation and supervision by the FDIC and the Connecticut Commissioner of Banks. Further, as a member of the Federal Home Loan Bank of Boston, the Banks must maintain certain levels of liquidity and have collateral available to support borrowings, if required. The Company is also subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered. Various federal and state consumer laws and regulations also affect the operations of the Company. The federal and state regulatory authorities have broad enforcement powers over depository institutions, including the power to impose substantial fines and other civil and criminal penalties, to terminate deposit insurance, and to appoint a conservator or receiver under a variety of circumstances. The Federal Reserve Board also has broad enforcement powers over bank holding companies including the power to impose substantial fines and other civil and criminal penalties. REGULATORY RESTRICTIONS ON DIVIDENDS The Company is a legal entity separate and distinct from SIS Bank and GBT and its other subsidiaries. The Company's principal source of revenue consists of dividends from SIS Bank and GBT. The payment of dividends by both SIS Bank and GBT is subject to various regulatory requirements. Massachusetts law generally provides that SIS Bank may pay cash dividends to the Company from its undistributed earnings. SIS Bank cannot declare or pay any dividend, however, which would reduce its capital below (i) the amount required to be maintained by federal and state laws and regulations, or (ii) the amount in the SIS Bank liquidation account established in connection with SIS Bank's conversion to stockholder owned form in 1995. Connecticut law generally provides that GBT may pay cash dividends to the Company without first obtaining approval from the Connecticut Commissioner of Banks only if the amount of dividends does not exceed GBT's net profits from that year combined with the retained net profits from the previous two years. GBT cannot declare or pay any dividend, however, which would reduce its capital below the amount required to be maintained by federal and state laws and regulations. The payment of dividends on common stock and preferred stock by a bank holding company and its bank subsidiaries may also be limited by other factors, including applicable regulatory capital requirements and broad enforcement powers of the federal bank regulatory agencies. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") generally prohibits a depository institution from making any capital distribution (including the payment of a dividend) or paying any management fee to its holding company if any subsidiary depository institution would thereafter be undercapitalized. CAPITAL REQUIREMENTS The Company and the Banks are required to maintain regulatory capital as follows: (i) Tier 1 capital of at least four percent of risk-weighted assets (including off-balance sheet items); (ii) Total capital of at least eight 13 percent of risk-weighted assets and (iii) Tier 1 capital of at least four percent of adjusted quarterly average total assets. The capital ratios for the Company and the Banks are set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II Item 7. Failure to meet applicable capital requirements could subject a bank holding company or its subsidiary depository institutions to various enforcement actions, including substantial restrictions on its operations and activities, dividend limitations, issuance of a directive to increase capital and, for a depository institution, termination of deposit insurance and the appointment of a conservator or receiver. PROMPT CORRECTIVE ACTION FDICIA requires the federal banking regulators to take prompt supervisory and regulatory actions against undercapitalized depository institutions. FDICIA establishes five capital categories: "well capitalized", "adequately capitalized", "undercapitalized", "significantly undercapitalized", and "critically undercapitalized". Under regulations a "well capitalized" institution has a total capital to total risk-weighted assets ratio of at least ten percent, a Tier 1 capital to total risk-weighted assets ratio of a least six percent, a Tier 1 capital to average total assets ("leverage ratio") of at least five percent and is not subject to any written order, agreement or directive; an "adequately capitalized" institution has a total capital to total risk-weighted assets ratio of at least eight percent, a Tier 1 capital to total risk-weighted assets ratio of at least four percent, and a leverage ratio of at least four percent (three percent if given the highest regulatory rating and not experiencing significant growth), but does not qualify as "well capitalized". An "undercapitalized" institution fails to meet one of the three minimum capital requirements. A "significantly undercapitalized" institution has a total capital to total risk-weighted assets ratio of less than six percent, a Tier 1 capital to total risk-weighted assets ratio of less than three percent, and a leverage ratio of less than three percent. A "critically undercapitalized" institution has a ratio of tangible equity to assets of two percent or less. Under certain circumstances, a "well capitalized", "adequately capitalized" or "undercapitalized" institution may be required to comply with supervisory actions as if the institution was in the next lowest category. A bank generally must file a written capital restoration plan which meets specified requirements, as well as a performance guaranty by each company that controls the bank, with an appropriate federal banking regulator within 45 days of the date that the bank receives notice or is deemed to have notice that it may become an "undercapitalized" institution. Immediately upon becoming undercapitalized, a bank would become subject to statutory provisions which, among other things, set forth various mandatory and discretionary restrictions on the operations of such bank. SIS Bank and GBT had capital levels which qualified each as a "well- capitalized" institution under the applicable FDIC prompt corrective action regulations at December 31, 1997. The Company also qualified as "well capitalized" under applicable Federal Reserve Board regulations at December 31, 1997. For more detail as to the capital requirements for the Company, please see footnote 24 "Regulatory Capital" in the Notes to the Financial Statements. EMPLOYEES As of December 31, 1997, the Company employed 622 persons (full-time equivalent). 14 ITEM 2: PROPERTIES The Company conducts its business from its main offices and other properties listed below, all of which are considered to be in good condition and adequate for the purposes for which they are used. The Company also serves customers through seven (7) off-site SISTEM24 Automated Teller Machines ("ATM") which are on leased parcels and through its affiliation with the "NYCE"(R) and CIRRUS(R) ATM networks. The following table sets forth certain information relating to bank premises owned or used by the Company in conducting its business: OWN/LEASE LOCATION EXPIRATION DATE -------- --------------- SIS BANK BANKING OFFICES 40 Springfield Street, Agawam, MA.......................... Own 11 Amity Street, Amherst, MA............................... Lease/2006 693 Memorial Drive, Chicopee, MA........................... Own 153 Meadow Street, Chicopee, MA............................ Own 465 North Main Street, East Longmeadow, MA................. Lease/2010 1360 Carew Street, East Springfield, MA.................... Lease/2004 50 Holyoke Street, Holyoke, MA............................. Lease/2001 724 Bliss Road, Longmeadow, MA (1)......................... Lease/2002 819 Williams Street, Longmeadow, MA (1).................... Lease/2006 52 East Street, Ludlow, MA................................. Lease/2002 549 Center Street, Ludlow, MA.............................. Own 175 Main Street, Northampton, MA........................... Own 501 Newton Street, South Hadley, MA........................ Lease/2003 412 Boston Road, Springfield, MA........................... Own 1800 Boston Road, Springfield, MA.......................... Own 619 Chestnut Street, Springfield, MA....................... Own 300 Cooley Street, Springfield, MA......................... Lease/2001 441 Cooley Street, Springfield, MA......................... Own 561 Sumner Avenue, Springfield, MA......................... Own 1441 Main Street, Springfield, MA.......................... Own 807 Wilbraham Road, Springfield, MA........................ Lease/1998 958 State Street, Springfield, MA.......................... No Lease 968 Riverdale Road, West Springfield, MA................... Lease/2006 1425 Westfield Street, West Springfield, MA................ Lease/2002 60 Main Street, Westfield, MA.............................. Own 451 East Main Street, Westfield, MA........................ Lease/2002 GBT BANKING OFFICES 64 Norwich Avenue, Colchester, CT.......................... Own 29 Main Street, East Hartford, CT.......................... Lease/2000 730 Hebron Avenue, Glastonbury, CT......................... Lease/2006 2461 Main Street, Glastonbury, CT.......................... Own 255 Main Street, Portland, CT.............................. Lease/1999 38 Town Line Road, Rocky Hill, CT.......................... Lease/2000 901 Main Street, South Glastonbury, CT..................... Lease/1999 171 Silas Deane Highway, Wethersfield, CT.................. Lease/1998 - -------- (1) The Company is scheduled to open a new full-service branch location in Longmeadow, Massachusetts in the second quarter of 1998 which would replace these two smaller locations adjacent to the new Longmeadow location. 15 ITEM 3: LEGAL PROCEEDINGS Except as set forth below, the Company is not involved in any pending litigation other than routine legal proceedings occurring in the ordinary course of business. While the legal responsibility and financial impact with respect to such litigation cannot presently be ascertained, the Company does not anticipate that any of these matters will result in the payment by the Company of damages, that, in the aggregate, would be material in relation to the consolidated financial position or operations of the Company. A lawsuit was brought against GBT and seven directors of GBT on or about November 1, 1995 by a former director of GBT, Henry J. Stone, and a second suit was brought contemporaneously by Mr. Stone's wife, Merriam March. Both suits allege misconduct by the GBT directors in connection with the rejection of a proposed acquisition offer received by GBT in 1994. Mr. Stone's suit sought money damages and to be reinstated as a director of GBT. The damages portion of Mr. Stone's suit was dismissed and he has not appealed. His action to be returned to the board of GBT remains, and GBT intends to vigorously oppose Mr. Stone. Ms. March's suit is a derivative suit in which she, as a shareholder of GBT, had sued the directors of GBT on behalf of GBT for damages they allegedly caused GBT. The derivative action, filed in Connecticut Superior Court, seeks approximately $11.7 million in money damages from the directors. Because the suit is a derivative suit, any damages that the court may order the defendants to pay (GBT believes this to be unlikely and, in any event, limited to one year's compensation from each director under applicable Connecticut law and GBT's Certificate of Incorporation) would be paid to GBT. GBT considers Ms. March's suit to be without merit. Under Connecticut law, GBT is required in some cases, and is permitted in others, to "indemnify" or reimburse the GBT directors from damages and costs incurred by them in connection with litigation brought against them in their official capacities at GBT. As part of the acquisition of GBT by SIS Bank, SIS Bank had agreed that GBT would continue to provide this indemnification to these GBT directors to the extent allowed by law. Through December 31, 1997, GBT had accrued for all expenses incurred for attorney's fees and related costs in connection with the suit, including the advancing of such fees for the defendant directors. As of December 31, 1997, the parties continue to be engaged in mutual discovery efforts, and the Stone lawsuit had been dismissed in its entirety except for the count which requests that Mr. Stone be re-seated on the GBT Board of Directors. The Stone suit is scheduled for trial in late 1998 and the March suit in early 1999. The amount of additional legal fees to be incurred by GBT will depend upon a number of factors, including the scope of the plaintiff's discovery efforts and whether the suits actually go to trial. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) On December 4, 1997, a Special Meeting of the shareholders of SIS Bancorp, Inc. was held at the headquarters of the Company, 1441 Main Street, Springfield, Massachusetts, to consider the following matters: (b) Election of Directors: Not applicable (c) Other matters voted upon: The shareholders voted upon a proposal to approve and adopt the Agreement and Plan of Reorganization dated August 18, 1997 relating to the acquisition of Glastonbury Bank & Trust Company and each of the transactions contemplated thereby, including the issuance of Company common stock to the shareholders of GBT, upon the terms and conditions set forth in the Agreement and Plan of Reorganization, all as more fully described in the Joint Proxy Statement-Prospectus dated October 28, 1997. VOTES FOR (SHARES) VOTES AGAINST ABSTAIN ------------------ ------------- ------- 3,914,555 90,324 16,821 16 PART II ITEM 5: MARKET FOR COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS (a) The market on which the Company's Common Stock is traded is the NASDAQ National Market System under the symbol "SISB". The following table sets forth the high and low last sale prices of the Common Stock for the past two fiscal years, as reported by NASDAQ. DIVIDEND HIGH LOW -------- ------ ------ 1996 First Quarter..................................... N/A $18.75 $16.25 Second Quarter (1)................................ N/A $18.63 $16.75 Third Quarter..................................... N/A $23.63 $17.50 Fourth Quarter.................................... N/A $24.25 $22.13 1997 First Quarter (2)................................. $0.12 $27.38 $22.38 Second Quarter.................................... $0.12 $29.63 $23.38 Third Quarter..................................... $0.14 $34.75 $27.63 Fourth Quarter (3)................................ $0.14 $40.25 $32.63 - -------- (1) On June 21, 1996, the Company acquired 100% of the outstanding shares of SIS Bank's common stock, par value $1.00 per share, in a 1:1 exchange for shares of the Company's common stock, par value $0.01 per share (the "Company's Common Stock"). Upon the effectiveness of such share-for-share exchange on June 21, 1996, SIS Bank became a wholly-owned subsidiary of the Company and SIS Bank's former stockholders became stockholders of the Company. (2) The Company declared its first quarterly cash dividend of $0.12 per share to stockholders of record as of February 3, 1997 payable on February 20, 1997. It has subsequently paid a dividend each quarter as reflected above. (3) The Company acquired 100% of the outstanding shares of GBT as of December 17, 1997 in an exchange whereby shareholders of GBT received 0.74 of a share of the Company's Common Stock for each share of GBT common stock, par value $2.50 per share. Upon the effectiveness of the exchange on December 17, 1997, GBT became a wholly-owned subsidiary of the Company and GBT's former stockholders became stockholders of the Company. The transaction was accounted for as a pooling of interests. (b) As of March 6, 1998, the most recent practicable date, the closing sale price of the Company's Common Stock, as reported by NASDAQ, was $38.50 per share and the Company had 1,599 holders of record of the Company's Common Stock. The figure does not reflect beneficial ownership of shares held in nominee names. 17 ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA The Company's historical financial statements have been restated to reflect the combination with GBT in accordance with the pooling of interest method of accounting. SELECTED BALANCE SHEET DATA: DECEMBER 31, ------------------------------------------------------ 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Total assets............ $1,733,618 $1,596,610 $1,300,155 $1,138,424 $1,198,506 Investment securities... 769,115 704,718 484,848 386,893 286,397 Loans receivable, gross.................. 849,494 774,107 715,344 644,604 788,896 Allowance for possible loan losses............ 22,724 19,549 18,612 20,918 23,488 Investments in real estate and real estate partnerships........... 2,903 2,757 6,092 6,699 9,939 Deposits................ 1,267,298 1,177,561 1,075,356 1,047,544 1,076,961 Borrowings.............. 299,912 269,246 101,071 15,392 20,063 Total stockholders' equity................. 125,472 118,786 96,443 36,543 69,585 Asset Quality: Non-accruing loans.... 5,352 8,011 9,770 18,415 57,792 Loans past due 90 days and still accruing... 431 428 587 376 3,262 ---------- ---------- ---------- ---------- ---------- Total non-performing loans.............. 5,783 8,439 10,357 18,791 61,054 Foreclosed real estate, net.................... 1,209 1,540 1,847 6,709 29,288 Restructured loans on accrual status (1)..... 1,124 892 3,417 6,446 18,245 ---------- ---------- ---------- ---------- ---------- Total non-performing assets............. $ 8,116 $ 10,871 $ 15,621 $ 31,946 $ 108,587 ========== ========== ========== ========== ========== - -------- (1) Restructured loans are loans for which concessions, including reduction of interest rates or deferral of interest or principal payments, have been granted to acknowledge changes in the borrower's financial condition or changes in the underlying cash flows of the loan's collateral. Restructured loans on non-accrual status are reported in the non-accrual loan category. Restructured loans on accrual status are those that have complied with the terms of a restructuring agreement for a satisfactory period (generally six months). 18 SELECTED OPERATING DATA: FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- ------- -------- -------- (DOLLARS IN THOUSANDS) Interest and dividend in- come........................ $119,214 $101,599 $86,296 $ 73,189 $ 79,183 Interest expense............. 59,125 48,915 39,448 29,729 33,567 -------- -------- ------- -------- -------- Net interest and dividend in- come........................ 60,089 52,684 46,848 43,460 45,616 Less: provision for possible loan losses................. 1,895 3,721 6,262 27,728 19,881 -------- -------- ------- -------- -------- Net interest and dividend in- come after provision for possible loan losses........ 58,194 48,963 40,586 15,732 25,735 Noninterest income: Net gain (loss) on sale of loans and securities...... 413 812 (643) (63) 3,186 Loan fees.................. 3,212 3,553 3,530 3,583 4,201 Deposit fees............... 7,562 6,834 5,843 4,875 5,212 Merchant income............ 1,904 1,894 1,690 1,549 1,101 Other fees................. 2,751 1,713 1,387 1,286 2,143 -------- -------- ------- -------- -------- Total noninterest in- come.................. 15,842 14,806 11,807 11,230 15,843 Noninterest expense: Operating expenses: Salaries and employee benefits................ 24,764 22,709 20,167 21,080 21,558 Occupancy expense of bank premises, net........... 4,826 4,308 4,310 4,344 4,430 Furniture and equipment expense................. 3,477 3,433 3,228 3,156 3,056 Other operating ex- penses.................. 16,841 17,487 16,715 18,367 16,765 Merger related costs..... 4,968 -- -- -- -- -------- -------- ------- -------- -------- Total operating ex- penses................ 54,876 47,937 44,420 46,947 45,809 Foreclosed real estate (in- come) expenses............ (5) 449 1,358 6,759 13,460 Net expense (income) of real estate operations.... 352 (272) (227) 988 2,632 -------- -------- ------- -------- -------- Total noninterest ex- pense ................ 55,223 48,114 45,551 54,694 61,901 -------- -------- ------- -------- -------- Income (loss) before income taxes and cumulative effect of change in accounting principles.................. 18,813 15,655 6,842 (27,732) (20,323) Income tax (benefit) ex- pense....................... 7,395 (5,030) (6,259) 35 (3,319) -------- -------- ------- -------- -------- Income (loss) before cumulative effect of change in accounting principle..... 11,418 20,685 13,101 (27,767) (17,004) Cumulative effect of change in accounting principle..... -- -- -- -- 52 -------- -------- ------- -------- -------- Net income (loss)...... $ 11,418 $ 20,685 $13,101 $(27,767) $(16,952) ======== ======== ======= ======== ======== Earnings (loss) per share: Basic...................... $ 1.74 $ 3.14 $ 2.14 $ (4.53) $ (2.77) Diluted.................... $ 1.65 $ 3.03 $ 2.12 $ (4.53) $ (2.77) 19 SELECTED FINANCIAL RATIOS AND OTHER DATA: AT OR FOR THE YEARS ENDED DECEMBER 31, --------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- PERFORMANCE RATIOS: (1) Return on average assets... 0.68% 1.45% 1.08 % (2.40)% (1.40)% Return on average equity... 9.51% 20.04% 16.70 % (51.40)% (20.47)% Net interest income/spread (2)....................... 3.26% 3.44% 3.68 % 3.83 % 4.12 % Net interest margin (3)....... 3.83% 3.94% 4.11 % 4.03 % 4.22 % Efficiency ratio (4)....... 72.67% 71.89% 74.91 % 85.74 % 78.61 % Operating expenses to average assets............ 3.28% 3.36% 3.67 % 4.06 % 3.78 % Ratio of net loan recoveries (charge-offs) to average loans outstanding............... 0.16% (0.38)% (1.26)% (4.27)% (1.54)% ASSET QUALITY RATIOS: Non-performing loans to total gross loans......... 0.68% 1.09% 1.45% 2.92 % 7.74 % Non-performing assets to total assets.............. 0.47% 0.68% 1.20% 2.81 % 9.06 % Allowance for possible loan losses to non-performing loans..................... 392.94% 231.65% 179.70% 111.32 % 38.47 % Allowance for possible loan losses to total gross loans..................... 2.68% 2.53% 2.60% 3.25 % 2.98 % CAPITAL RATIOS: Equity to total assets..... 7.24% 7.44% 7.42% 3.21 % 5.81 % Tier 1 leverage capital ratio..................... 7.17% 7.35% 7.43% 3.67 % 5.77 % Tier 1 risk-based capital ratio..................... 11.87% 12.69% 12.36% 6.39 % 8.26 % Total risk-based capital ratio..................... 13.13% 13.95% 13.61% 7.68 % 9.53 % OTHER DATA: Number of deposit accounts.................. 290,145 248,716 211,362 174,223 165,636 Residential loan originations ($000s)...... $ 98,620 $ 95,445 $107,045 $176,355 $380,202 Loans serviced for others ($000s)................... $768,108 $827,267 $921,147 $979,974 $955,153 Number of full time equivalent employees...... 622 583 529 582 663 FACILITIES: Full-service customer service facilities........ 34 31 28 27 27 Mortgage origination offices................... -- -- -- 2 2 - -------- (1) With the exception of end of period ratios, all ratios are based on average daily balances during the indicated periods and are annualized where appropriate. (2) Interest spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities (which do include non-interest bearing demand accounts). (3) Net interest margin represents the net interest income as a percent of average interest-earning assets, including the average daily balance amount of non-performing loans. (4) The efficiency ratio represents operating expenses as a percentage of net interest income and noninterest income, excluding gains/(losses) on sales of loans and securities. 20 ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of the financial condition and results of operations of the Company should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto, which are included in Item 8 of this report. OVERVIEW The Company reported net income of $11.4 million or $1.65 per share (diluted) for the year ended December 31, 1997. The 1997 financial results, along with the results for prior periods, have been restated to reflect the effect of the acquisition of GBT which was accounted for as a pooling of interests. Financial results for the year ended December 31, 1997 were influenced by non-recurring merger related charges totaling $5.2 million. On January 23, 1997, the Company announced the adoption of a shareholder rights plan, the authorization of a share repurchase program, and the declaration of its first quarterly cash dividend payment in the amount of $0.12 per share. See also Item 5, "Market for Registrant's Common Equity and Related Stockholder Matters," for additional information regarding the Company's quarterly dividend payments. Under the shareholder rights plan each shareholder of record as of the close of business on February 3, 1997 received one right for each share of common stock held by such share holder to purchase, upon the occurrence of certain triggering events, one one-hundredth of a share of Series A junior Participating Preferred Stock of the Company at a purchase price of $100.00. Until and unless the rights are triggered, the rights will be evidenced by the common stock certificates directly, and will transfer automatically with the transfer of any common stock. The initial issuance of the rights has no dilutive effect on the outstanding shares of the Company or the Company's earnings, is not taxable to the Company or the shareholders, and does not otherwise affect the trading of the Company's shares. If the rights are not triggered or otherwise redeemed by the Board of Directors, the rights will expire on January 22, 2007. Under the share repurchase program, the Board of Directors authorized the Company to purchase up to 286,180 shares or up to 5% of the common stock issued and outstanding as of December 31, 1996. On August 17, 1997, in connection with the proposed acquisition of GBT, the Board of Directors rescinded its authorization to repurchase stock. During 1997, the Company repurchased 133,400 shares, net of shares reissued under various benefit plans and shares reissued in connection with the acquisition of GBT. YEAR 2000 During 1997, the Company conducted a review of its computer systems to identify those areas that could be affected by the "Year 2000" issue (i.e., that current computer programs use only two digits to identify a year in the date field and cannot reflect a change in the century). The Company is addressing this issue in accordance with the guidelines set forth in the Federal Financial Institutions Examination Counsel Year 2000 statements dated May 5, and December 17, 1997. The Company has completed the phases associated with awareness and assessment. The Company has developed an implementation plan to resolve its Year 2000 issues. A timely resolution of the Year 2000 issues depends largely upon the expertise and advice of outside vendors retained by the Company to both modify the Company's existing software and develop new software to address current internal systems deficiencies. All of the Company's third party vendors with non-compliant systems have also been identified and notified. The Company is also preparing plans to test all modifications to critical internal systems and verify that critical third party vendors have adequately addressed their own systems issues. Management expects that testing will be completed by the end of first quarter, 1999. Additionally, the Company is currently assessing the potential impact of Year 2000 on its larger commercial borrowers. The Company is presently unaware of any situation where any vendor will not be able to modify its products and systems in a timely manner. 21 The primary costs associated with the Year 2000 issue consist of expenses for the replacement or upgrade of third party systems, and the replacement of personal computers. The Company is not aware of any obstacles or issues that are presently anticipated in connection with the resolution of Year 2000 issues that are likely to cause significant operational problems or are otherwise expected to have a material adverse effect on the Company's financial condition or results of operations. FINANCIAL CONDITION BALANCE SHEET CHANGES Total assets of $1.7 billion at December 31, 1997 increased $137.0 million or 8.6% from $1.6 billion at December 31, 1996. This growth in total assets occurred primarily in commercial and home equity loans and the investment portfolio and was funded by an increase in deposits and borrowings. Commercial loans totaled $212.9 million as of December 31, 1997 compared to $179.7 million as of December 31, 1996, an increase of $33.2 million or 18.5%. This increase reflects the Company's continued focus on lending activities in the local business market. Home equity loan balances grew from $118.2 million as of December 31, 1996 to $158.8 million as of December 31, 1997, an increase of $40.6 million or 34.3%. This increase is the result of the Company's consumer strategy and the active promotion of this product. Investments increased $64.8 million to a total of $769.1 million as of December 31, 1997 from the $704.3 million reported one year earlier. Total deposits were $1.3 billion as of December 31, 1997 compared to $1.2 billion as of December 31, 1996, an increase of $89.7 million or 7.6%. During this period, the Company continued to focus on increasing its share of primary deposit relationships. Demand deposits and savings accounts increased $35.4 million and $10.1 million, respectively, as customers continued to take advantage of the Company's consumer deposit strategy to attract and retain core deposits. Time deposit balances increased $33.6 million primarily due to the introduction of new CD products and growth in time deposits with local municipalities. ASSET QUALITY/NON-PERFORMING ASSETS Non-performing assets declined $2.8 million from $10.9 million at December 31, 1996 to $8.1 million at December 31, 1997. Non-performing asset balances have declined significantly since December 31, 1993 as a result of the accelerated disposition program initiated by the Company, as well as an improvement in economic conditions. The following table sets forth information regarding the components of non-performing assets for the periods presented. DECEMBER 31, ------------------------------------------- 1997 1996 1995 1994 1993 ------ ------- ------- ------- -------- (DOLLARS IN THOUSANDS) Non-accrual loans (1): Residential real estate loans.. $1,211 $ 1,287 $ 2,817 $ 3,292 $ 6,984 Commercial real estate loans... 1,542 4,754 5,824 11,048 34,206 Commercial loans............... 2,414 1,750 1,026 3,643 16,414 Home equity loans.............. 181 210 90 369 -- Consumer loans................. 4 10 13 63 188 ------ ------- ------- ------- -------- Total non-accrual loans...... 5,352 8,011 9,770 18,415 57,792 ------ ------- ------- ------- -------- Loans past due 90 days still accruing (2).................... 431 428 587 376 3,262 ------ ------- ------- ------- -------- Total non-performing loans... 5,783 8,439 10,357 18,791 61,054 Foreclosed real estate (3)....... 1,209 1,540 1,847 6,709 29,288 Restructured loans on accrual status (4)...................... 1,124 892 3,417 6,446 18,245 ------ ------- ------- ------- -------- Total non-performing assets.. $8,116 $10,871 $15,621 $31,946 $108,587 ====== ======= ======= ======= ======== Total non-performing loans to total gross loans............... 0.68% 1.09% 1.45% 2.92% 7.74% Total non-performing assets to total assets.................... 0.47% 0.68% 1.20% 2.81% 9.06% Allowance for possible loan losses to non-performing loans.. 392.94% 231.65% 179.70% 111.32% 38.47% 22 - -------- (1) Non-accrual loans are loans that are contractually past due in excess of 90 days, for which the Company has stopped the accrual of interest, or loans which are not past due but on which the Company has stopped the accrual of interest based on management's assessment of the circumstances surrounding these loans. (2) Accruing loans past due 90 days or more are loans which have not been placed on non-accrual status as, in management's opinion, the collection of the loan and contractual interest, in full, is not in doubt. (3) Foreclosed real estate includes OREO, defined as real estate acquired through foreclosure or acceptance of a deed in lieu of foreclosure. The Company carries foreclosed real estate at net realized value, which approximates fair value less estimated selling costs. (4) Restructured loans are loans for which concessions, including reduction of interest rates or deferral of interest or principal payments, have been granted due to the borrower's financial condition. Restructured loans on non-accrual status are reported in the non-accrual loan category. Restructured loans on accrual status are those loans that have complied with terms of a restructuring agreement for a satisfactory period (generally six months). WATCH LIST LOANS The Company maintains a "watch list" of loans, which represents performing loans that have potential weaknesses that require management's attention. These potential weaknesses may stem from a variety of factors including, among other things, economic or market conditions, adverse trends in the obligor's operations or weaknesses in the obligor's balance sheet. Watch list loans totaled $24.1 million and $33.2 million at December 31, 1997 and 1996, respectively. CLASSIFIED LOANS The Company's Credit Grade Policy (the "Policy") provides for the classification of loans considered to be of lesser quality as "substandard", "doubtful", or "loss" loans. A loan is considered substandard under the Company's Policy if it is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans include those characterized by the "distinct possibility" that the Company will sustain "some loss" if the deficiencies are not corrected. Loans classified as doubtful under the Company's Policy have all of the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses present make "collection or liquidation in full" on the basis of currently existing facts, conditions and values, "improbable." Assets characterized as loss are those considered "uncollectible" and of such little value that their continuance as bankable assets is not warranted. Substandard classified loans totaled $6.2 million and $9.4 million at December 31, 1997 and 1996, respectively. Doubtful classified loans totaled zero and $53 thousand at December 31, 1997 and 1996, respectively. Included in these amounts are $5.4 million and $8.0 million of loans which have been reported as non-performing loans at December 31, 1997 and 1996, respectively. LIQUIDITY Liquidity measures the ability of the Company to meet its maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund its operations and to provide for customer credit needs. The Company's sources of funds are deposits, advances from the FHLB of Boston, repurchase agreements, repayments and maturities on loans and securities, proceeds from the sale of securities in the available-for-sale portfolio, and funds provided by operations. While scheduled loan and security amortization and maturities are relatively predictable sources of funds, deposit flows and loan and security prepayments are greatly influenced by economic conditions and the general level of interest rates and competition. The Company utilizes particular sources of funds based on comparative costs and availability. The Company generally manages the pricing of its deposits to maintain a steady deposit balance, but has from time to time decided not to pay rates on deposits as high as its competition, and when necessary, will supplement deposits with longer term and/or less expensive alternative sources of funds such as advances from the FHLB and repurchase agreements. Liquidity management is both a daily and long-term responsibility of management. The Company adjusts its investments in cash and cash equivalents based upon management's assessment of expected loan demand, 23 projected security maturities, expected deposit flows, yields available on interest-bearing deposits, and the objectives of its asset/liability management program. If the Company requires funds beyond its ability to generate them internally, it has additional borrowing capacity with the FHLB and collateral eligible for repurchase agreements. Because the Company has a stable retail deposit base, management believes that significant borrowings will not be necessary to maintain its current liquidity position. The Company's ongoing principal use of capital resources remains the origination of single-family residential mortgage loans, commercial real estate loans, commercial loans, and home equity loans secured by residential real estate as well as the purchase of investment securities. Management intends to continue seeking opportunities for expansion and believes that the Company's liquidity, capital resources and borrowing capabilities are adequate for its current and intended operations. CAPITAL RESOURCES/REGULATORY CAPITAL The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material adverse effect on the Company's financial statements. Under applicable capital adequacy guidelines the Company must meet specific minimum capital requirements that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Banks to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and Tier 1 capital to total average assets. As of December 31, 1997, the Company and the Banks exceed all capital adequacy requirements to which they are subject and qualify as "well capitalized" under applicable regulations of the Federal Reserve Board and the FDIC. The Company's current capital position and its regulatory requirements are discussed in greater detail in footnote 24 "Regulatory Capital" in the Notes to the Financial Statements. INTEREST RATE RISK MANAGEMENT The operations of the Company are subject to the risk of interest rate fluctuations to the extent that there is a substantial difference in the amount of the Company's assets and liabilities that reprice or mature within specific time periods. An asset-sensitive position indicates that there are more rate-sensitive assets than rate-sensitive liabilities repricing or maturing within specific time horizons, which would generally imply a favorable impact on net interest income in periods of rising interest rates and an unfavorable impact in periods of falling interest rates. A liability- sensitive position would generally imply an unfavorable impact on net interest income in periods of rising interest rates and a favorable impact in periods of falling interest rates. The objective of the Company's interest rate risk management process is to identify, manage, and control its interest rate risk within established limits in order to produce consistent earnings that are not contingent upon favorable trends in interest rates. This is attained by monitoring the levels of interest rates, the relationships between the rates earned on assets and the rates paid on liabilities, the absolute amount of assets and liabilities which reprice or mature over similar periods, and the effect of all of these factors on the estimated level of net interest income. There are a number of industry standards used to measure a financial institution's interest rate risk position. Most common among these is the one- year cumulative gap which is the difference between assets and liabilities that will mature or reprice within one year expressed as a percentage of total assets. Using management's estimates of asset prepayments and core deposit decay in its computation, the Company estimates that its one-year cumulative gap position was liability sensitive by $87.0 million or 5.02% of total assets at December 31, 1997. The Company also utilizes income simulation modeling in measuring its interest rate risk and managing its interest rate sensitivity. Income simulation not only considers the impact of changing market interest rates on forecasted net interest income, but also takes into consideration other factors such as yield curve relationships, the volume and mix of assets and liabilities, customer preferences, and general market conditions. 24 The following table sets forth the amounts of assets and liabilities outstanding at December 31, 1997, which are anticipated by the Company to mature or reprice in each of the future time periods shown using certain assumptions based on its historical experience, the current interest rate environment, and other data available to management. Management believes that these assumptions approximate actual experience and considers such assumptions reasonable; however, the interest rate sensitivity of the Company's assets and liabilities could vary substantially if different assumptions were used or actual experience differs from the assumptions used. Management periodically reviews and, when appropriate, changes assumptions used in evaluating the Company's interest rate sensitivity. GAP POSITION AT DECEMBER 31, 1997 ---------------------------------------------------------- MORE THAN SIX LESS THAN MONTHS LESS 1- SIX MONTHS THAN ONE YEAR 5 YEARS OVER 5 YRS TOTAL ---------- ------------- -------- ---------- ---------- (DOLLARS IN THOUSANDS) Assets: Federal funds sold and interest bearing deposits............. $ 17,317 $ -- $ -- $ -- $ 17,317 Investment securities........... 301,250 173,454 253,714 40,697 769,115 Residential real estate loans......... 74,029 53,469 115,622 37,094 280,214 Commercial real estate loans................ 39,922 24,816 102,336 16,631 183,705 Commercial loans...... 89,408 8,345 97,941 15,272 210,966 Home equity loans..... 115,815 1,879 19,563 22,719 159,976 Consumer loans........ 5,153 62 3,875 2,181 11,271 Other assets.......... -- -- -- 101,054 101,054 -------- -------- -------- -------- ---------- Total assets........ $642,894 $262,025 $593,051 $235,648 $1,733,618 ======== ======== ======== ======== ========== Liabilities & stockholders' equity: Savings accounts...... $ 39,515 $ 39,515 $184,419 $ -- $ 263,449 NOW accounts.......... 13,629 13,629 63,601 -- 90,859 Money market accounts............. 66,902 61,878 82,506 -- 211,286 Time deposits......... 303,217 142,553 83,781 810 530,361 Borrowed funds........ 206,170 36,597 57,145 -- 299,912 Other liabilities & stockholders' equity............... 34,156 34,156 102,466 166,973 337,751 -------- -------- -------- -------- ---------- Total liabilities & stockholders' equity............. $663,589 $328,328 $573,918 $167,783 $1,733,618 ======== ======== ======== ======== ========== Period GAP position..... $(20,695) $(66,303) $ 19,133 $ 67,865 Net period GAP as a percentage of total assets................. (1.19)% (3.82)% 1.10% 3.91% Cumulative GAP.......... $(20,695) $(86,998) $(67,865) -- Cumulative GAP as a percentage of total assets................. (1.19)% (5.02)% (3.91)% -- Cumulative GAP as a percentage of total interest-earning assets................. (1.27)% (5.33)% (4.16)% -- Cumulative interest- earning assets as a percentage of cumulative interest- bearing liabilities.... 102.14% 97.98% 107.38% 116.96% For purposes of the above interest sensitivity analysis: Residential loans held for sale at December 31, 1997 totaling $8.3 million are in the less than six month interest sensitivity period. Fixed rate assets are scheduled by contractual maturity and adjustable rate assets are scheduled by their next repricing date. In both cases, assets that have prepayment optionality are adjusted for the Company's estimate of prepayments. 25 Loans do not include non-accrual loans of $5.4 million. Loans do not include the allowance for loan loss of $22.7 million. In certain deposit categories where there is no contractual maturity, Management assumed the sensitivity characteristics listed below based on the current interest rate environment and the Company's historical experience. Management reviews these assumptions on a quarterly basis and may modify them as circumstances dictate. --Savings accounts are assumed to decay at an annual rate of 30%. --NOW accounts are assumed to decay at an annual rate of 30%. --Money market accounts are assumed to decay at an annual rate of 60%. --Non-interest bearing accounts of $171.3 million are included in other liabilities and are assumed to decay at an annual rate of 40%. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, while certain assets and liabilities may have similar contractual maturities or periods to repricing, they may react in different ways to changes in market interest rates. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Additionally, certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Finally, the ability of borrowers to service their adjustable rate mortgages may decrease in the event of an interest rate increase. MARKET RISK As a financial institution, the Company's chief market risk is interest rate risk. The Company has no exposure to foreign currency or commodity prices. Its exposure to equity prices is limited to marketable equity securities contained within its available for sale investment portfolio. At December 31, 1997 the Company does not have a trading portfolio. Interest rate risk is the sensitivity of income to variations in interest rates over defined time horizons. The primary goal of interest rate risk management is to control this risk within limits and guidelines approved by the Company's Asset/Liability Committee (ALCO). These limits and guidelines reflect the Company's tolerance for interest rate risk. The Company attempts to control interest rate risk by identifying exposures, quantifying them, and identifying their impact on income. The Company quantifies its interest rate risk exposures using simulation models as well as gap analyses. The Company manages its interest rate exposures using a combination of on-balance sheet instruments, consisting principally of fixed and variable rate securities, deposit pricing and FHLB borrowings. See the GAP Position analysis under this Item 7 and the notes to the Consolidated Financial Statements under Item 8 for further information regarding market risk of these instruments at December 31, 1997. At December 31, 1997, the Company had no outstanding exposures to off- balance sheet interest rate instruments such as swaps, forwards or futures. GBT held derivative financial instruments during 1997. However, in December, 1997, concurrent with the acquisition of GBT, the Company sold its position in these instruments. At December 31, 1997 the Company held no derivative financial instruments. 26 RESULTS OF OPERATIONS COMPARISON OF YEARS ENDED DECEMBER 31, 1997 AND 1996 GENERAL For the year ended December 31, 1997 the Company reported net income of $11.4 million, or $1.65 per share (diluted), as compared to net income of $20.7 million, or $3.03 per share (diluted), for the year ended December 31, 1996. The financial results for 1997 were influenced by non-recurring merger related charges totaling $5.2 million, including expenses of $4.9 million and a loss of $0.3 million related to the restructuring of the investment portfolio at GBT. December 31, 1996 results were favorably affected by non- recurring tax events totaling $8.8 million. Excluding the effect of nonrecurring items the Company experienced improved results in core earnings primarily attributed to increased net interest income and non interest income as well as lower provisions for possible loan losses, partially offset by higher operating expenses. NET INTEREST INCOME Net interest income represents the difference between income earned on interest-earning assets and expense incurred on interest-bearing liabilities. Net interest income is affected by the mix and volume of assets and liabilities, and the movement and level of interest rates. 27 The following table sets forth, for the periods indicated, average balances, interest income and expense, and yields earned or rates paid on the major categories of assets and liabilities. Non-accrual loans have been included in the appropriate average balance loan category, but unpaid interest on non- accrual loans has not been included for purposes of determining interest income. In addition, investment securities available for sale are reflected at amortized cost. FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------------------------------------- 1997 1996 --------------------------------------- --------------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST (1) YIELD/COST (1) BALANCE INTEREST (1) YIELD/COST (1) ---------- ------------ -------------- ---------- ------------ -------------- (DOLLARS IN THOUSANDS) INTEREST-EARNING ASSETS: Fed funds sold and short-term investments............ $ 19,840 $ 1,073 5.33% $ 16,026 $ 871 5.35% Investment securities held to maturity....... 210,048 14,416 6.86% 218,078 14,669 6.73% Investment securities available for sale..... 541,930 35,962 6.64% 375,297 24,771 6.60% Investment securities held for trading....... 465 15 3.23% 345 6 1.74% Residential real estate loans.................. 289,800 22,994 7.93% 296,949 23,310 7.85% Commercial real estate loans.................. 172,371 15,683 9.10% 171,921 15,190 8.84% Commercial loans........ 199,763 17,544 8.66% 154,517 13,876 8.83% Home equity loans....... 137,460 10,981 7.99% 95,838 8,010 8.36% Consumer loans.......... 9,791 1,069 10.92% 10,548 1,016 9.63% ---------- -------- ----- ---------- -------- ---- Total interest- earning assets..... 1,581,468 119,737 7.57% 1,339,519 101,719 7.59% Allowance for loan losses................. (20,559) (18,666) Non-interest-earning assets................. 114,174 105,042 ---------- ---------- Total assets........ $1,675,083 $119,737 $1,425,895 $101,719 ========== ======== ========== ======== INTEREST-BEARING LIABILITIES: Deposits Savings accounts...... $ 263,148 $ 6,158 2.34% $ 252,212 $ 6,278 2.49% NOW accounts (2)...... 60,741 749 1.23% 78,305 989 1.26% Money manager accounts (2).................. 20,633 223 1.08% -- -- -- Money market accounts............. 206,929 6,895 3.33% 208,180 6,912 3.32% Time deposit accounts............. 521,887 27,695 5.31% 465,472 24,894 5.35% ---------- -------- ----- ---------- -------- ---- Total interest- bearing deposits... 1,073,338 41,720 3.89% 1,004,169 39,073 3.89% Borrowed funds.......... 298,212 17,405 5.76% 174,300 9,842 5.55% ---------- -------- ----- ---------- -------- ---- Total interest-bearing liabilities............ 1,371,550 59,125 4.31% 1,178,469 48,915 4.15% Non-interest-bearing liabilities............ 183,517 144,232 ---------- ---------- Total liabilities... 1,555,067 1,322,701 Total stockholders' equity................. 120,016 103,194 ---------- ---------- Total liabilities and stockholders' equity............. $1,675,083 $ 59,125 $1,425,895 $ 48,915 ========== ======== ========== ======== Net interest income/spread.......... $ 60,612 3.26% $ 52,804 3.44% ======== ===== ======== ==== Net interest margin as a % of interest-earning assets................. 3.83% 3.94% ===== ==== Tax equivalent adjustment............. $ 523 $ 120 -------- -------- Net interest income/spread per Condensed Consolidated Statement of Operations............. $ 60,089 $ 52,684 ======== ======== - ------- (1) On a fully taxable equivalent basis. Calculated using a Federal income tax rate of 34% for 1997 and 1996. (2) During July 1997, the Company implemented a program which converted certain NOW accounts to money manager accounts. This program has no effect on the Company's depositors, but has provided additional investable funds to the Company by substantially reducing the reserve balances required to be maintained at the Federal Reserve Bank of Boston. 28 Net interest income increased $7.8 million or 14.8% for the year ended December 31, 1997 versus the same period last year. This increase was the result of a $241.9 million increase in interest-earning assets partially offset by a 11 basis point decrease in net interest margin. Total interest income was $119.7 million for the year ended December 31, 1997, an increase of $18.0 million or 17.7%. This increase is primarily attributable to higher levels of interest-earning assets. Average interest- earning assets totaled $1.6 billion for the year ended December 31, 1997 compared to $1.3 billion for the year ended December 31, 1996, an increase of $241.9 million or 18.1%. Average investments increased $158.7 million or 26.7% and were funded by higher deposit levels and borrowed funds. Average loans increased $79.4 million or 10.9% as the Company continued to focus on the commercial and home equity market segments, which grew by $45.2 million or 29.3% and $41.6 million or 43.4%, respectively. Residential real estate loan balances declined $7.1 million or 2.4%, reflecting amortization and prepayments of the existing portfolio offset in part by adjustable rate mortgage production. The Company originates long-term fixed rate mortgages for sale in the secondary market and generally holds adjustable rate mortgages in the Company's loan portfolio. Total interest expense was $59.1 million for the year ended December 31, 1997 compared to $48.9 million for the same period in 1996, an increase of $10.2 million or 20.9%. This increase is primarily attributable to increases in interest-bearing deposits and the use of borrowed funds. Interest-bearing deposits totaled $1.1 billion for the year ended December 31, 1997 compared to $1.0 billion for the same period in 1996, an increase of $69.2 million or 6.9%. This growth occurred primarily in time deposits, which increased $56.4 million as a result of new CD products as well as growth in the municipal CD portfolio. Borrowed funds averaged $298.2 million during 1997 reflecting the use of FHLB advances and repurchase agreements to leverage a portion of the Company's capital as well as the match funding of certain fixed rate commercial loans. 29 RATE/VOLUME ANALYSIS The following table presents the changes in net interest income resulting from changes in interest rates or changes in the volume of interest-earning assets and interest-bearing liabilities during the periods indicated. Changes which are attributable to both rate and volume have been allocated evenly between the change in rate and volume components. FOR THE YEARS ENDED DECEMBER 31, 1997 VERSUS 1996 ----------------------------------- INCREASE (DECREASE) DUE TO ----------------------------------- VOLUME RATE NET ------------ ---------- ----------- (DOLLARS IN THOUSANDS) INTEREST-EARNING ASSETS: Federal funds sold and short term investments............ $ 207 $ (5) $ 202 Investment securities held to maturity.................... (546) 293 (253) Investment securities avail- able for sale............... 11,028 163 11,191 Investment securities held for trading................. 3 6 9 Residential real estate loans....................... (564) 248 (316) Commercial real estate loans....................... 40 453 493 Commercial loans............. 4,018 (350) 3,668 Home equity loans............ 3,402 (431) 2,971 Consumer loans............... (78) 131 53 ----------- --------- ----------- Total interest-earning assets.................. 17,510 508 18,018 ----------- --------- ----------- INTEREST-BEARING LIABILITIES: Deposits: Savings accounts........... 264 (384) (120) NOW accounts............... (219) (21) (240) Money manager accounts..... 112 111 223 Money market accounts...... (42) 25 (17) Time deposit accounts...... 3,005 (204) 2,801 ----------- --------- ----------- Total deposits........... 3,120 (473) 2,647 Borrowed funds............... 7,114 449 7,563 ----------- --------- ----------- Total interest-bearing liabilities............. 10,234 (24) 10,210 ----------- --------- ----------- Change in net interest income.................. $ 7,276 $ 532 $ 7,808 =========== ========= =========== PROVISION FOR LOAN LOSSES The Company recorded a $1.9 million provision for possible loan losses in 1997 compared to $3.7 million in 1996. The provision for possible loan losses is based upon management's judgment of the amount necessary to maintain the allowance for possible loan losses at a level which is considered adequate. For further discussion of this topic please refer to the section titled "Allowance for Possible Loan Losses" in Item 1 of this document. 30 NON-INTEREST INCOME Non-interest income is composed of fee income for bank services and gains or losses from the sale of assets. The components of non-interest income for the periods presented are as follows: FOR THE YEARS ENDED DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) Net gain on sale of loans........................ $ 539 $ 604 Net (loss) gain on sale of securities............ (183) 193 Net gain on securities held for trading.......... 57 15 Loan charges and fees............................ 3,212 3,521 Deposit related fees............................. 7,562 6,834 Merchant fees.................................... 1,904 1,894 Other charges and fees........................... 2,751 1,745 ----------- ----------- $ 15,842 $ 14,806 =========== =========== Non-interest income totaled $15.8 million for the year ended December 31, 1997 compared to $14.8 million for the same period in 1996, an increase of $1.0 million or 7.0%. Other charges and fees increased $1.0 million for the year ended December 31, 1997 compared to the same period in 1996 primarily due to a $0.3 million increase in fees associated with Business Manager, a commercial cash management product introduced by the Company in 1997, a $0.3 million increase in fees earned in sales of non-deposit investment products, and a recovery of $0.2 million paid in 1997 by a state sponsored small business investment once held by the Company. Deposit service charges and fees increased $0.7 million due primarily to fees associated with the Company's larger non-interest bearing account base. At December 31, 1997 there was a loss of $0.2 million on sale of securities compared to a gain of $0.2 million at December 31, 1996. This $0.4 million decrease in income is attributed to a decline in sale activity combined with a loss of $0.3 million related to the restructuring of GBT's investment portfolio. Loan charges and fees decreased $0.3 million due to lower mortgage servicing fees and commercial loan prepayment fees. NON-INTEREST EXPENSE Salaries and Benefits Expense Salaries and benefits expense totaled $24.8 million for the year ended December 31, 1997 compared to $22.7 million for the same period in 1996, an increase of $2.1 million or 9.0% reflecting standard wage increases, higher ESOP expenses resulting from an increase in the Company's stock price, and additional staffing relating to new branch openings. Other Operating Expense The components of other operating expenses for the periods presented are as follows: FOR THE YEARS ENDED DECEMBER 31, ----------------------- 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) Marketing.......................................... $ 2,052 $ 2,237 Insurance.......................................... 705 751 Professional services.............................. 2,949 3,998 Outside processing................................. 4,871 4,287 Other.............................................. 6,264 6,214 ----------- ----------- $ 16,841 $ 17,487 =========== =========== 31 Total other operating expenses declined $0.6 million from December 31, 1996 to December 31, 1997. Professional services expenses decreased $1.0 million primarily due to lower levels of legal, consulting and audit and accounting expenses. Outside processing expenses increased $0.6 million due to higher transaction and account volume associated with increased account activity resulting from the Company's consumer banking strategy. Marketing expense decreased $0.2 million due to reduced levels of media production. Foreclosed Real Estate Expense Foreclosed real estate expense reflects losses on sales, writedowns and net operating results of foreclosed properties. These expenses were zero in 1997 compared to $0.4 million in 1996. This $0.4 million decrease reflects increased gains on the sale of foreclosed properties as well as lower levels of foreclosed properties. Net Expenses of Real Estate Operations SIS Bank has been in the process of divesting its real estate business that was largely conducted through Colebrook Corporation and SIS Bank's other wholly-owned real estate investment subsidiaries (collectively the "Real Estate Subsidiaries"). This divestment is required by FDICIA. SIS Bank's divestment of all such real estate investment activities pursuant to a divestiture plan previously approved by the FDIC, was initially scheduled to be completed by December 31, 1997, and is now scheduled to be completed by June 30, 1998. The FDIC has been notified of this extension and has granted its approval. Net expense of real estate operations reflects the net operating results of these activities, writedowns on real estate properties and gains/losses on sales of these properties. Net expense of real estate operations was $0.4 million for the year ended December 31, 1997 an increase of $0.6 million compared to the same period in 1996. In the first quarter of 1997, the Company established a reserve of $1.0 million relating to the divestment of Colebrook which was partially offset by a $0.6 million gain on the sale of real estate property. The $1.0 million reserve consists of $0.7 million in severance and benefit accruals and $0.3 million for other expenses. As of December 31, 1997, no amounts have been paid relating to the divestiture. This divestment is scheduled to be completed by June 30, 1998. INCOME TAXES During 1996 and 1997, management's evaluation of the weight of currently available evidence resulted in the conclusion that it was more likely than not that the Company would realize a portion of its net deferred tax asset which was reserved for at those times. During 1996, management reduced the Company's valuation allowance from $9.5 million to $0.1 million, while in 1997, management reduced the Company's allowance of $0.1 million to zero. In both instances, management's judgment was influenced by factors including changes in the levels of actual and expected future taxable income and anticipated reversals of net deductible temporary differences. As a result of these adjustments the net change in the total valuation allowance for the years ended December 31, 1997 and 1996 was a net decrease of $0.1 million and $9.4 million, respectively. At December 31, 1997 the Company had investment tax credit carryforwards of approximately $1.7 million which expire in years 1998 through 2008. In addition, the Company had alternative minimum tax credit carryforwards of approximately $0.4 million which have an indefinite utilization period. At December 31, 1997, SIS Bank had state net tax operating loss carryforwards of approximately $1.9 million which will expire in the years 1998 through 2002. If certain substantial direct or indirect changes in the Company's ownership should occur, there may be an annual limitation on the amount of carryforwards (including certain net unrealized built-in losses) which can be utilized for regular and alternative minimum tax purposes. IMPACT OF INFLATION Monetary assets and liabilities are claims to receive or pay a sum of money, the amount of which is fixed. Most assets and liabilities of a bank are monetary in nature. In times of inflation, monetary assets lose purchasing 32 power and monetary liabilities gain purchasing power because the obligations will be repaid with dollars that have less purchasing power than at the time the assets and liabilities were recorded. Since the Company's primary source of earnings is net interest income, interest rates have a more significant impact on the Company's financial performance than the general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. IMPACT OF ACCOUNTING CHANGES In March 1995, the FASB issued SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. SFAS 121 is effective prospectively for fiscal years beginning after December 15, 1995, and was adopted by the Company effective January 1, 1996. The adoption of this statement did not have a material impact on the Company's results of operations or financial position. In May 1995, the FASB issued SFAS 122, "Accounting for Mortgage Service Rights." SFAS 122 amends certain provisions of SFAS 65, "Accounting for Certain Mortgage Banking Activities," to eliminate the accounting distinction between rights to service mortgage loans for others that are acquired through loan origination activities and those acquired through purchase transactions. SFAS 122 is effective prospectively for fiscal years beginning after December 15, 1995, and was adopted by the Company effective January 1, 1996. The adoption of this statement did not have a material impact on the Company's results of operations or financial position. In November 1995, the FASB issued SFAS 123, "Accounting for Stock Based Compensation" which gives companies the option of employing intrinsic value accounting under the guidelines of Accounting Principles Board (APB) No. 25 or fair value accounting for stock based compensation. While SFAS 123 does not require the adoption of fair value accounting, it does require certain disclosures in the financial statements as if fair value accounting had been adopted, including pro forma net income and earnings per share. The Company adopted this accounting standard effective January 1, 1996 for disclosure purposes only and will continue to apply APB 25 in accounting for stock based compensation. In June 1996, the FASB issued SFAS 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", that provides accounting and reporting standards which require that after a transfer of financial assets, an entity recognizes the financial and servicing asset it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. In addition to setting requirements regarding the initial recording and subsequent accounting for assets, liabilities and derivatives acquired in transfers of financial assets, this Statement requires that debtors reclassify financial assets pledged as collateral and that secured parties recognize those assets and their obligation to return them in certain circumstances in which the secured party has taken control of those assets. SFAS 125 is effective prospectively for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996 and for collateral related matters on January 1, 1998 and was adopted January 1, 1997. The adoption of this statement did not have a material impact on the Company's results of operations or financial position. In June 1997, the FASB issued SFAS 130 "Reporting Comprehensive Income" which establishes standards for disclosure of comprehensive income. Comprehensive income represents the change in equity of a business during a period from transactions and other events and circumstances from non- shareholder sources. SFAS 130 requires the restatement of prior periods for comparative purposes. The Company adopted SFAS 130 on January 1, 1998 and management does not expect the adoption to have a material impact on the Company's financial position or results of operations. 33 In June 1997, the FASB issued SFAS 131 "Disclosures about Segments of an Enterprise and Related Information" which establishes standards for the way that public business enterprises report financial and descriptive information about operating segments. SFAS 131 defines an operating segment as components of an enterprise about which separate financial information is available that is evaluated by management in deciding how to allocate resources and in assessing performance. The Company adopted SFAS 131 on January 1, 1998 and management does not expect the adoption to have a material impact on the Company's financial position or results of operations. In February 1998, the FASB issued SFAS 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits--an amendment of FASB Statements No. 87, 88 and 106" (SFAS 132) which revises employers' disclosures about pension and other postretirement benefit plans, though it does not change the measurement or recognition of those plans. The Company adopted SFAS 132 effective January 1, 1998 and management does not expect the adoption to have a material effect on the Company's financial position or results of operations. COMPARISON OF YEARS ENDED DECEMBER 31, 1996 AND 1995 GENERAL For the year ended December 31, 1996 the Company reported net income of $20.7 million, or $3.03 per share (diluted), as compared to net income of $13.1 million, or $2.12 per share (diluted), for the year ended December 31, 1995. The financial results for 1996 and 1995 were favorably affected by non- recurring tax events totaling $8.8 million and $6.5 million, respectively. The Company also experienced improved results in core earnings primarily attributed to increased net interest income and noninterest income as well as lower provisions for loan losses, partially offset by higher operating expenses. NET INTEREST INCOME Net interest income represents the difference between income earned on interest-earning assets and expense on interest-bearing liabilities. Net interest income is affected by the mix and volume of assets and liabilities, and the movement and level of interest rates. 34 The following table sets forth, for the periods indicated, average balances, interest income and expense, and yields earned or rates paid on the major categories of assets and liabilities. Non-accrual loans have been included in the appropriate average balance loan category, but unpaid interest on non- accrual loans has not been included for purposes of determining interest income. For purposes of this table, investment securities available for sale are reflected at amortized cost. FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------------------------------------- 1996 1995 --------------------------------------- --------------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST (1) YIELD/COST (1) BALANCE INTEREST (1) YIELD/COST (1) ---------- ------------ -------------- ---------- ------------ -------------- (DOLLARS IN THOUSANDS) INTEREST-EARNING ASSETS: Fed funds sold and short-term investments............ $ 16,026 $ 871 5.35% $ 23,658 $ 1,385 5.77% Investment securities held to maturity....... 218,078 14,669 6.73% 222,474 13,315 5.98% Investment securities available for sale..... 375,297 24,771 6.60% 213,342 13,927 6.53% Investment securities held for trading....... 345 6 1.74% -- -- -- Residential real estate loans.................. 296,948 23,310 7.85% 308,695 24,349 7.89% Commercial real estate loans.................. 171,921 15,190 8.84% 172,700 14,791 8.56% Commercial loans........ 154,517 13,876 8.83% 120,572 11,486 9.40% Home equity loans....... 95,838 8,010 8.36% 66,373 6,149 9.26% Consumer loans.......... 10,548 1,016 9.63% 10,925 894 8.18% ---------- -------- ---- ---------- ------- ---- Total interest- earning assets..... 1,339,518 101,719 7.59% 1,138,739 86,296 7.58% Allowance for loan losses................. (18,666) (20,974) Non-interest-earning assets................. 105,042 91,381 ---------- ---------- Total assets........ $1,425,894 $101,719 $1,209,146 $86,296 ========== ======== ========== ======= INTEREST-BEARING LIABILITIES: Deposits Savings accounts...... $ 252,212 $ 6,278 2.49% $ 248,318 $ 6,163 2.48% NOW accounts.......... 78,305 989 1.26% 75,024 1,083 1.44% Money market accounts............. 208,180 6,912 3.32% 212,272 6,945 3.27% Time deposit accounts............. 465,472 24,894 5.35% 423,641 22,133 5.22% ---------- -------- ---- ---------- ------- ---- Total interest-bearing deposits............... 1,004,169 39,073 3.89% 959,255 36,324 3.79% Borrowed funds.......... 174,300 9,842 5.55% 53,231 3,124 5.79% ---------- -------- ---- ---------- ------- ---- Total interest-bearing liabilities............ 1,178,469 48,915 4.15% 1,012,486 39,448 3.90% Non-interest-bearing liabilities............ 144,232 118,191 ---------- ---------- Total liabilities....... 1,322,701 1,130,677 Total stockholders' equity................. 103,194 78,469 ---------- ---------- Total liabilities and stockholders' equity............. $1,425,895 $ 48,915 $1,209,146 $39,448 ========== ======== ========== ======= Net interest income/spread.......... $ 52,804 3.44% $46,848 3.68% ======== ==== ======= ==== Net interest margin as a % of interest-earning assets................. 3.94% 4.11% ==== ==== Tax equivalent adjustment............. $ 120 $ -- -------- ------- Net interest income/spread per Condensed Consolidated Statement of Operations............. $ 52,684 $46,848 ======== ======= - ------- (1) On a fully taxable equivalent basis. Calculated using a Federal income tax rate of 34% for 1996 and 1995. 35 Net interest income increased $6.0 million or 12.7% for the year ended December 31, 1996 versus the same period for the prior year. This increase was the result of a $200.8 million increase in interest-earning assets partially offset by a 17 basis point decrease in net interest margin. Total interest income was $101.7 million for the year ended December 31, 1996, an increase of $15.4 million or 17.9%. This increase is attributable to higher levels of interest-earning assets. Average interest-earning assets totaled $1.3 billion for the year ended December 31, 1996 compared to $1.1 billion for the year ended December 31, 1995, an increase of $200.8 million or 17.6%. Average investments increased $157.9 million or 36.2% and were funded by higher deposit levels and borrowed funds. Average loans increased $50.5 million as the Company continued to focus on the commercial and home equity market segments, which grew by $33.9 million or 28.2% and $29.5 million or 44.4%, respectively. Residential real estate loan balances declined $11.8 million or 3.8%, reflecting refinancing activity to fixed rate products during the first quarter of 1996, as well as a decline in the production for adjustable rate mortgage products. The Company originates long-term fixed rate mortgages for sale in the secondary market and generally holds adjustable rate mortgages in the Company's loan portfolio. Total interest expense was $48.9 million for the year ended December 31, 1996 compared to $39.4 million for the same period in 1995, an increase of $9.5 million or 24.0%. This increase is attributable to increases in interest- bearing deposits and the use of borrowed funds. Interest-bearing deposits totaled $1.0 billion for the year ended December 31, 1996 compared to $959.3 million for the same period in 1995, an increase of $44.9 million or 4.7%. This growth occurred primarily in time deposits, which increased $41.8 million largely attributable to the introduction of new CD products. Borrowed funds averaged $174.3 million during 1996 reflecting the use of FHLB advances and repurchase agreements to leverage a portion of the Company's capital position. 36 RATE/VOLUME ANALYSIS The following table presents the changes in net interest income resulting from changes in interest rates or changes in the volume of interest-earning assets and interest-bearing liabilities during the periods indicated. Changes which are attributable to both rate and volume have been allocated evenly between the change in rate and volume components. FOR THE YEARS ENDED DECEMBER 31, 1996 VERSUS 1995 ------------------------------------ INCREASE (DECREASE) DUE TO ------------------------------------ VOLUME RATE NET ------------ ---------- ----------- INTEREST-EARNING ASSETS: Federal funds sold and interest bearing deposits............................... $ (431) $ (83) $ (514) Investment securities held to maturity.. (280) 1,634 1,354 Investment securities available for sale................................... 10,631 213 10,844 Investment securities held for trading.. 6 -- 6 Residential real estate loans........... (924) (115) (1,039) Commercial real estate loans............ (68) 467 399 Commercial loans........................ 3,141 (751) 2,390 Home equity loans....................... 2,596 (735) 1,861 Consumer loans.......................... (34) 156 122 ----------- ---------- ----------- Total interest-earning assets....... 14,637 786 15,423 ----------- ---------- ----------- INTEREST-BEARING LIABILITIES: Deposits: Savings accounts...................... 97 18 115 NOW accounts.......................... 44 (138) (94) Money market accounts................. (135) 102 (33) Time deposit accounts................. 2,211 550 2,761 ----------- ---------- ----------- Total deposits...................... 2,217 532 2,749 Borrowed funds.......................... 6,971 (253) 6,718 ----------- ---------- ----------- Total interest-bearing liabilities.. 9,188 279 9,467 ----------- ---------- ----------- Change in net interest income....... $ 5,449 $ 507 $ 5,956 =========== ========== =========== PROVISION FOR LOAN LOSSES The Company recorded a $3.7 million provision for possible loan losses in 1996 compared to $6.3 million in 1995. The provision for possible loan losses is based upon management's judgment of the amount necessary to maintain the allowance for possible loan losses at a level which is considered adequate. For further discussion of this topic please refer to the section titled "Allowance for Possible Loan Losses" in Item 1 of this document. 37 NON-INTEREST INCOME Non-interest income is composed of fee income for bank services and gains or losses from the sale of assets. The components of non-interest income for the periods presented are as follows: FOR THE YEARS ENDED DECEMBER 31, ----------------------- 1996 1995 ----------- ----------- (DOLLARS IN THOUSANDS) Net gain on sale of loans......................... $ 604 $ 243 Net gain (loss) on sale of securities............. 193 (886) Net gain on securities held for trading........... 15 -- Loan charges and fees............................. 3,521 3,507 Deposit related fees.............................. 6,834 5,843 Merchant fees..................................... 1,894 1,690 Other charges and fees............................ 1,745 1,410 ----------- ----------- $ 14,806 $ 11,807 =========== =========== Non-interest income totaled $14.8 million for the year ended December 31, 1996 compared to $11.8 million for the same period in 1995, an increase of $3.0 million or 25.4%. Net gain on sale of securities increased $1.1 million in the year ended December 31, 1996 compared to the same period in 1995. The $0.2 million gain on sale of securities in 1996 is associated with the sale of preferred stocks and mortgage-backed securities. The $0.9 million loss recorded in 1995 is related to the sale of securities in connection with the restructuring of the investment portfolio. Deposit related fees increased $1.0 million due primarily to fees associated with the Company's larger non- interest bearing account base. Net gain on sale of loans increased $0.4 million due to an increase in the amount of loans sold on a servicing released basis. Other charges and fees increase $0.3 million primarily as a result of an increase in brokerage fee income. Merchant fees increased $0.2 million due to continued growth in the customer base, resulting in an increase in the dollar volume of activity. NON-INTEREST EXPENSE Salaries and Benefits Expense Salaries and benefits expense totaled $22.7 million for the year ended December 31, 1996 compared to $20.2 million for the same period in 1995, an increase of $2.5 million or 12.6% reflecting increased headcount, standard wage increases, and higher employee stock ownership plan ("ESOP"), restricted stock and 401K plan expenses. Other Operating Expense FOR THE YEARS ENDED DECEMBER 31, ----------------------- 1996 1995 ----------- ----------- (DOLLARS IN THOUSANDS) Marketing.......................................... $ 2,237 $ 1,163 Insurance.......................................... 751 3,259 Professional services.............................. 3,998 3,735 Outside processing................................. 4,287 3,079 Other.............................................. 6,214 5,479 ----------- ----------- $ 17,487 $ 16,715 =========== =========== Other operating expenses totaled $17.5 million for the year ended December 31, 1996 compared to $16.7 million for the same period in 1995, an increase of $0.8 million or 4.6%. Insurance expense decreased $2.5 million due to a significant reduction in FDIC premiums. Outside processing expense increased $1.2 million due 38 to higher transaction and account volume associated with increased account activity resulting from the Company's consumer banking strategy, as well as costs associated with the outsourcing of the Company's item processing operations in 1996. Marketing expense increased $1.1 million reflecting the expanded use of television, billboards, radio and print advertising directed towards the Company's consumer strategy and new branch openings. Other operating expenses increased $0.7 million reflecting increased supplies and postage costs associated with the growth in consumer deposit accounts as a result of the Company's consumer strategy. Foreclosed Real Estate Expense Foreclosed real estate expense reflects losses on sales, writedowns and net operating results of foreclosed properties. These expenses were $0.4 million in 1996 compared to $1.4 million in 1995. This $1.0 million decrease reflects lower levels of foreclosed properties. Net Expenses of Real Estate Operations The Company has certain subsidiaries that are engaged in various real estate investments directly or in joint ventures with unaffiliated partners. The Company has terminated its real estate development activities and plans to sell its remaining real estate investments. Net expense of real estate operations reflects the net operating results of these activities, writedowns on real estate properties and gains/losses on sales of these properties. Net income of real estate operations was $0.3 million and $0.2 million in 1996 and 1995, respectively. INCOME TAXES In accordance with SFAS 109, "Accounting for Income Taxes," management evaluated the income tax benefits associated with temporary differences, based on the weight of available evidence, as to whether it is more likely than not that the income tax benefits would be realized. As a result, a 100% valuation allowance was established at December 31, 1994. Management reviews the valuation allowance on a periodic basis, and, based upon all available facts and circumstances at that time, may adjust the level of the allowance. During both 1995 and 1996, management's evaluation of the weight of currently available evidence resulted in the conclusion that it was more likely than not that the Company would realize a portion of its net deferred tax asset which was reserved for at those times. In December 1995, management reduced the Company's valuation allowance from $18.3 million to $9.5 million. In 1996, management reduced the Company's valuation allowance from $9.5 million to $0.1 million. In both instances management's judgment was influenced by factors including changes in the levels of actual and expected future taxable income and anticipated reversals of net deductible temporary differences. Also in the third quarter of 1996, pursuant to the enactment of the Small Business Jobs Protection Act during 1996, the Company was required, for tax purposes, to change its method of accounting for bad debts. The change required the Company to change from the reserve method to the specific charge- off method. The Company recognized a one-time tax benefit of $2.8 million during the third quarter, representing the tax effects of pre-1988 loan loss reserves not subject to recapture provisions. As a result of this third quarter activity, the Company became fully taxable for financial reporting purposes beginning in the fourth quarter of 1996. Certain future distributions in excess of the Company's current earnings and profits would require the recapture of the taxes related to the pre-1988 loan loss reserves that were not subject to recapture under the Small Business Job Protection Act. The total tax liability that would be subject to recapture for which no deferred tax liability has been recorded is $3.0 million. 39 ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following Consolidated Financial Statements and Notes are included herein. PAGE ---- Consolidated Balance Sheet as of December 31, 1997 and 1996.............. 41 Consolidated Statement of Operations for the years ended December 31, 1997, 1996, and 1995.................................................... 42 Consolidated Statement of Changes in Stockholders' Equity for the years ended December 31, 1997, 1996, and 1995................................. 43 Consolidated Statement of Cash Flows for the years ended December 31, 1997, 1996, and 1995.................................................... 44 Notes to Consolidated Financial Statements............................... 45 Report of Independent Accountants........................................ 76 All schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto. 40 SIS BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS) DECEMBER 31, ---------------------- 1997 1996 ---------- ---------- ASSETS Cash and due from banks................................ $ 50,297 $ 58,045 Federal funds sold and short term investments.......... 17,317 10,045 Investment securities available for sale............... 576,108 483,614 Investment securities held to maturity (fair value: $193,396 at December 31, 1997 and $219,911 at December 31, 1996)............................................. 193,007 220,646 Investment securities held for trading................. -- 458 Loans receivable, net of allowance for possible losses ($22,724 at December 31, 1997 and $19,549 at December 31, 1996)............................................. 828,761 755,378 Accrued interest and dividends receivable.............. 10,749 10,417 Investments in real estate and real estate partnerships.......................................... 2,903 2,757 Foreclosed real estate, net............................ 1,209 1,540 Bank premises, furniture and fixtures, net............. 35,843 34,547 Other assets........................................... 17,424 19,163 ---------- ---------- Total assets....................................... $1,733,618 $1,596,610 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits............................................... $1,267,298 $1,177,561 Federal Home Loan Bank advances........................ 184,121 89,471 Securities sold under agreements to repurchase......... 113,299 176,927 Loans payable.......................................... 2,492 2,848 Mortgage escrow deposits............................... 5,642 4,772 Accrued expenses and other liabilities................. 35,294 26,245 ---------- ---------- Total liabilities.................................. 1,608,146 1,477,824 ---------- ---------- Commitments and contingent liabilities (See Note 22)... -- -- Stockholders' equity: Preferred stock ($.01 par value; 5,000,000 shares authorized: no shares issued and outstanding)....... -- -- Common stock ($.01 par value; 25,000,000 shares authorized; shares issued: 7,081,187 at December 31, 1997 and 7,077,741 at December 31, 1996; shares outstanding: 6,947,787 at December 31, 1997 and 7,077,741 at December 31, 1996)..................... 71 71 Unearned compensation................................ (3,123) (3,693) Additional paid-in capital........................... 54,755 53,836 Retained earnings.................................... 75,153 67,119 Net unrealized gain on investment securities available for sale.................................. 2,133 1,453 Treasury stock, at cost (133,400 and 0 shares at December 31, 1997 and 1996, respectively)........... (3,517) -- ---------- ---------- Total stockholders' equity......................... 125,472 118,786 ---------- ---------- Total liabilities and stockholders' equity............. $1,733,618 $1,596,610 ========== ========== See accompanying Notes to the Consolidated Financial Statements 41 SIS BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS) FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- Interest and dividend income Loans................................... $ 68,186 $ 61,402 $ 57,668 Investment securities available for sale................................... 35,527 24,651 13,928 Investment securities held to maturity.. 14,416 14,669 13,315 Investment securities held for trading.. 12 6 -- Federal funds sold and short term investments............................ 1,073 871 1,385 ---------- ---------- ---------- Total interest and dividend income.. 119,214 101,599 86,296 ---------- ---------- ---------- Interest expense Deposits................................ 41,720 39,073 36,324 Borrowings.............................. 17,405 9,842 3,124 ---------- ---------- ---------- Total interest expense.............. 59,125 48,915 39,448 ---------- ---------- ---------- Net interest and dividend income.......... 60,089 52,684 46,848 Less: Provision for possible loan losses.. 1,895 3,721 6,262 ---------- ---------- ---------- Net interest and dividend income after provision for possible loan losses....... 58,194 48,963 40,586 Noninterest income: Net gain on sale of loans............... 539 604 243 Net (loss) gain on sale of securities... (183) 193 (886) Net gain on sale of trading securities.. 57 15 -- Fees and other income................... 15,429 13,994 12,450 ---------- ---------- ---------- Total noninterest income............ 15,842 14,806 11,807 ---------- ---------- ---------- Noninterest expense: Operating expenses: Salaries and employee benefits........ 24,764 22,709 20,167 Occupancy expense of bank premises, net.................................. 4,826 4,308 4,310 Furniture and equipment expense....... 3,477 3,433 3,228 Other operating expenses.............. 16,841 17,487 16,715 Merger related costs.................. 4,968 -- -- ---------- ---------- ---------- Total operating expenses............ 54,876 47,937 44,420 ---------- ---------- ---------- Foreclosed real estate (income) expense................................ (5) 449 1,358 Net expense (income) of real estate operations............................. 352 (272) (227) ---------- ---------- ---------- Total noninterest expense........... 55,223 48,114 45,551 Income before income tax expense (benefit)................................ 18,813 15,655 6,842 Income tax expense (benefit).............. 7,395 (5,030) (6,259) ---------- ---------- ---------- Net income.......................... $ 11,418 $ 20,685 $ 13,101 ========== ========== ========== Earnings per share and pro forma earnings per share: (1) Basic................................... $ 1.74 $ 3.14 $ 2.14 Diluted................................. $ 1.65 $ 3.03 $ 2.12 Weighted average and pro forma weighted average shares outstanding: (1) Basic................................... 6,564,073 6,580,282 6,127,116 Diluted................................. 6,907,192 6,836,634 6,170,077 - ------- (1) Net income per share for the years ended December 31, 1997 and 1996 is computed on weighted average shares outstanding for the period. Net income per share for the year ended December 31, 1995 is computed on a pro forma basis as if the conversion of SIS Bank from mutual to stock form had been completed as of the beginning of the period presented. See accompanying Notes to the Consolidated Financial Statements 42 SIS BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 (DOLLARS IN THOUSANDS) NET UNREALIZED GAIN (LOSS) ON INVESTMENT ADDITIONAL SECURITIES TREASURY COMMON UNEARNED PAID-IN RETAINED AVAILABLE STOCK STOCK COMPENSATION CAPITAL EARNINGS FOR SALE AT COST TOTAL ------ ------------ ---------- -------- -------------- -------- -------- Balance at December 31, 1994................... $10 $ -- $ 7,713 $34,095 $(5,275) $ -- $ 36,543 Net income.............. -- -- -- 13,101 -- -- 13,101 Issuance of common stock in connection with the conversion............. 56 -- 39,665 (250) -- -- 39,471 Issuance of common stock.................. 4 -- 3,458 -- -- -- 3,462 Issuance of common stock in connection with employee and non- employee directors benefit programs....... 1 (5,375) 1,814 -- -- -- (3,560) Decrease in unearned compensation........... -- 438 311 -- -- -- 749 Change in unrealized gain (loss) on investment securities available for sale..... -- -- -- -- 6,677 -- 6,677 --- ------- ------- ------- ------- ------- -------- Balance at December 31, 1995................... $71 $(4,937) $52,961 $46,946 $ 1,402 $ -- $ 96,443 === ======= ======= ======= ======= ======= ======== Balance at December 31, 1995................... $71 $(4,937) $52,961 $46,946 $ 1,402 $ -- $ 96,443 Net income.............. -- -- -- 20,685 -- -- 20,685 Cash dividends declared ($0.21 per equivalent share) (1)............. -- -- -- (512) -- -- (512) Issuance of common stock in connection with employee and non- employee directors benefit programs....... -- (315) 297 -- -- -- (18) Decrease in unearned compensation........... -- 1,559 578 -- -- -- 2,137 Change in unrealized gain (loss) on investment securities available for sale..... -- -- -- -- 51 -- 51 --- ------- ------- ------- ------- ------- -------- Balance at December 31, 1996................... $71 $(3,693) $53,836 $67,119 $ 1,453 $ -- $118,786 === ======= ======= ======= ======= ======= ======== Balance at December 31, 1996................... $71 $(3,693) $53,836 $67,119 $ 1,453 $ -- $118,786 Net income.............. -- -- -- 11,418 -- -- 11,418 Cash dividends declared ($0.77 per share) (1).. -- -- -- (3,384) -- -- (3,384) Partial shares and dissenter shares canceled (GBT)......... -- -- (5) -- -- -- (5) Common stock issued from treasury in connection with acquisition of GBT.................... -- -- 90 -- -- 342 432 Issuance of common stock in connection with employee and non- employee directors benefit programs....... -- (98) (67) -- -- 334 169 Decrease in unearned compensation........... -- 668 901 -- -- -- 1,569 Change in unrealized gain (loss) on investment securities available for sale..... -- -- -- -- 680 -- 680 Treasury stock purchased.............. -- -- -- -- -- (4,193) (4,193) --- ------- ------- ------- ------- ------- -------- Balance at December 31, 1997................... $71 $(3,123) $54,755 $75,153 $ 2,133 $(3,517) $125,472 === ======= ======= ======= ======= ======= ======== - -------- (1) Includes $0.21 and $0.25 dividends per equivalent share paid by GBT for 1996 and 1997, respectively. See accompanying Notes to the Consolidated Financial Statements 43 SIS BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (DOLLARS IN THOUSANDS) FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES Net income................................. $ 11,418 $ 20,685 $ 13,101 Adjustments to reconcile net income to net cash provided by operating activities Provision for possible loan losses........ 1,895 3,721 6,262 Provision for foreclosed real estate...... 11 10 1,619 Depreciation.............................. 4,159 4,033 4,073 Amortization of premium on investment securities, net.......................... 3,351 2,216 1,125 ESOP and restricted stock expenses........ 1,569 1,890 749 Investment security (gains) losses........ 126 (208) 886 (Increase) decrease in assets held in trading.................................. 458 (443) -- (Income) loss from equity investment in partnerships............................. 7 (48) 133 Gain on sale of loans..................... (539) (604) (243) Disbursements for mortgage loans held for sale..................................... (68,170) (79,442) (65,747) Receipts from mortgage loans held for sale..................................... 68,709 80,046 65,989 Loss (gain) on sale of fixed assets and real estate.............................. (150) (131) 494 Changes in assets and liabilities: (Increase) decrease in other assets, net..................................... 581 (5,459) (8,934) Decrease (increase) in accrued expenses and other liabilities................... 9,187 3,754 (10,469) ---------- ---------- ---------- Net cash provided by operating activities........................... 32,612 30,020 9,038 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sales of investment securities available for sale............ 21,005 56,980 214,747 Proceeds from maturities and principal payments received on investment securities available for sale............ 170,129 121,064 136,649 Purchase of investment securities available for sale....................... (285,366) (379,577) (350,233) Proceeds from sales of investment securities held to maturity.............. 11,751 -- -- Proceeds from maturities and principal payments received on investment securities held to maturity.............. 49,611 50,917 38,763 Purchase of investment securities held to maturity................................. (34,113) (69,964) (132,878) Net decrease in investments in real estate................................... 20 475 -- Net increase in loans receivable.......... (75,799) (68,326) (86,492) Net decrease in foreclosed real estate.... 523 2,132 2,928 Proceeds from sale of loans............... 92 4,064 6,038 Proceeds from sale of fixed assets........ 481 2,799 1,065 Purchase of fixed assets.................. (5,714) (4,503) (6,299) ---------- ---------- ---------- Net cash used for investing activities........................... (147,380) (283,939) (175,712) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES Net proceeds from stock conversion........ -- -- 35,911 Net proceeds from stock issuance.......... -- -- 3,462 Net increase in deposits.................. 89,737 102,205 27,812 Net increase in borrowings................ 30,666 168,175 85,679 Net increase (decrease) in mortgagors' escrow deposits.......................... 870 234 (1,241) Reissuance of treasury stock.............. 432 -- -- Net proceeds from exercise of stock options.................................. 169 -- -- Cash paid for partial and dissenter shares in connection with the GBT acquisition.............................. (5) Repurchase of common stock................ (4,193) -- -- Cash dividends paid....................... (3,384) (512) -- ---------- ---------- ---------- Net cash provided by financing activities........................... 114,292 270,102 151,623 ---------- ---------- ---------- Increase (decrease) in cash and cash equivalents............................... (476) 16,183 (15,051) Cash and cash equivalents, beginning of year...................................... 68,090 51,907 66,958 ---------- ---------- ---------- Cash and cash equivalents, end of year..... $ 67,614 $ 68,090 $ 51,907 ========== ========== ========== Supplemental disclosures of cash flow information: Cash paid during the year for interest to depositors and interest on debt.......... $ 58,754 $ 48,462 $ 39,234 Income taxes paid......................... $ 3,721 $ 447 $ 72 Non-cash investing activities: Transfers to foreclosed real estate, net...................................... $ 438 $ 2,141 $ 550 See accompanying Notes to the Consolidated Financial Statements 44 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) GENERAL SIS Bancorp, Inc. (the "Company") is a Massachusetts corporation formed in 1996 and serves as the bank holding company for Springfield Institution for Savings ("SIS Bank"), and Glastonbury Bank & Trust Company ("GBT"). The Company was formed for the purpose of reorganizing SIS Bank into a holding company structure ("the Reorganization"). Upon the effectiveness of the Reorganization, SIS Bank became a wholly owned subsidiary of the Company and SIS Bank's former stockholders became stockholders of the Company. The Company acquired GBT on December 17, 1997. Established in 1827, SIS Bank is a Massachusetts chartered stock savings bank headquartered in Springfield, Massachusetts. GBT, with its headquarters located in Glastonbury, Connecticut, is a Connecticut chartered commercial bank founded in 1919. Substantially all of the Company's operations are conducted through its subsidiary banks. The Company provides a wide variety of financial services through both SIS Bank and GBT (the "Banks"), including retail and commercial banking, residential mortgage origination and servicing, commercial and consumer lending, merchant processing and insurance sales. The Banks serve the consumers and businesses located in western Massachusetts and central Connecticut through a network of 34 full service branches. The Company's revenues are derived principally from dividend payments received from the Banks, which in turn derive their revenues principally from interest payments on their loan portfolios and mortgage-backed and other investment securities. The Banks' primary sources of funds are deposits, borrowings and principal and interest payments on loans and mortgage-backed securities. 1. ACCOUNTING POLICIES The accounting and reporting policies of the Company conform with generally accepted accounting principles. The significant policies are summarized below. The consolidated financial statements of the Company are dependent on the use of estimates, particularly with regard to the allowance for possible loan losses and the value of other real estate. Estimates of loan collectability and real estate values involve a high degree of judgment and the use of appraisals and other information. Subsequent changes in general economic conditions and the financial condition of borrowers may require changes in such estimates. CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany items have been eliminated. Certain amounts in prior periods have been reclassified to conform to the current year presentation. CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold and interest bearing deposits. Generally, federal funds are sold on an overnight basis. INVESTMENT SECURITIES Investment securities which management has the positive intent and ability to hold until maturity are classified as held-to-maturity and carried at amortized cost, adjusted for amortization of premiums and accretion 45 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) of discounts into interest income using the level yield method over the remaining contractual life of the securities, adjusted for estimated prepayments. Premiums are amortized to the earlier of the call or maturity date and discounts are accreted to the maturity date. Investment securities which have been identified as assets which may be sold prior to maturity or for which there is not a positive intent to hold until maturity, based on foreseeable conditions, including all marketable equity securities, are classified as available-for-sale. Available-for-sale securities are reported at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity, net of tax. Short- term investment securities held for sale are classified as trading and are carried at market value, with unrealized gains and losses recognized currently in the statement of operations. Gains and losses on sales of investment securities are computed under the specific identification method. Investment securities which have experienced an other than temporary decline in value are written down to fair value as a new cost basis with the amount of the writedown included in earnings as a realized loss. The new cost basis is not increased for subsequent recoveries in fair value. INVESTMENTS IN REAL ESTATE AND REAL ESTATE PARTNERSHIPS Investments in real estate reflect the Company's interest in wholly owned real estate properties. Investments in real estate properties are carried at the lower of cost, including cost of improvements incurred subsequent to acquisition, or fair value less costs to sell. Investments in partnerships reflect the Company's interest in joint venture real estate developments. Investments in partnerships which are greater than 20% but less than 50% owned by the Company are accounted for using the equity method and are carried at the Company's equity in the underlying net assets. LOANS Loans are stated at the principal amount outstanding, net of unearned income. Interest income on loans is accrued based on rates applied to amounts outstanding. Unearned income on loans made or purchased on a discounted basis are recognized in interest income over the lives of the loans using a method that approximates a level yield. Loans held for sale are carried at the lower of cost or market value. Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount is amortized as a yield adjustment over the estimated life of the loans using a method that approximates a level yield method. Loans on which the accrual of interest has been discontinued are classified as nonaccrual loans. Interest accruals on loans are normally discontinued whenever the payment of interest or principal is more than 90 days past due or when, in the opinion of management, such action is prudent. When a loan is placed on nonaccrual status, all interest previously accrued in the current year but not collected is reversed against current year interest income. Loans are removed from nonaccrual status when they become current as to principal and interest and when, in the opinion of management, the loans are estimated to be fully collectible as to principal and interest. The Company may continue to accrue interest on loans past due 90 days or more that are well secured and in the process of collection. Restructured loans are loans for which concessions, including reduction of interest rates or deferral of interest or principal payments, have been granted to acknowledge changes in the borrower's financial condition or changes in underlying cash flows of the loan's collateral. Interest income on restructured loans is accrued at the modified rates after a satisfactory period of performance (generally six months). 46 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Company records the allowance for possible loan losses related to impaired loans based on the present value of expected cash flows discounted at the loan's effective interest rate or, as a practical expedient, the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Impaired loans are defined as those loans, where, based on current information and events, it is probable that the creditor will be unable to collect all amounts due, both interest and principal, according to the contractual terms of the loan agreement. Generally, interest income received on impaired loans either continues to be applied against principal or is realized as interest income, according to management's judgment as to the collectability of the principal. ALLOWANCE FOR POSSIBLE LOAN LOSSES The allowance for possible loan losses is established through charges against income. Loans deemed uncollectable are charged against the allowance, while recoveries of amounts previously charged-off are credited to the allowance. The allowance represents an amount which, in management's judgment, will be adequate to absorb probable losses on existing loans that may become uncollectable. Management's judgment in determining the adequacy of the allowance is based on various factors influencing the collectability of the loan. These factors include, but are not limited to, an analysis of the borrower's ability to meet the repayment terms, the borrower's overall financial condition, the estimated value of collateral supporting the credit, the concentration of credit risk in the portfolio and judgments as to the effect of current and anticipated economic conditions. Management's determination of the allowance is, by necessity, dependent upon estimates, appraisals and judgments, which may change because of changing economic conditions and the Company's perception as to how these factors may affect the financial condition of the borrowers. FORECLOSED REAL ESTATE Real estate acquired through foreclosure is transferred to foreclosed real estate at the lower of the estimated fair value of the asset acquired or book value. The excess if any, of the loan over the fair value of the property at the time of transfer is charged to the allowance for possible loan losses. Subsequent declines in the value of the property are reflected as a valuation allowance and charged to operations. Subsequent to transfer, foreclosed real estate is carried at the lower of cost or the estimated fair value less expenses to dispose of the asset. PREMISES, FURNITURE AND FIXTURES Premises, furniture and fixtures are stated at cost less accumulated depreciation and amortization. Depreciation is computed by use of the straight-line method over the estimated useful lives of the related assets, ranging from 3 to 30 years. Leasehold improvements are amortized over the shorter of the lease terms or the useful life of the improvement. FAIR VALUES OF FINANCIAL INSTRUMENTS The Company follows SFAS 107, "Disclosures about Fair Value of Financial Instruments," which requires disclosure of fair value information about financial instruments, whether or not recognized in the statement of financial position, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The calculation of fair value estimates is dependent upon certain subjective assumptions and involves significant uncertainties, resulting in variability in estimates with changes in assumptions. Potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected in the fair value amounts disclosed. SFAS 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. In addition, the fair value 47 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) estimates are not intended to reflect the liquidation value of the financial instruments. The following methods and assumptions were used by the Company to estimate the fair value for each class of financial instruments for which it is practicable to estimate that value. Cash and short-term investments--The carrying amounts for cash and short- term investments are reasonable estimates of those assets' fair values. Investment securities--Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices for similar securities, adjusted for unique risk characteristics, where appropriate. Loans receivable, net--For adjustable rate residential loans that reprice frequently and with no significant change in credit risk, fair values are based on quoted market prices available in the secondary market. For certain homogeneous categories of loans, such as some residential fixed rate mortgages, fair value is estimated using the quoted market price for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Accrued interest and dividends receivable--The carrying amount of interest and dividends receivable approximates its fair value. Deposit liabilities--The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date, that is, the carrying value. The fair value of fixed maturity certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates currently offered for deposits of similar remaining maturities on the future cash flows expected to be paid on the deposits. In estimating the fair value of deposit liabilities, SFAS 107 prohibits financial entities from taking into account the value of its long- term relationships with depositors, commonly known as core deposit intangibles. Federal Home Loan Bank advances--The fair value of advances from the Federal Home Loan Bank of Boston is based on discounted values of contractual cash flows using rates currently offered for instruments with similar terms and maturities or, when available, quoted market prices. Securities sold under agreements to repurchase--The fair value of securities sold under agreements to repurchase are based on the discounted value of contractual cash flows using dealer quoted rates for agreements of similar terms and maturities. Loans payable --The fair values of the Company's loans payable are estimated using discounted cash flow analyses, based on rates currently available to the Company for debt with similar terms and remaining maturities. Standby letters of credit--The estimated fair value of financial guarantees, such as standby letters of credit, are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the creditworthiness of the counterparties or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. Commitments to extend credit--The fair value of commitments to extend credit, which includes unused lines of credit and commitments to fund loans, is estimated using the fees currently charged to enter into similar agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The commitments to extend credit have terms that are consistent with current market terms. 48 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) LONG-LIVED ASSETS In March 1995, the Financial Accounting Standards Board ("FASB") issued SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The adoption of this statement did not have a material impact on the Company's results of operations. PENSION PLAN AND OTHER EMPLOYEE BENEFIT PLANS All eligible employees of SIS Bank are covered by a non-contributory defined benefit pension plan which is administered by the Savings Bank Employees' Retirement Association. All eligible employees of GBT are covered by a non- contributory defined benefit pension plan which is administered by CIGNA. The pension plans are funded in an amount consistent with the funding requirements of federal laws and regulations. The Company sponsors postretirement health care and life insurance benefit plans that provide health care and life insurance benefits for retired employees that have met certain age and service requirements. Postretirement health care and life insurance benefits expense is based upon an actuarial computation of current and future benefits to earnings for employees and retirees. The Company accounts for its postretirement health care and life insurance benefits in accordance with SFAS 106 "Employers' Accounting for Postretirement Benefits Other Than Pensions." Benefits such as salary continuation, supplemental unemployment benefits, severance benefits, disability-related benefits (including workers' compensation), job training and counseling and continuation of such benefits as health care and life insurance coverage are accounted for under SFAS 112, "Employers' Accounting for Postemployment Benefits." SFAS 112 requires accrual of a liability for all types of benefits paid to former or inactive employees after employment but before retirement. The Company sponsors a leveraged employee stock ownership plan ("ESOP") that covers all full-time and part-time employees with more than one year of service at the Company. The ESOP was formed with the completion of SIS Bank's conversion from mutual to stock form (the "Conversion") on February 7, 1995 (see Note 3). The Company makes annual contributions to the ESOP equal to the ESOP's debt service. The ESOP's shares initially were pledged as collateral for its debt. As the debt is repaid, shares are released from collateral and allocated to active employees, based on the proportion of debt service paid during the year in excess of dividends on ESOP stock and other earnings applied to repayment of the ESOP's debt. The Company accounts for its ESOP in accordance with the American Institute of Certified Public Accountants' Statement of Position (SOP) 93-6. Accordingly, the debt of the ESOP is recorded as long-term debt and the shares pledged as collateral are reported as unearned compensation in the Company's Consolidated Balance Sheet. As shares are released from collateral, the Company records compensation expense equal to the current market price of the shares, and the shares are treated as outstanding for purposes of calculating earnings per share. The Financial Accounting Standards Board has issued SFAS 123, "Accounting for Stock Based Compensation" which gives companies the option of employing intrinsic value accounting under the guidelines of Accounting Principles Board Opinion No. 25 (APB 25) or fair value accounting for stock based compensation. While SFAS 123 does not require the adoption of fair value accounting, it does require certain disclosures in the financial statements as if fair value accounting had been adopted, including pro forma net income and earnings per share. The Company adopted this accounting standard effective January 1, 1996 for disclosure purposes only and will continue to apply APB 25 in accounting for stock based compensation. 49 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Company's Management and Directors Stock Option Plans (the "Stock Option Plans") were approved by SIS Bank's stockholders on May 31, 1995 and were assumed by the Company upon the completion of the Reorganization. The Stock Option Plans provide for the granting of incentive and nonqualified stock options to certain employees and non-employee directors of the Company and its wholly-owned subsidiaries for the purchase of the Company's common stock at 100 percent of the fair market value at the date of grant. The maximum option term is 10 years. Options granted to non-employee Directors of the Company or Banks under the Stock Option Plans are exercisable in installments of 20% per year commencing on the first anniversary of the date of grant. Options granted to employees of the Company and its subsidiaries under the Stock Option Plans will vest in accordance with the terms set by the Company's Compensation Committee with the ratification of the Company's Board of Directors. Under the terms of the Stock Option Plans, 806,250 shares of authorized but unissued common stock were reserved for issuance under the Stock Option Plans. At December 31, 1997 and 1996, 104,350 and 211,950 stock options were available for grant under the Stock Option Plans, respectively. The Company's Management and Directors Restricted Stock Plans (the "Restricted Stock Plans") were approved by SIS Bank's stockholders on May 31, 1995 and were assumed by the Company upon completion of the Reorganization. The Restricted Stock Plans provide for the awarding of restricted stock to certain employees and non-employee directors of the Company and its wholly- owned subsidiaries. The restricted stock vests over a period of time provided that the awardee continues to be employed by or serves as a director of the Company. Under the terms of the Restricted Stock Plans, 222,500 shares of restricted stock were reserved for awarding under the Restricted Stock Plans. Each award of restricted stock to non-employee Directors of the Company or Banks under the Restricted Stock Plans vests in installments of 20% per year commencing on the first anniversary of the date of grant. Each award of restricted stock to employees of the Company and its subsidiaries under the Restricted Stock Plans vests in accordance with the terms set by the Company's Compensation Committee with ratification of the Company's Board of Directors. At December 31, 1997 and 1996, 58,400 and 61,400 shares of restricted stock were available for grant under the Restricted Stock Plans. The Company sponsors a defined contribution profit sharing plan (the "Plan"), with cash or deferral arrangements permitted by Internal Revenue Code subsection 401(k). The Plan was formed by the Company in 1995. Substantially all employees are eligible to participate after satisfaction of the one year service requirement under the Plan. Under the savings aspect of the Plan, employees may contribute 1% to 12% of base compensation with up to 6% being eligible for matching contributions, at 25%, from the Company. Contributions to the Plan by the Company were $141 for the year ended December 31, 1997 as compared to $120 for the year ended December 31, 1996. MORTGAGE BANKING ACTIVITIES Fees paid for the right to service mortgage loans are capitalized and amortized in proportion to, and over the period of, estimated net servicing income. Amortization is adjusted prospectively to reflect increases or decreases in prepayment experience. Purchased mortgage servicing rights of $936 and $412 at December 31, 1997 and 1996, respectively, are included in other assets. Servicing income represents fees earned for servicing real estate mortgage loans owned by outside investors. The fees are calculated on the outstanding principal balances of the loans serviced and are recorded as income when earned. The mortgage loans being serviced for outside investors are not included in the consolidated financial statements because they are not assets of the Company. The Company maintained a servicing portfolio for other investors of $768,108 and $827,267 at December 31, 1997 and 1996, respectively. Effective January 1, 1996, the Company adopted SFAS 122, "Accounting for Mortgage Service Rights." SFAS 122 amends certain provisions of SFAS 65, "Accounting for Certain Mortgage Banking Activities," to eliminate the accounting distinction between rights to service mortgage loans for others that are acquired through 50 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) loan origination activities and those acquired through purchase transactions. The adoption of this statement did not have a material impact on the Company's results of operations or financial position. Effective January 1, 1997, the Company adopted SFAS 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS 125 supersedes SFAS 122 and provides accounting and reporting standards which require that after a transfer of financial assets, an entity recognizes the financial and servicing asset it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. In addition, this statement provides guidance on the accounting for initial capitalization and subsequent carrying amounts for mortgage servicing rights. The adoption of this Statement did not have a material impact on the Company's results of operations or financial position. MERCHANT PROCESSING The Company recognizes fees arising from the sales and processing of merchant card services as merchant income. In addition, the Company includes $643 and $600 at December 31, 1997 and 1996, respectively, in its allowance for possible loan losses for potential losses related to its merchant processing business. Such amounts are determined based on an historical loss analysis of the Company's merchant processing business. INCOME TAXES The Company uses the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. EARNINGS PER SHARE SFAS No. 128, "Earnings per Share" is effective for periods ending after December 15, 1997. SFAS No. 128 simplifies the standards of computing earnings per share (EPS) previously found in APB Opinion No. 15. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS pursuant to APB Opinion No. 15. The Company has computed and presented basic and diluted EPS for the years ended December 31, 1997, 1996 and 1995 in accordance with SFAS No. 128 (see Note 18). Both basic and diluted net income per share for the year ended December 31, 1995 are computed on a pro forma basis as if the stock issued in the Conversion (as defined below) had been issued as of the beginning of 1995 and is adjusted for common stock equivalents as appropriate. 51 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the FASB issued SFAS 130 "Reporting Comprehensive Income" which establishes standards for disclosure of comprehensive income. Comprehensive income represents the change in equity of a business during a period from transactions and other events and circumstances from non- shareholder sources. SFAS 130 requires the restatement of prior periods for comparative purposes. The Company adopted SFAS 130 on January 1, 1998 and management does not expect the adoption to have a material impact on the Company's financial position or results of operations. In June 1997, the FASB issued SFAS 131 "Disclosures about Segments of an Enterprise and Related Information" which establishes standards for the way that public business enterprises report financial and descriptive information about operating segments. SFAS 131 defines an operating segment as components of an enterprise about which separate financial information is available that is evaluated by management in deciding how to allocate resources and in assessing performance. The Company adopted SFAS 131 on January 1, 1998 and management does not expect the adoption to have a material impact on the Company's financial position or results of operations. In February 1998, the FASB issued SFAS 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits--an amendment of FASB Statements No. 87, 88 and 106" (SFAS 132) which revises employers' disclosures about pension and other postretirement benefit plans, though it does not change the measurement or recognition of those plans. The Company adopted SFAS 132 effective January 1, 1998 and management does not expect the adoption to have a material effect on the Company's financial position or results of operations. 52 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 2. ACQUISITION OF GLASTONBURY BANK & TRUST COMPANY On December 17, 1997 the Company acquired GBT by issuing 1,354,141 shares of the Company's common stock in exchange for all the outstanding shares of GBT. The transaction was accounted for as a pooling of interests. Accordingly, the Company's historical financial statements have been restated to reflect the combination with GBT. Combined and separate results of the Company and GBT during the periods preceding the merger were as follows (certain reclassifications have been made to conform to presentation): SIS GBT TOTAL ------- ------ ------- YEAR ENDING DECEMBER 31, 1995 Net interest and dividend income after provision for possible loan losses............ $33,001 $7,585 $40,586 Non interest income............................ $ 8,124 $3,683 $11,807 Net income..................................... $11,459 $1,642 $13,101 Other changes in stockholders' equity, net..... $41,507 $5,292 $46,799 YEAR ENDING DECEMBER 31, 1996 Net interest and dividend income after provision for possible loan losses............ $40,154 $8,809 $48,963 Non interest income............................ $11,470 $3,336 $14,806 Net income..................................... $18,160 $2,525 $20,685 Other changes in stockholders' equity, net..... $ 2,288 $ (630) $ 1,658 YEAR ENDING DECEMBER 31, 1997(1) Net interest and dividend income after provision for possible loan losses............ $48,485 $9,709 $58,194 Non interest income............................ $12,474 $3,368 $15,842 Net income..................................... $10,815 $ 603 $11,418 Other changes in stockholders' equity, net..... $(4,831) $ 99 $(4,732) - -------- (1) Period ending most recent to the date of acquisition. The company incurred merger related expenses of $5,228 in the fourth quarter of 1997, including expenses of $4,968 and a loss of $260 related to the restructuring of GBT's investment portfolio (see Note 5). 3. CONVERSION AND REGULATORY MATTERS SIS Bank completed its conversion from a mutual to a stockholder-owned bank on February 7, 1995 (the "Conversion"). The Conversion resulted in a net increase to capital of $35.9 million and a classification of SIS Bank as "well-capitalized" under applicable regulatory definitions. During 1995 GBT had been under a Cease & Desist Order dated September 27,1993 with the FDIC (the "GBT Order"), which required GBT to, among other things, reduce its levels of classified assets and maintain a Tier 1 leverage capital ratio of 6%. GBT raised additional capital through a rights offering in the fourth quarter of 1995, and conducted a bulk sale of nonperforming assets in late 1995. In May, 1996, the FDIC unconditionally terminated the GBT Order in recognition of GBT's improvement to capital, reduced nonperforming asset levels, and satisfactory resolution of all other regulatory concerns. SIS Bank has been in the process of divesting its real estate business that was largely conducted through Colebrook Corporation and SIS Bank's other wholly-owned real estate investment subsidiaries (collectively the 53 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) "Real Estate Subsidiaries"). This divestment is required by FDICIA. SIS Bank's divestment of all such real estate investment activities pursuant to a divestiture plan previously approved by the FDIC, was initially scheduled to be completed by December 31, 1997, and now is scheduled to be completed in June 30, 1998. The FDIC has been notified of this extension and has granted its approval. 4. CASH AND DUE FROM BANKS Under provisions of the Federal Reserve Act, depository institutions are required to maintain certain average balances in the form of cash or non- interest bearing balances with a Federal Reserve Bank. Reserve balances of $4,881 and $5,670 at December 31, 1997 and 1996, respectively, were maintained in accordance with these requirements. 5. INVESTMENT SECURITIES The amortized cost, unrealized gains and losses and approximate fair values of investment securities were as follows: Securities Available for Sale DECEMBER 31, 1997 ---------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- -------- U.S. Government and agency obligations..................... $ 15,608 $ 35 $ (7) $ 15,636 Collateralized mortgage obligations..................... 51,273 218 (76) 51,415 Mortgage-backed securities....... 458,659 2,855 (1,036) 460,478 State and Municipal bonds........ 8,966 389 -- 9,355 Federal Home Loan Bank and other stock........................... 38,128 1,096 -- 39,224 -------- ------ ------- -------- Total........................ $572,634 $4,593 $(1,119) $576,108 ======== ====== ======= ======== Securities Held to Maturity DECEMBER 31, 1997 ---------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- -------- U.S. Government and agency obligations..................... $ 2,400 $ -- $ (9) $ 2,391 Collateralized mortgage obligations..................... 2,934 44 (25) 2,953 Mortgage-backed securities....... 141,282 699 (418) 141,563 Asset-backed securities.......... 46,046 241 (144) 46,143 Other bonds and short-term obligations..................... 345 1 -- 346 Federal Home Loan Bank and other stock........................... -- -- -- -- -------- ---- ----- -------- Total........................ $193,007 $985 $(596) $193,396 ======== ==== ===== ======== 54 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Securities Available for Sale DECEMBER 31, 1996 ---------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- -------- U.S. Government and agency obligations..................... $ 31,458 $ 58 $ (56) $ 31,460 Collateralized mortgage obligations..................... 43,337 128 (245) 43,220 Mortgage-backed securities....... 387,467 2,739 (609) 389,597 State and Municipal bonds........ 855 3 (1) 857 Other bonds and short-term obligations..................... 1,681 -- -- 1,681 Federal Home Loan Bank and other stock........................... 16,601 199 (1) 16,799 -------- ------ ----- -------- Total........................ $481,399 $3,127 $(912) $483,614 ======== ====== ===== ======== Securities Held to Maturity DECEMBER 31, 1996 ---------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- -------- U.S. Government and agency obligations..................... $ 7,932 $ -- $ (105) $ 7,827 Collateralized mortgage obligations..................... 5,062 151 (7) 5,206 Mortgage-backed securities....... 164,934 647 (1,470) 164,111 Asset-backed securities.......... 42,118 118 (71) 42,165 State and Municipal bonds........ 185 -- -- 185 Other bonds and short-term obligations..................... 415 2 -- 417 -------- ---- ------- -------- Total........................ $220,646 $918 $(1,653) $219,911 ======== ==== ======= ======== At December 31, 1997, the net unrealized gain, net of tax effect, on available for sale securities that was included as a separate component of stockholders' equity was $2,133. At December 31, 1996, the net unrealized gain, net of tax effect, on available for sale securities was $1,453. Proceeds from the sale of available for sale investment securities were $21,005 and $56,980 during 1997 and 1996, respectively. Gross realized gains on sales of available for sale investment securities were $78 in 1997 and $313 in 1996, while gross realized losses were $98 in 1997 and $121 in 1996. Trading securities were held at GBT during 1997 and 1996, however, the Company liquidated GBT's trading portfolio effective with the merger. In 1997, net gains on trading securities included a decrease of $59 in unrealized holding gains, gross realized gains of $172, and net realized losses on put and call options of $78. In 1996, net gains on trading securities included an increase of $59 in unrealized holding gains, gross realized gains of $2 and net realized losses on put and call options of $46. In 1995, the Financial Accounting Standards Board ("FASB") issued a special report, "Implementation of Statement 115," that provided additional guidance related to the application of SFAS 115. In connection with the issuance of this special report, the FASB allowed all organizations to review their portfolio classifications and make a one-time reclassification of securities between categories during the period from November 15, 1995 to December 15, 1995. On December 15, 1995, the Company transferred securities with an amortized cost of $94,736 and an unrealized loss of $1,195 from the held to maturity portfolio to the available for sale portfolio. In addition, the Company also transferred securities with an estimated fair value of $47,280 and an unrealized gain of $299 from the available for sale portfolio to the held to maturity portfolio. Subsequent to the transfer of these securities, the Company sold $82,900 of available for sale securities in December 1995 at a net loss of $899. 55 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) In December, 1997 in connection with the acquisition of GBT, the Company sold $20,560 in investments from the held to maturity and available for sale portfolios in order to maintain its existing interest rate risk position. However, the Company intends to hold to maturity its debt and equity securities which are so classified. The company realized a net loss of $260 related to these sales. At December 31, 1997, investment securities having a carrying value of $141,894 and an estimated fair value of $141,953 were pledged to collateralize securities sold under agreements to repurchase and other items. The amortized cost and estimated fair value of debt securities are shown below by contractual maturity. Actual maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties. DECEMBER 31, 1997 ----------------------------------------- SECURITIES AVAILABLE SECURITIES HELD FOR SALE TO MATURITY ---------------------- ------------------ AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE ---------------------- --------- -------- Within 1 year..................... $ -- $ -- $ 105 $ 105 1-5 years......................... 30,838 30,962 6,558 6,561 5-10 years........................ 15,409 15,498 10,938 10,972 over ten years.................... 488,259 490,424 175,406 175,758 ---------- ---------- -------- -------- Total......................... $ 534,506 $ 536,884 $193,007 $193,396 ========== ========== ======== ======== DECEMBER 31, 1996 ----------------------------------------- SECURITIES AVAILABLE SECURITIES HELD FOR SALE TO MATURITY ---------------------- ------------------ AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE ---------------------- --------- -------- Within 1 year..................... $ 8,202 $ 8,213 $ 6,404 $ 6,392 1-5 years......................... 61,103 61,209 14,010 13,866 5-10 years........................ 10,889 10,773 11,166 11,158 over ten years.................... 384,604 386,620 189,066 188,495 ---------- ---------- -------- -------- Total......................... $ 464,798 $ 466,815 $220,646 $219,911 ========== ========== ======== ======== As of December 31, 1997, approximately 97.1% of mortgage-backed securities available for sale and 67.1% of mortgage-backed securities held to maturity were adjustable rate. 6. INVESTMENTS IN REAL ESTATE AND REAL ESTATE PARTNERSHIPS The Company has certain subsidiaries that are engaged in various real estate activities individually or in joint ventures with unaffiliated partners. Investments in real estate and real estate partnerships are composed of the following: DECEMBER 31, ------------- 1997 1996 ------ ------ Operating properties Land...................................................... $ 946 $ 688 Buildings and improvements, net of accumulated depreciation of $2,946 and $2,832, respectively.......... 1,957 2,042 ------ ------ Total investments in real estate............................ 2,903 2,730 Investments in real estate partnerships..................... -- 27 ------ ------ Investments in real estate and real estate partnerships........................................... $2,903 $2,757 ====== ====== 56 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Net (income) expense of real estate operations is summarized as follows: FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 --------- --------- --------- Net (income) expenses of operating real estate....................... $ (47) $ (26) $ (3) Writedowns on real estate.......... 10 447 6 Net (gain)/loss on sale of real estate............................ (611) (693) (230) Divestment reserve................. 1,000 -- -- --------- -------- -------- Net (income) expenses of real estate operations............. $ 352 $ (272) $ (227) ========= ======== ======== Depreciation expense of $113 in 1997, $299 in 1996, and $381 in 1995 is included in net expense of real estate operations. Losses recorded from the real estate partnerships under the equity method were $7, $110 and $69 for the same three year period and are also included in net expense of real estate operations. Loans to these partnerships at December 31, 1997 and 1996 amounted to zero and $150, respectively. The Company plans to complete its divestment of its real estate business by June 30, 1998. Accordingly, during 1997, the Company established a reserve of $1,000 for severance and other expenses related to the divestment. At December 31, 1997, no amounts have been paid relating to the divestiture and the entire reserve is included as a component of investments in real estate and real estate partnerships. 7. LOANS RECEIVABLE, NET Loans receivable, net, is composed of the following: DECEMBER 31, ------------------ 1997 1996 -------- -------- Residential real estate loans.......................... $281,457 $295,503 Commercial real estate loans........................... 185,226 171,744 Commercial loans....................................... 212,869 179,705 Home equity loans...................................... 158,753 118,235 Consumer loans......................................... 11,189 8,920 -------- -------- Total loans receivable................................. 849,494 774,107 Less: Unearned discounts..................................... (1,991) (820) Allowance for possible losses.......................... 22,724 19,549 -------- -------- Loans receivable, net.................................. $828,761 $755,378 ======== ======== At December 31, 1997 and December 31, 1996, residential real estate loans included loans held for sale of $8,252 and $5,171, respectively, which were carried at the lower of cost or market. RISK ELEMENTS The Company grants commercial and residential loans to customers primarily in New England. Although the Company has a diversified portfolio, its debtors' ability to honor their contracts is substantially dependent upon the general economic conditions of the region. The Company manages its loan portfolio to avoid concentration by industry or loan size to minimize its credit exposure. Commercial loans may be collateralized by the assets underlying the borrowers' business such as accounts receivable, equipment, inventory and real property. Residential mortgage and home equity loans are generally secured by the real property financed. Commercial real estate loans are generally secured by the underlying real property and lease agreements. 57 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The following table shows the components of non-performing assets: DECEMBER 31, -------------- 1997 1996 ------ ------- Non-accruing loans......................................... $5,352 $ 8,011 Loans past due 90 days and still accruing.................. 431 428 ------ ------- Total non-performing loans................................. 5,783 8,439 Foreclosed real estate, net................................ 1,209 1,540 Restructured loans on accrual status....................... 1,124 892 ------ ------- Total non-performing assets............................ $8,116 $10,871 ====== ======= The principal amount of non-performing loans, excluding non-performing restructured loans, aggregated approximately $5,223 and $7,820 at December 31, 1997 and 1996, respectively. Interest income that would have been recorded if the loans had been performing in accordance with their original terms aggregated $530, $1,035 and $1,251 for the years ended December 31, 1997, 1996 and 1995, respectively. Interest income recorded on these loans during the three years ended December 31, 1997, 1996 and 1995 was $373, $830 and $1,014, respectively. The principal amount of restructured loans aggregated $1,666 at December 31, 1997, and $1,511 at December 31, 1996. Interest income that would have been recorded if the loans had been performing in accordance with their original terms aggregated $246, $238 and $522 for the years ended December 31, 1997, 1996 and 1995, respectively. Interest income recorded on these loans amounted to $107, $79 and $243 for the years ended December 31, 1997, 1996 and 1995, respectively. WATCH LIST LOANS The Company maintains a "watch list" of loans, which represents performing loans that have potential weaknesses that require management's attention. These potential weaknesses may stem from a variety of factors including, among other things, economic or market conditions, adverse terms in the obligor's operations or balance sheet weaknesses. Watch list loans totaled $24,082 and $33,190 at December 31, 1997 and 1996, respectively. CLASSIFIED LOANS The Company's Credit Grade Policy (the "Policy") provides for the classification of loans considered to be lesser quality as "substandard", "doubtful", or "loss" loans. A loan is considered substandard under the Company's Policy if it is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans include those characterized by the "distinct possibility" that the Company will sustain "some loss" if the deficiencies are not corrected. Loans classified as doubtful under the Company's Policy have all of the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses present make "collection or liquidation in full" on the basis of currently existing facts, conditions and values, "improbable." Assets characterized as loss are those considered "uncollectible" and of such little value that their continuance as bankable assets is not warranted. Substandard classified loans totaled $6,244 and $9,374 at December 31, 1997 and 1996, respectively. Doubtful classified loans totaled zero and $53 thousand at December 31, 1997 and 1996, respectively. Included in classified loans are $5,352 and $8,011 of loans which have been reported as non-performing loans at December 31, 1997 and 1996, respectively. LOANS TO RELATED PARTIES At December 31, 1997, and 1996, the amount of loans outstanding to directors, officers and other related parties (including real estate partnerships) was approximately $4,261 and $8,212, respectively. There were no 58 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) non-accrual loans included in the loans to related parties at December 31, 1997 and 1996. During 1997 and 1996, new loans aggregating $1,388 and $1,416, respectively, were made or added and deductions and repayments totaled $5,339 and $4,338, respectively. There were no charge-offs made against these loans in 1997 and 1996. Changes in the composition of the related parties resulted in additions to or deductions from loans outstanding to related parties. Loans made to insiders are on substantially the same terms as available to the general public. 8. ALLOWANCE FOR POSSIBLE LOAN LOSSES Changes in the allowance for possible loan losses are summarized as follows: FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- Balance, beginning of year........... $ 19,549 $ 18,612 $ 20,918 Provision charged to operating expense............................. 1,895 3,721 6,262 Loan charge-offs..................... (2,212) (5,152) (9,756) Loan recoveries...................... 3,492 2,368 1,188 ---------- ---------- ---------- Balance, end of year............. $ 22,724 $ 19,549 $ 18,612 ========== ========== ========== As discussed in Note 1, the Company adopted SFAS 114 effective January 1, 1995. The SFAS 114 analysis is applied only to the commercial and commercial real estate loan portfolios. Because of their homogeneous nature, the Company's residential mortgage, home equity and consumer portfolios are evaluated collectively for impairment and a reserve requirement is developed under the historical loss method. Impaired loans are those loans for which, based on current information, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. All commercial and commercial real estate non-accrual loans are considered impaired loans, however the impaired classification may also include other loans which in Management's judgment meet the criteria described above. At December 31, 1997, the recorded investment in loans that are considered impaired under SFAS 114 was $5,271 as compared to $8,001 at December 31, 1996. Included in this amount as of December 31, 1997 is $2,037 of impaired loans for which the related SFAS 114 allowance is $431 and $3,234 of impaired loans for which the SFAS 114 allowance is zero. At December 31, 1996 there were $2,850 of impaired loans for which the related SFAS 114 allowance was $243 and $5,151 of impaired loans for which the SFAS 114 allowance was zero. The average recorded investment in impaired loans during the year ended December 31, 1997 was approximately $8,950 as compared to $9,736 at December 31, 1996. For the years ended December 31, 1997 and 1996, the Company recognized interest income on these impaired loans of $512 and $328, respectively. 9. FORECLOSED REAL ESTATE, NET Foreclosed real estate, net consists of the following: FOR THE YEARS ENDED DECEMBER 31, ------------- 1997 1996 ------ ------ Residential................................................. $ 296 $ 684 Commercial.................................................. 913 913 ------ ------ 1,209 1,597 Less valuation allowance.................................... -- 57 ------ ------ Foreclosed real estate, net................................. $1,209 $1,540 ====== ====== 59 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Changes in the allowance for foreclosed real estate are summarized as follows: FOR THE YEARS ENDED DECEMBER 31, ----------------------------------- 1997 1996 1995 ---------- ---------- ------------ Balance, beginning of year.......... $ 57 $ 775 $ 542 Provision charged to expense........ 11 10 1,619 Dispositions, net................... (68) (728) (1,386) --------- ---------- ------------ Balance, end of year............ $ -- $ 57 $ 775 ========= ========== ============ Foreclosed real estate expense is summarized as follows: FOR THE YEARS ENDED DECEMBER 31, ----------------------------------- 1997 1996 1995 ---------- ---------- ------------ Net expense (income) of operating foreclosed real estate............. $ 86 $ 228 $ 26 Writedowns and (income) loss on foreclosed real estate, net........ (91) 221 1,332 --------- ---------- ------------ Foreclosed real estate expense.. $ (5) $ 449 $ 1,358 ========= ========== ============ 10. BANK PREMISES, FURNITURE AND FIXTURES, NET Major categories of fixed assets are as follows: DECEMBER 31, --------------- 1997 1996 ------- ------- Buildings and improvements.............................. $36,701 $36,033 Leasehold improvements.................................. 11,257 9,633 Furniture and fixtures.................................. 23,466 22,360 ------- ------- 71,424 68,026 Less accumulated depreciation........................... 35,581 33,479 ------- ------- Bank premises, furniture and fixtures, net.............. $35,843 $34,547 ======= ======= Depreciation expense aggregated $4,046, $3,724 and $3,693 for the years ended December 31, 1997, 1996 and 1995, respectively, and is included in occupancy expense and furniture and equipment expense. Rental income of $1,508, $1,584 and $1,419 for the years ended December 31, 1997, 1996, and 1995, respectively, is included in occupancy expense. 60 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 11. DEPOSITS Deposits consist of the following: DECEMBER 31, --------------------- 1997 1996 ---------- ---------- Demand deposits..................................... $ 171,343 $ 135,965 NOW accounts (1).................................... 51,412 81,943 Money manager accounts (1).......................... 39,447 -- Savings accounts.................................... 263,449 253,358 Money market accounts............................... 211,286 209,523 Time deposits....................................... Time deposits under $100............................ 442,948 433,473 Time deposits of $100 or more....................... 87,413 63,299 ---------- ---------- Total deposits.................................... $1,267,298 $1,177,561 ========== ========== - -------- (1) During July 1997, the Company implemented a program which converted certain NOW accounts to money manager accounts. This program has no effect on the Company's depositors, but has provided additional investable funds to the Company by substantially reducing the reserve balances required to be maintained at the Federal Reserve Bank of Boston. 12. FEDERAL HOME LOAN BANK ADVANCES Pursuant to a blanket pledge agreement with the Federal Home Loan Bank ("FHLB") of Boston, advances are secured by the Company's stock in the FHLB, certain qualifying first mortgage loans, mortgage-backed and mortgage-related securities, and other securities not otherwise pledged. Advances from the FHLB at December 31, 1997 and 1996 are summarized as follows: DECEMBER 31, ---------------------------------- 1997 1996 ----------------- ---------------- WEIGHTED WEIGHTED AVERAGE AVERAGE YEAR OF MATURITY AMOUNT RATE AMOUNT RATE ---------------- -------- -------- ------- -------- 1997.................................... $ -- -- $66,000 5.54% 1998.................................... 155,800 5.76% 12,000 5.86% 1999.................................... 2,000 6.58% 2,000 6.58% 2000.................................... 1,000 6.11% 1,000 6.11% 2001.................................... 1,074 6.23% 1,100 6.23% 2002.................................... 10,434 6.74% -- -- 2004.................................... 1,235 6.31% -- -- 2006.................................... 1,119 6.39% 1,200 6.39% 2007.................................... 3,660 6.45% -- -- 2009.................................... 686 6.97% -- -- 2011.................................... 1,622 6.97% 1,690 6.97% 2012.................................... 1,073 5.55% -- -- 2015.................................... 1,466 6.23% 1,484 6.23% 2016.................................... 2,952 7.18% 2,997 7.18% -------- ---- ------- ---- $184,121 5.89% $89,471 5.73% ======== ==== ======= ==== 61 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The FHLB advances above which mature in the year 2001 and beyond are amortizing borrowings. The outstanding balances for each amortizing advance at December 31, 1997 and 1996 are listed above by their contractual maturities. At December 31, 1997 there was a commitment for a Community Investment Program Plus advance from the FHLB for $2,500 at 7.02% for settlement on March 16, 1998. At December 31, 1996 there was a commitment for a Community Investment Program Plus advance from the FHLB for $1,880 at 6.38% for settlement on January 15, 1997. 13. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE At December 31, 1997 and December 31, 1996, securities sold under agreements to repurchase totaled $113,299 and $176,927 respectively. These agreements are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the Consolidated Balance Sheet. An analysis of securities sold under agreements to repurchase identical securities for the years ended December 31, 1997, 1996 and 1995 is summarized as follows: DECEMBER 31, --------------------------- 1997 1996 1995 -------- -------- ------- Maximum month-end balance during the period... $189,133 $176,927 $39,552 Average balance during the period............. $153,938 $101,098 $19,297 Weighted average interest rate during the period....................................... 5.67% 5.47% 5.87% Weighted average interest rate at end of period....................................... 5.67% 5.49% 5.49% At December 31, 1997, securities sold under agreements to repurchase had maturity ranges from January 1998 to May 2000 with a weighted average maturity at December 31, 1997 of 306 days. At December 31, 1997, mortgage-backed securities with carrying values totaling $119,242 and estimated fair values totaling $119,144 and U.S. agency obligations with carrying values of $158 and estimated fair values totaling $158 were pledged as collateral for securities sold under agreements to repurchase. It is the Company's policy to enter into repurchase agreements only with major brokerage firms that are primary dealers in government securities. 14. LOANS PAYABLE Loans payable consist of the following: DECEMBER 31, ------------- 1997 1996 ------ ------ Note issued by the Company's Employee Stock Ownership Plan ("ESOP"), and guaranteed by the Company. This note is subject to mandatory redemption through the operation of a sinking fund commencing on the last business day of June 1995 and continuing on the last business day of each June and December thereafter. The note bears interest at a variable rate per annum equal to the Prime Rate as published from time to time in the Wall Street Journal. The interest rate at December 31, 1997 was 8.50%. The proceeds for the issuance of the note were used by the Company's ESOP solely for the purpose of purchasing 445,000 shares of the Company's common stock....... 2,492 2,848 ------ ------ $2,492 $2,848 ====== ====== 62 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Aggregate required principal payments on the loans payable at December 31, 1997 for the next five years and thereafter are as follows: 1998.............................. $ 356 1999.............................. 356 2000.............................. 356 2001.............................. 356 2002.............................. 356 2003 and thereafter............... 712 ------ $2,492 ====== At December 31, 1997, investment securities having a carrying value of $4,107 and an estimated fair value of $4,131 were pledged to collateralize a letter of credit supporting the ESOP note, which honors demands for payment by the Note Trustee presented in accordance with the terms of the letter of credit. At December 31, 1997, the Company had an available, but unused, line of credit in the amount of $22,000 with the FHLB of Boston through its Ideal Way program. At December 31, 1997 asset-backed securities having a carrying value of $10,617 and an estimated fair value of $10,687 were pledged to secure an available, but unused, line of credit in the amount of $10,000 with another financial institution. 15. FAIR MARKET VALUE OF FINANCIAL INSTRUMENTS The following table presents the Company's assets, liabilities, and unrecognized financial instruments at both their respective carrying or notional amounts and fair values. DECEMBER 31, 1997 DECEMBER 31, 1996 --------------------- --------------------- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE ---------- ---------- ---------- ---------- Financial Assets: Cash and due from banks...... $ 50,297 $ 50,297 $ 58,045 $ 58,045 Federal funds sold and interest-bearing deposits... 17,317 17,317 10,045 10,045 Investment securities........ 769,115 769,504 704,260 703,525 Trading assets............... -- -- 458 458 Loans receivable, net........ 828,761 853,026 755,378 771,712 Accrued interest and dividends receivable........ 10,749 10,749 10,417 10,417 Financial Liabilities: Deposits..................... $1,267,298 $1,268,324 $1,177,561 $1,178,614 Federal Home Loan Bank advances.................... 184,121 184,484 89,471 89,602 Securities sold under agreements to repurchase.... 113,299 113,440 176,927 176,894 Loans payable................ 2,492 2,492 2,848 2,848 NOTIONAL FAIR NOTIONAL FAIR AMOUNT VALUE AMOUNT VALUE ---------- ---------- ---------- ---------- Unrecognized Financial Instruments: Standby letters of credit.... $ 9,678 $ 97 $ 4,906 $ 49 Commitments to extend credit...................... 265,487 -- 206,402 -- 63 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Certain assets, which are not financial instruments and, accordingly, are not included in the above fair values, contribute substantial value to the Company in excess of the related amounts recognized in the balance sheet. These include the core deposit intangibles and the related retail banking network, and mortgage servicing rights. A discussion of the methodologies and assumptions used by the Company in determining these fair values is included in Note 1 under the subheading "Fair Values of Financial Instruments." 16. PENSION PLAN AND OTHER EMPLOYEE BENEFIT PLANS The Company's subsidiary banks, SIS Bank and GBT, have separate pension plans covering their respective employees. The Company's ESOP plan is shared by both SIS Bank and GBT employees. The SIS Bank pension plan covers all SIS Bank employees who meet certain age and service requirements. Vested benefits, paid at retirement, are computed based upon a formula considering length of service and average compensation. Plan assets consist of marketable equity securities and United States Government and agency obligations. Net periodic pension cost for 1997, 1996 and 1995 included the following components: FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- Service cost--current period......... $ 712 $ 786 $ 631 Interest cost on projected benefit obligation.......................... 635 712 725 Actual return on assets.............. (1,262) (1,330) (1,549) Net amortization and deferral........ 429 532 799 ---------- ---------- ---------- Net periodic pension cost............ $ 514 $ 700 $ 606 ========== ========== ========== Assumptions used in the accounting for pension cost in 1997, 1996, and 1995 were as follows: FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 ---------- ---------- ---------- Discount rate........................... 7.25% 7.50% 7.00% Average remaining service............... 27 years 28 years 28 years Expected long-term rate of return on plan assets............................ 8.0% 8.0% 8.0% The discount rate is the estimated rate at which the obligation for pension benefits could effectively be settled. The average wage increase assumption of 5% reflects the Company's best estimate of the future compensation levels of the individual employees covered by the plan. The expected long-term rate of return on plan assets reflects the average rate of earnings that the Company estimates will be generated on the assets of the plan. 64 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The funded status of the plan for its most recent fiscal years is as follows: OCTOBER 31, ---------------- 1997 1996 ------- ------- Accumulated benefit obligation Vested benefits........................................ $ 5,451 $ 5,027 Nonvested benefits..................................... 470 336 ------- ------- Accumulated benefit obligation........................... $ 5,921 $ 5,363 ======= ======= Projected benefit obligation............................. $(9,841) $(8,464) Plan assets at fair value................................ 9,556 8,357 ------- ------- Projected benefit obligation in excess of plan assets.... (285) (107) Unrecognized net gain.................................... (4,431) (4,076) Unrecognized net transition asset being recognized over 25 years................................................ (279) (297) ------- ------- Accrued pension cost..................................... $(4,995) $(4,480) ======= ======= The GBT pension plan covers all GBT employees who meet certain age and service requirements. Vested benefits, paid at retirement, are computed based upon a formula considering length of service and average compensation. Plan assets consist of marketable equity securities and United States Government and agency obligations. Net periodic pension cost for 1997, 1996 and 1995 included the following components: FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- Service cost--current period......... $ 120 $ 116 $ 69 Interest cost on projected benefit obligation.......................... 85 77 72 Actual return on assets.............. (82) (79) (74) Net amortization and deferral........ (15) (15) (15) ---------- ---------- ---------- Net periodic pension cost............ $ 108 $ 99 $ 52 ========== ========== ========== Assumptions used in the accounting for pension cost in 1997, 1996, and 1995 were as follows: FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ----------- ----------- ---------- Discount rate......................... 7.50% 7.50% 7.00% Average remaining service............. 10 years 10 years 8 years Expected long-term rate of return on plan assets.......................... 8.0% 8.0% 8.0% The discount rate is the estimated rate at which the obligation for pension benefits could effectively be settled. The average wage increase assumption of 4% reflects the Company's best estimate of the future compensation levels of the individual employees covered by the plan. The expected long-term rate of return on plan assets reflects the average rate of earnings that the Company estimates will be generated on the assets of the plan. 65 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The funded status of the plan for its most recent fiscal years is as follows: SEPTEMBER 30, ---------------- 1997 1996 ------- ------- Accumulated benefit obligation Vested benefits........................................ $ 966 $ 898 Nonvested benefits..................................... 120 96 ------- ------- Accumulated benefit obligation........................... $ 1,086 $ 994 ======= ======= Projected benefit obligation............................. $(1,310) $(1,203) Plan assets at fair value................................ 1,323 1,060 ------- ------- Projected benefit obligation in excess of plan assets.... 13 (143) Unrecognized net gain.................................... 77 170 Unrecognized net transition asset being recognized over 25 years................................................ (63) (78) ------- ------- Accrued pension cost..................................... $ 27 $ (51) ======= ======= As discussed in Note 1, the Company formed an ESOP with the completion of the Conversion in February, 1995. ESOP compensation expense for the year ended December 31, 1997 was $1,216 as compared to expense of $1,065 for the year ended December 31, 1996. The ESOP shares as of December 31, 1997 and 1996 were as follows (dollars in thousands except share amounts): FOR THE YEARS ENDED DECEMBER 31, ------------------- 1997 1996 --------- --------- Allocated shares, net................................... 104,714 53,549 Shares released for allocation.......................... 42,045 53,829 Unreleased shares....................................... 294,314 336,359 --------- --------- Total ESOP shares..................................... 441,073 443,737 ========= ========= Fair value of unreleased shares, at December 31,...... $ 11,828 $ 7,694 ========= ========= 17. STOCK PLANS As discussed in Note 1, the Company has four stock-based compensation plans, which are described below. The Company applies APB Opinion 25 and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its fixed stock option plan. Had compensation cost for the Company's Stock Option Plan been determined based on the fair value at the grant dates for awards under that plan consistent with the method of SFAS 123, the Company's net income and earnings per share would have changed to the pro forma amounts indicated below (dollars in thousands except per share amounts): 1997 1996 1995 ------- ------- ------- Net income.............................. As reported $11,418 $20,685 $13,101 Pro forma $10,892 $20,092 $12,953 Basic earnings per share................ As reported $ 1.74 $ 3.14 $ 2.14 Pro forma $ 1.66 $ 3.05 $ 2.14 Diluted earnings per share.............. As reported $ 1.65 $ 3.03 $ 2.12 Pro forma $ 1.59 $ 2.97 $ 2.12 66 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) STOCK OPTION PLAN Under the Company's Management and Directors Stock Option Plans, the Company may grant stock options to certain employees and non-employee directors of the Company for the purchase of the Company's common stock. Under these plans, the exercise price of each option equals the market price of the Company's stock on the date of grant and the maximum term of the option is 10 years. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1997, 1996 and 1995, respectively: dividend yield of 2.0%, 2.5% and 2.5%; expected volatility of 23%, 24% and 25%; risk- free interest rates of 6.30%, 6.42% and 5.57%; and expected lives of 5 years for all periods. A summary of the status of the Company's Stock Option Plans as of December 31, 1997, 1996 and 1995 and changes during the years ending on those dates is presented below: FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------------- 1997 1996 1995 ------------------ ------------------ ----------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------- --------- ------- --------- ------- --------- Options outstanding, beginning of year...... 594,300 $14 415,600 $12 -- $-- Granted............... 108,600 24 194,700 18 415,600 12 Exercised............. (18,200) 12 -- -- -- -- Cancelled............. (1,000) 24 (16,000) 12 -- -- ------- ------- ------- Options outstanding, end of year........ 683,700 $16 594,300 $14 415,600 $ 12 ======= ======= ======= Options exercisable at year-end............... 282,200 187,280 -- Weighted-average fair value of options granted during the year................... $6.41 $4.50 $3.06 The following table summarizes information regarding stock options outstanding at December 31, 1997: OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------- --------------------- WEIGHTED- WEIGHTED- NUMBER WEIGHTED-AVERAGE AVERAGE NUMBER AVERAGE RANGE OF OUTSTANDING AT REMAINING EXERCISE EXERCISABLE EXERCISE EXERCISE PRICES 12/31/97 CONTRACTUAL LIFE PRICE AT 12/31/97 PRICE --------------- -------------- ---------------- --------- ----------- --------- $10 to $15.............. 381,400 7.4 years $12 214,560 $12 $16 to $23.............. 194,700 8.2 years $18 67,640 $18 $24 to $27.............. 107,600 9.1 years $24 -- -- ------- ------- $10 to $27.............. 683,700 7.9 years $16 282,200 $14 ======= ======= RESTRICTED STOCK PLAN The Company's Management and Directors Restricted Stock Plans provide for the granting of restricted stock to certain employee and non-employee directors of the Company. The fair market value of the stock allocations, based on the market price at date of grant, is recorded as unearned compensation. Unearned compensation is amortized over the periods to be benefited. The Company recorded compensation cost related to the Restricted Stock Plans of $438, $848 and $230 for 1997, 1996 and 1995, respectively. 67 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) A summary of the Company's Restricted Stock Plans as of December 31, 1997, 1996 and 1995 and changes during the years ending on those dates is presented below: FOR THE YEARS ENDED DECEMBER 31, ------------------------ 1997 1996 1995 ------- ------- ------- Balance, beginning of year........................ 161,100 148,200 -- Granted......................................... 3,000 18,900 148,200 Cancelled....................................... -- (6,000) -- ------- ------- ------- Balance, end of year.............................. 164,100 161,100 148,200 ======= ======= ======= Weighted-average fair value of restricted shares granted during the year.......................... $25 $18 $12 18. EARNINGS PER SHARE Basic and diluted net income per share and weighted average shares outstanding follow (dollars in thousands except per share amounts): FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 ---------- ---------- ---------- Net Income................................. $ 11,418 $ 20,685 $ 13,101 Weighted average shares outstanding: Basic.................................... 6,564,073 6,580,282 6,127,116 Effect of dilutive securities: Stock options........................ 289,238 138,821 24,692 Restricted stock..................... 53,881 117,531 18,269 ---------- ---------- ---------- Diluted.................................. 6,907,192 6,836,634 6,170,077 ========== ========== ========== Net income per share: Basic.................................... $1.74 $3.14 $2.14 Diluted.................................. $1.65 $3.03 $2.12 19. FEES AND OTHER INCOME Fees and other income are composed of the following: FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 ---------- ---------- ---------- Loan charges and fees...................... $ 3,212 $ 3,521 $ 3,507 Deposit related fees....................... 7,562 6,834 5,843 Merchant fees.............................. 1,904 1,894 1,690 Other charges and fees..................... 2,751 1,745 1,410 ---------- ---------- ---------- $ 15,429 $ 13,994 $ 12,450 ========== ========== ========== 68 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 20. OTHER OPERATING EXPENSES Other operating expenses are composed of the following: FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 ---------- ---------- ---------- Marketing................................... $ 2,052 $ 2,237 $ 1,163 Insurance................................... 705 751 3,259 Professional services....................... 2,949 3,998 3,735 Outside processing.......................... 4,871 4,287 3,079 Other....................................... 6,264 6,214 5,479 ---------- ---------- ---------- $ 16,841 $ 17,487 $ 16,715 ========== ========== ========== 21. INCOME TAXES The components of the income tax expense (benefit) for the years ended December 31, are as follows: FOR THE YEARS ENDED DECEMBER 31, ----------------------------------- 1997 1996 1995 ---------- ----------- ----------- Current Federal............................... $ 1,722 $ 371 $ 136 State................................. 1,261 896 99 Deferred Federal............................... 4,369 (7,324) (6,995) State................................. 43 1,026 501 ---------- ----------- ----------- $ 7,395 $ (5,031) $ (6,259) ========== =========== =========== A reconciliation of the statutory income tax rate to the consolidated effective income tax rate as well as a reconciliation of expected income tax expense (benefit), computed at the applicable statutory rate, to the actual income tax expense (benefit) for the three years ended December 31, 1997, 1996, and 1995 follows: FOR THE YEARS ENDED DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 ------------------ ------------------- ------------------- PERCENTAGE PERCENTAGE PERCENTAGE OF PRETAX OF PRETAX OF PRETAX AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME ------ ---------- ------- ---------- ------- ---------- Federal income tax at statutory rate......... $6,396 34.00 % $ 5,323 34.00 % $ 2,326 34.00 % Change in valuation allowance.............. (81) (0.43)% (9,377) (59.90)% (8,932) (130.55)% State income taxes, net of federal benefit..... 987 5.25 % 1,269 8.11 % 396 5.79 % Tax bad debt recapture.. -- -- (2,790) (17.82)% -- -- Employee stock ownership plan................... 311 1.65 % 207 1.32 % -- -- Merger costs............ 445 2.37 % -- -- -- -- Other................... (663) (3.52)% 337 2.15% (49) (0.72)% ------ ----- ------- ------ ------- ------- $7,395 39.32 % $(5,031) (32.14)% $(6,259) (91.48)% ====== ===== ======= ====== ======= ======= 69 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1997 and 1996 are as follows: DECEMBER 31, ---------------- 1997 1996 ------- ------- Deferred tax assets: Allowance for loan losses.............................. $ 4,465 $ 4,282 Accrued pension........................................ 2,321 2,023 Employee stock awards.................................. 213 190 Net operating loss carryforwards, state................ 120 6,180 Alternative minimum tax credit carryforwards........... 430 563 Investment tax credit carryforwards.................... 1,721 1,721 Other.................................................. 2,282 1,417 ------- ------- Total gross deferred tax assets...................... 11,552 16,376 ------- ------- Deferred tax liabilities: Investment in real estate and bank premises............ (2,099) (3,202) Other.................................................. (1,334) (578) ------- ------- Total gross deferred tax liabilities................. (3,433) (3,780) ------- ------- Net deferred tax asset prior to valuation allowance...... 8,119 12,596 Valuation allowance...................................... -- (81) ------- ------- Net deferred tax asset after valuation allowance......... $ 8,119 $12,515 ======= ======= This valuation allowance indicated in the above table partially reserved the gross deferred tax assets at December 31, 1996 in accordance with SFAS 109, with the exception of the deferred tax asset relating to unrealized holding losses on securities which were transferred from available for sale to held to maturity. During the third quarter of 1996, and the fourth quarter of 1997, management's evaluation of the weight of currently available evidence resulted in the conclusion that it was more likely than not that the Company would realize a portion of its net deferred tax asset which was reserved for at those times. During the third quarter of 1996, management reduced the Company's valuation allowance from $9,458 to $81, while at the fourth quarter of 1997, management reduced the Company's allowance of $81 to zero. In both instances, management's judgment was influenced by factors including changes in the levels of actual and expected future taxable income and anticipated reversals of net deductible temporary differences. As a result of these adjustments the net change in the total valuation allowance for the years ended December 31, 1997 and 1996 was a net decrease of $81 and $9,377, respectively. At December 31, 1997, the Company had investment tax credit carryforwards of approximately $1,721 which expire in years from 1998 through 2008. In addition, the Company had alternative minimum tax credit carryforwards of approximately $430 which have an indefinite utilization period. At December 31, 1997, SIS Bank had state net tax operating loss carryforwards of approximately $1,920 which will expire in the years 1998 through 2002. If certain substantial direct or indirect changes in the Company's ownership should occur, there may be an annual limitation on the amount of carryforwards (including certain net unrealized built-in losses) which can be utilized for regular and alternative minimum tax purposes. 70 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 22. COMMITMENTS, CONTINGENCIES AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK OFF-BALANCE SHEET INSTRUMENTS The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk which are not reflected in the Balance Sheet. The contract or notional amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company uses the same credit policies in making commitments and standby letters of credit 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 many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on Management's credit evaluation of the counterparty. The Company's commitments to extend credit, which includes unused lines of credit and commitments to fund loans, were approximately $265,487 and $206,402 at December 31, 1997 and 1996, respectively. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company's commitments under standby letters of credit were $9,678 and $4,906 at December 31, 1997 and 1996, respectively. Commitments to sell loans are contracts for delayed delivery of loans in which the Company agrees to make delivery at a specific future date of a specified instrument, at a specific price or yield. Risks arise from the possible inability to meet the terms of the contracts and from movements in interest rates. The Company had commitments to sell $23,597 and $11,603 of loans at December 31, 1997 and 1996, respectively. LEASES The Company leases certain of its branch office facilities and equipment under nonfinancing leases having various maturities to 2010. Certain of the leases require payment of real estate taxes, insurance and maintenance. The future minimum rental payments required under these leases are approximately as follows: YEAR ENDED DECEMBER 31, ----------------------- 1998.............................. $ 916 1999.............................. 879 2000.............................. 819 2001.............................. 728 2002.............................. 596 2003--2010........................ 1,894 ------ $5,832 ====== Total rental expense for 1997, 1996, and 1995 amounted to approximately $974, $746, and $779, respectively. 71 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) LITIGATION Except as set forth below, the Company is not involved in any pending litigation other than routine legal proceedings occurring in the ordinary course of business. While the legal responsibility and financial impact with respect to such litigation cannot presently be ascertained, the Company does not anticipate that any of these matters will result in the payment by the Company of damages, that, in the aggregate, would be material in relation to the consolidated financial position or operations of the Company. A lawsuit was brought against GBT and seven directors of GBT on or about November 1, 1995 by a former director of GBT, Henry J. Stone, and a second suit was brought contemporaneously by Mr. Stone's wife, Merriam March. Both suits allege misconduct by the GBT directors in connection with the rejection of a proposed acquisition offer received by GBT in 1994. Mr. Stone's suit sought money damages and to be reinstated as a director of GBT. The damages portion of Mr. Stone's suit was dismissed and he has not appealed. His action to be returned to the board of GBT remains, and GBT intends to vigorously oppose Mr. Stone. Ms. March's suit is a derivative suit in which she, as a shareholder of GBT, had sued the directors of GBT on behalf of GBT for damages they allegedly caused GBT. The derivative action, filed in Connecticut Superior Court, seeks approximately $11.7 million in money damages from the directors. Because the suit is a derivative suit, any damages that the court may order the defendants to pay (GBT believes this to be unlikely and, in any event, limited to one year's compensation from each director under applicable Connecticut law and GBT's Certificate of Incorporation) would be paid to GBT. GBT considers Ms. March's suit to be without merit. Under Connecticut law, GBT is required in some cases, and is permitted in others, to "indemnify" or reimburse the GBT directors from damages and costs incurred by them in connection with litigation brought against them in their official capacities at GBT. As part of the acquisition of GBT by SIS Bank, SIS Bank had agreed that GBT would continue to provide this indemnification to these GBT directors to the extent allowed by law. Through December 31, 1997, GBT had accrued for all expenses incurred for attorney's fees and related costs in connection with the suit, including the advancing of such fees for the defendant directors. As of December 31, 1997, the parties continue to be engaged in mutual discovery efforts, and the Stone lawsuit had been dismissed in its entirety except for the count which requests that Mr. Stone be re-seated on the GBT Board of Directors. The Stone suit is scheduled for trial in late 1998 and the March suit in early 1999. The amount of additional legal fees to be incurred by GBT will depend upon a number of factors, including the scope of the plaintiff's discovery efforts and whether the suits actually go to trial. 23. QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED) Following is the quarterly financial information of the Company for 1997 and 1996: FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER ---------------- --------------- --------------- ---------------- 1997 1996 1997 1996 1997 1996 1997 1996 ------- ------- ------- ------- ------- ------- ------- ------- Net interest and dividend income........ $14,913 $11,956 $15,063 $12,855 $15,028 $13,635 $15,085 $14,238 Provision for possible loan losses............ 500 942 465 905 466 904 464 970 Net gain (loss) on sale of loans............... 106 270 86 162 136 105 211 67 Net gain (loss) on sale of securities.......... -- 2 60 -- 17 69 (260) 122 Net gain (loss) on sale of securities held for trading................ (11) -- 30 2 24 1 14 12 Fees and other income... 3,298 3,069 3,697 3,424 4,042 3,637 4,392 3,864 Noninterest expense..... 12,435 11,253 12,307 11,623 12,624 12,047 17,857 13,191 Income tax expense (benefit).............. 2,091 212 2,449 278 2,327 (6,421) 528 901 ------- ------- ------- ------- ------- ------- ------- ------- Net income.............. $ 3,280 $ 2,890 $ 3,715 $ 3,637 $ 3,830 $10,917 $ 593 $ 3,241 ======= ======= ======= ======= ======= ======= ======= ======= Earnings per share Basic................... $ 0.50 $ 0.44 $ 0.56 $ 0.56 $ 0.59 $ 1.66 $ 0.09 $ 0.49 Diluted................. $ 0.48 $ 0.43 $ 0.53 $ 0.54 $ 0.56 $ 1.60 $ 0.09 $ 0.47 72 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 24. REGULATORY CAPITAL The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under applicable capital adequacy requirements the Company must meet specific minimum capital requirements that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets, and Tier 1 capital to total average assets. Management believes, as of December 31, 1997, that the Company meets all capital adequacy requirements to which it is subject. Under the regulatory framework for prompt corrective action, both SIS Bank and GBT are considered well capitalized as of December 31, 1997. To be categorized as well capitalized the Banks must maintain minimum total risk- based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. As of December 31, 1997 the Company also qualified as well capitalized under the applicable Federal Reserve Board regulations. The actual capital amounts and ratios for the Company, SIS Bank and GBT are presented in the table below, no deductions were made from capital for interest-rate risk. MINIMUM MINIMUM REQUIREMENTS REQUIREMENTS FOR CAPITAL TO QUALIFY AS ACTUAL ADEQUACY PURPOSES WELL CAPITALIZED -------------- ------------------ ----------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO -------- ----- ------------------ --------- ------- AS OF DECEMBER 31, 1997: Tier I Capital (to Average Assets) Company.................. $123,340 7.2% $ 68,834 4.0% N/A SIS Bank................. $103,780 7.1% $ 58,358 4.0% $ 72,947 5.0% GBT...................... $ 17,291 6.6% $ 10,422 4.0% $ 13,028 5.0% Tier I Capital (to Risk Weighted Assets) Company.................. $123,340 11.9% $ 41,568 4.0% $ 62,352 6.0% SIS Bank................. $103,780 11.9% $ 35,044 4.0% $ 52,565 6.0% GBT...................... $ 17,291 10.6% $ 6,507 4.0% $ 9,761 6.0% Total Capital (to Risk Weighted Assets) Company.................. $136,438 13.1% $ 83,137 8.0% $ 103,921 10.0% SIS Bank................. $114,825 13.1% $ 70,087 8.0% $ 87,609 10.0% GBT...................... $ 19,344 11.9% $ 13,014 8.0% $ 16,268 10.0% AS OF DECEMBER 31, 1996: Tier I Capital (to Average Assets) Company.................. $113,628 7.4% $ 61,802 4.0% N/A SIS Bank................. $ 95,816 7.4% $ 51,999 4.0% $ 64,999 5.0% GBT...................... $ 17,311 7.1% $ 9,795 4.0% $ 12,243 5.0% Tier I Capital (to Risk Weighted Assets) Company.................. $113,628 12.7% $ 35,813 4.0% $ 53,720 6.0% SIS Bank................. $ 95,816 12.7% $ 30,110 4.0% $ 45,165 6.0% GBT...................... $ 17,311 12.2% $ 5,695 4.0% $ 8,543 6.0% Total Capital (to Risk Weighted Assets) Company.................. $124,914 14.0% $ 71,627 8.0% $ 89,533 10.0% SIS Bank................. $105,300 14.0% $ 60,220 8.0% $ 75,275 10.0% GBT...................... $ 19,110 13.4% $ 11,391 8.0% $ 14,238 10.0% 73 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 25. PARENT COMPANY FINANCIAL INFORMATION The following condensed balance sheet, condensed statements of operations and of cash flows for SIS Bancorp, Inc. (parent company only) reflect the Company's investment in its wholly owned subsidiaries using the equity method of accounting. The parent company formation occurred June 21, 1996. There were no results prior to this date. DECEMBER 31, DECEMBER 31, CONDENSED BALANCE SHEET 1997 1996 ----------------------- ------------ ------------ (DOLLARS IN THOUSANDS) ASSETS Cash and due from banks........................... $ 1 $ -- Investment securities available for sale.......... 1,627 206 Due from subsidiaries............................. 1,184 398 Investment in subsidiaries........................ 123,204 118,285 Other assets...................................... 383 -- -------- -------- Total assets.................................... $126,399 $118,889 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Borrowings from subsidiaries...................... $ -- $ -- Other liabilities................................. 927 103 -------- -------- Total liabilities............................... 927 103 Stockholders' equity.............................. 125,472 118,786 -------- -------- Total liabilities and stockholders' equity...... $126,399 $118,889 ======== ======== FOR THE PERIOD FROM FOR THE YEAR ENDED JUNE 21, 1996 TO CONDENSED STATEMENT OF INCOME DECEMBER 31, 1997 DECEMBER 31, 1996 ----------------------------- ------------------ ------------------- (DOLLARS IN THOUSANDS) Revenues Interest income on investments available for sale............... $ 78 $ 7 Other income...................... -- -- ------- ------- Total income.................... 78 7 Expenses Interest expense.................. -- -- Other expenses.................... 1,128 155 ------- ------- Total expenses.................. 1,128 155 Income before income taxes and equity in undistributed income of subsidiaries....................... (1,050) (148) Income taxes...................... (366) -- ------- ------- Loss before equity in undistributed income of subsidiaries............. (684) (148) Equity in undistributed income of subsidiaries....................... 12,102 20,833 ------- ------- Net income.......................... $11,418 $20,685 ======= ======= 74 SIS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) FOR THE PERIOD FROM FOR THE YEAR ENDED JUNE 21, 1996 TO CONDENSED STATEMENT OF CASH FLOWS DECEMBER 31, 1997 DECEMBER 31, 1996 --------------------------------- ------------------ ------------------- (DOLLARS IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net income............................. $ 11,418 $ 20,685 Equity in undistributed earnings of subsidiaries.......................... (12,102) (20,833) Other, net............................. (362) -- -------- -------- Net cash used in operating activities.......................... (1,046) (148) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Investment in subsidiaries............. -- (86,297) Purchases of investment securities..... (8,830) (257) Sale of investment securities.......... 7,409 51 Other, net............................. 8,615 512 -------- -------- Net cash provided by (used in) investing activities................ 7,194 (85,991) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of common stock................................. 607 86,547 Payments to repurchase common stock.... (4,193) -- Advances from subsidiaries............. 1,128 155 Repayments of advances from subsidiaries.......................... (305) (51) Dividends paid......................... (3,384) (512) Other, net............................. -- -- -------- -------- Net cash (used in) provided by financing activities................ (6,147) 86,139 -------- -------- Net Increase in cash and due from banks.. 1 -- Beginning balance: cash and due from banks................................... -- -- -------- -------- Ending balance: cash and due from banks.. $ 1 $ -- ======== ======== 26. SUBSEQUENT EVENTS On January 21, 1998, the Company announced a 14% increase in its quarterly cash divided to $0.16 per share payable on February 23, 1998 to shareholders of record as of the close of business on February 2, 1998. 75 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of SIS Bancorp, Inc. In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, changes in stockholders' equity, and of cash flows present fairly, in all material respects, the financial position of SIS Bancorp, Inc. and its subsidiaries (the "Company") at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ Price Waterhouse Price Waterhouse LLP Boston, Massachusetts January 22, 1998 76 PART III ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) INFORMATION REGARDING DIRECTORS AND NOMINEES: The Directors of the Registrant are listed below. The other information required by the response to this Item regarding those persons who are directors of the Company is contained in the discussion under the caption "Directors and Nominees" contained on page 4 of the Proxy Statement, which is incorporated by reference herein. NAME & PRINCIPAL OCCUPATION POSITION HELD WITH COMPANY --------------------------- -------------------------- Ronald E. Bourbeau Director Owner, Yankee Boat Yard & Marina, Inc.; Treasurer, Northeast Yacht Sales Director, Chairman of the Board GBT Sr. Mary Caritas (Geary), S.P. Director Retired, former President & CEO of Mercy Hospital John M. Naughton Chairman of the Board of Directors Retired, former Executive Vice President, Massachusetts Mutual Life Insurance Co. Charles L. Johnson Director Consultant--Associated Energy Managers, an investment management firm F. William Marshall, Jr. Director, President and Chief President & CEO, SIS Bancorp, Inc. Executive Officer and SIS Bank Thomas O'Brien Director Dean, School of Management University of Massachusetts William B. Hart, Jr. Director President, the Dunfey Group Stephen A. Shatz Director Attorney, partner in Shatz, Schwartz & Fentin, P.C. (b) EXECUTIVE OFFICERS OF THE COMPANY: The following table sets forth certain information regarding the Executive Officers of the Company. The other information required by the response to this Item regarding those persons who are Executive Officers of the Company is contained in the discussion under the caption "Executive Officers of SIS Bancorp, Inc." contained on page 7 of the Proxy Statement, which is incorporated by reference herein. NAME POSITION AND OFFICE WITH THE COMPANY ---- ------------------------------------ F. William Marshall, Jr. President & Chief Executive Officer, Director--SIS Bancorp, Inc. and SIS Bank J. Gilbert Soucie Vice Chairman, SIS Bancorp, Inc.; President & CEO--Glastonbury Bank & Trust Company 77 NAME POSITION AND OFFICE WITH THE COMPANY ---- ------------------------------------ Frank W. Barrett Executive Vice President/Credit & Commercial Lending Group--SIS Bancorp, Inc. John F. Treanor Executive Vice President, Treasurer, Chief Operating Officer & Chief Financial Officer--SIS Bancorp, Inc. Gilbert F. Ehmke Senior Vice President & Chief Investment Officer--SIS Bancorp, Inc. Henry J. McWhinnie Senior Vice President/Human Resources Group--SIS Bancorp, Inc. Jeanne Rinaldo Senior Vice President/Residential Mortgage Group--SIS Bancorp, Inc. Christopher A. Sinton Senior Vice President/Retail Banking Group--SIS Bancorp, Inc. Michael E. Tucker Senior Vice President, General Counsel & Clerk--SIS Bancorp, Inc. Ting Chang Vice President, Investor Relations & Corporate Planning--SIS Bancorp, Inc. Laura Sotir Katz Vice President & Controller--SIS Bancorp, Inc. Patricia Train Jatkevicius Vice President/Marketing--SIS Bancorp, Inc. Brian Schwartz Vice President & Director of Internal Auditing--SIS Bancorp, Inc. (c) COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT: The information required by the response to this Item is contained in the discussion under the caption "Section 16(a) Compliance" contained on page 23 of the Proxy Statement, which is incorporated by reference herein. ITEM 11. EXECUTIVE COMPENSATION The response to this Item is contained in the discussion under the captions "Executive Compensation", "Employment Agreements", "Benefits Under Plans", contained on Pages 8 through 17 of the Proxy Statement, which is incorporated by reference herein. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The response to this Item is incorporated by reference from the discussion under the headings "Security Ownership of Management and Directors" on Page 5 of the Proxy Statement, which is incorporated by reference herein. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The response to this Item is contained in the discussion under the captions "Transactions with Certain Related Persons" and "Certain Business Relationships" contained on Page 18 of the Proxy Statement, which is incorporated by reference herein. PART IV ITEM 14. EXHIBITS, FINANCIAL SCHEDULES AND REPORTS ON FORM 8-K (a) CONTENTS: (1) FINANCIAL STATEMENTS: All Financial Statements are included as Part II, Item 8 of this Report. The index is on page 40 of this Report. (2) FINANCIAL STATEMENT SCHEDULES: All Financial Statement Schedules are included as Part II, Item 8 of this Report. The index is on page 40 of this Report. 78 (b) REPORTS ON FORM 8-K: During the fourth quarter of 1997, the following Form 8-K's were filed: . Form 8-K filed on October 22, 1997 relating to the press release issued on October 22, 1997 containing unaudited financial information and announcing a cash dividend for the quarter ended September 30, 1997 and containing information relating to the previously announced acquisition of GBT and the acceleration of systems conversions and full "back office" integration of GBT with the Company. . Form 8-K filed on December 31, 1997 announcing the completion on December 17, 1997 of the acquisition of GBT by the Company pursuant to the Agreement and Plan of Reorganization dated August 18, 1997. (c) EXHIBITS: EXHIBIT NO. EXHIBIT LOCATION ----------- ------- -------- (3)(a). Articles of Organization of SIS Bancorp, Inc. (1) (3)(b). By-laws of SIS Bancorp, Inc. (1) 4(a). Specimen Common Stock Certificate (4) 10. Material Contracts (a) Employment agreements for Messrs. F. William Marshall, Jr., Frank W. Barrett, B. John Dill, John F. Treanor, Henry J. McWhinnie, Ms. Jeanne Rinaldo, Mr. Michael E. Tucker (1) (b) Employment agreements for Messrs. Gilbert F. Ehmke and Christopher A. Sinton. (2) (c) Employment agreement for Mr. J. Gilbert Soucie (d) Director and Management Stock Option Plan, as amended. (4) (e) Director and Management Restricted Stock Plan, as amended. (4) (f) Rights Agreement, dated January 22, 1997 by and between the Company and ChaseMellon Shareholder Services, as Rights Agent (3) 21. Subsidiaries of the Registrant 23. Consent of Price Waterhouse, LLP. - -------- Locations of Exhibits if not attached hereto: (1) Exhibit is incorporated by reference to the Form 8-A Registration Statement filed by the Company with the Securities and Exchange Commission ("SEC") on June 21, 1996. (2) Exhibit is incorporated by reference to the Form 10-Q for the quarter ending June 30, 1996. (3) Exhibit is incorporated by reference to the Form 8-A Registration Statement filed by the Company with the SEC on January 23, 1997. (4) Exhibit is incorporated by reference to the Form 10-K filed for the year ended December 31, 1996. 79 SIGNATURES PURSUANT TO THE REQUIREMENTS OF THE SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934, THE BANK HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. March 30, 1998 Springfield Institution for Savings /s/ F. William Marshall, Jr. By: _________________________________ F. William Marshall, Jr., President and Chief Executive Officer PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE COMPANY AND IN THE CAPACITIES ON THE DATES INDICATED. SIGNATURE TITLE DATE /s/ F. William Marshall, Jr. President, Chief 03-30-98 By: ____________________________ Executive Officer and F. William Marshall, Jr. Director /s/ John F. Treanor Executive Vice 03-30-98 By: ____________________________ President, Chief John F. Treanor Financial Officer, Chief Operating Officer and Treasurer /s/ Laura Sotir Katz Vice President, 03-30-98 By: ____________________________ Controller (Chief Laura Sotir Katz Accounting Officer) /s/ John M. Naughton Director, Chairman of 03-30-98 By: ____________________________ the Board John M. Naughton /s/ Sister Mary Caritas Director 03-30-98 Geary, S.P. By: ____________________________ Sister Mary Caritas Geary, S.P. /s/ Charles L. Johnson Director 03-30-98 By: ____________________________ Charles L. Johnson /s/ Stephen A. Shatz Director 03-30-98 By: ____________________________ Stephen A. Shatz /s/ Thomas O'Brien Director 03-30-98 By: ____________________________ Thomas O'Brien /s/ William B. Hart, Jr. Director 03-30-98 By: ____________________________ William B. Hart, Jr. /s/ Ronald E. Bourbeau Director 03-30-98 By: ____________________________ Ronald E. Bourbeau 80