<PAGE>   1



                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC. 20549

                                  FORM 10-K

                           For Annual and Transition Reports Pursuant to
Sections 13 or 15(d) of the Securities Exchange Act of 1934

       [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 1998
                                             -----------------

                                       or

     [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES
                              EXCHANGE ACT OF 1934

                   For the transition period from ____ to ____

                         Commission file number 0-18513

                            SKANEATELES BANCORP, INC.
                            --------------------------
             (Exact name of Registrant as specified in its charter)

                         Delaware                              16-1368745
                         --------                              ----------
            (State or other jurisdiction                    (I.R.S. Employer
            of incorporation or organization)               Identification No.)

               33 E. Genesee St. Skaneateles, New York, 13152-0460
               ---------------------------------------------------
                (Address of principal executive office-Zip Code)

       Registrant's telephone number, including area code: (315) 685-2265

        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
                          -----------------------------
                                 Title of 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 twelve months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ] 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to this
Form 10-K. [ ]

As of March 10, 1999, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $33,018,000.

As of March 10, 1999, 1,452,372 shares of registrant's common stock were
outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

          Document                        Part of 10-K into which incorporated
          --------                        ------------------------------------
             None



<PAGE>   2


                                TABLE OF CONTENTS
                          FORM 10-K ANNUAL REPORT 1998
                            SKANEATELES BANCORP, INC.

<TABLE>
<CAPTION>
                                                                                               Page
                                                                                               ----

PART I.
<S>    <C>                                                                                  <C>
        Item 1.       Business ...............................................................    1

        Item 2.       Properties .............................................................   53

        Item 3.       Legal Proceedings ......................................................   54

        Item 4.       Submission of Matters to a vote of Security Holders ....................   54


PART II.

        Item 5.       Market For the Registrant's Common Stock and Related Stockholder Matters   54

        Item 6.       Selected Financial Data ................................................   55

        Item 7.       Management's Discussion and Analysis of Financial Condition
                             and Results of Operations .......................................   55
       Item 7A.            Quantitative and Qualitative Disclosures About Market Risk.........   55
       Item 8.        Financial Statements And Supplementary Data ............................   55

        Item 9.       Changes in and Disagreements With Accountants on Accounting
                             and Financial Disclosure ........................................   55

PART III.

        Item 10.      Directors and Executive Officers of the Registrant .....................   55
                                                                         
        Item 11.      Executive Compensation ..................................................  57

        Item 12.      Security Ownership of Certain Beneficial Owners and Management ..........  62
                                                                                     
        Item 13.      Certain Relationships and Related Transactions ..........................  64
                                                                     

PART IV.

       Item 14.       Exhibits, Financial Statement Schedules and Reports on Form 8-K .........  65
                                                                     
</TABLE>


<PAGE>   3



PART I.

Item 1.        BUSINESS

                                     GENERAL

        Skaneateles Bancorp, Inc. (the "Company") is a Delaware-chartered bank
holding company registered under the Bank Holding Company Act of 1956, as
amended (the "BHCA"), the primary business of which is the ownership and
operation of its sole subsidiary, Skaneateles Savings Bank ("Skaneateles" or the
"Bank"). Skaneateles is a New York-chartered stock savings bank headquartered in
the Village of Skaneateles, Onondaga County, New York. Deposit accounts of the
Bank are insured by the Bank Insurance Fund ("BIF"), as administered by the
Federal Deposit Insurance Corporation ("FDIC"). In continuous operation since
1866, the Bank conducts business from nine full-service banking offices located
in Onondaga and Oswego counties of New York State. Historically, Skaneateles has
been engaged in the business of attracting deposits from the general public and
earning income on those funds through various lending and investment activities.

       The Bank operated as a single office savings bank in Skaneateles, New
York until 1967, when it opened its first branch office in Camillus, a suburb of
Syracuse. During 1988, the Bank opened an office in downtown Syracuse. Since
1994, the Bank has acquired or opened six branch offices in and around Syracuse
and Oswego, New York. Three of these branches are in-store facilities in newly
constructed or renovated supermarkets. The in-store branches provide all of the
same products and services as the Banks' traditional branches, with the
exception of safe deposit boxes.

       In September 1998, the Bank formed Skaneateles Preferred Capital
Corporation ("SPCC"), a wholly-owned, real estate investment trust subsidiary.
SPCC was formed for the purpose of purchasing real estate secured loans
originated by the Bank from time to time.

       The Company was incorporated in the State of Delaware as Center Banks
Incorporated on January 7, 1988. On April 15, 1997, the stockholders approved
the Board of Director's proposal to change the Company's name to Skaneateles
Bancorp, Inc. The name change became effective April 16, 1997 at which time the
Company's stock began trading under the symbol "SKAN" on the NASDAQ National
Market System.

        On January 25, 1999, the Company entered into a definitive Agreement and
Plan of Merger with BSB Bancorp, Inc. ("BSB"), which provides for the
acquisition of the Company by BSB in a tax-free, stock-for-stock exchange to be
accounted for as a pooling of interests. In the transaction, Skaneateles
stockholders will receive 0.970 shares of BSB stock for each share of
Skaneateles stock. Based on BSB's closing price on January 22, 1999 (the last
trading day before the Agreement and Plan of Merger was signed), Skaneateles
stockholders will receive $27.89 per share in BSB stock, for a total transaction
value of approximately $41 million.

         The definitive Agreement and Plan of Merger, which has been approved by
both BSB's and the Company's boards of directors, is subject to approval by the
Company's stockholders as well as by regulatory authorities. The transaction is
expected to close in the Summer of 1999. In connection with the Agreement and
Plan of Merger, Skaneateles Bancorp also granted BSB an option to purchase
290,142 newly issued shares (19.9% of the Company's outstanding stock). Also in
connection with the Agreement and Plan of Merger, certain stockholders of the
Company, including the Company's directors and executive officers, entered into
a Stockholder Agreement pursuant to which each of such stockholders agreed to
vote in favor of the Agreement and Plan of Merger.

        The Company's financial performance depends primarily on the Bank's net
interest income, which is the difference between interest income on
interest-earning assets, primarily loans, investments and securities, and
interest expense on interest-bearing liabilities, primarily deposits and
borrowings. The relative amounts of interest-earning assets, deposits and
borrowings also impact net interest income. In addition, the Company's financial
performance is affected by the establishment of provisions for loan losses and
the level of its other income, including fees on loans sold, deposit service
charges, the results of foreclosed real estate activities, gains or losses 

<PAGE>   4



from the sale of loans as well as its other operating expenses and income tax
provisions. The Company's financial performance has historically been affected
by local economic and competitive conditions, primarily in the market area of
metropolitan Syracuse, New York. Changes in market interest rates, government
legislation and policies concerning monetary and fiscal affairs, housing and
financial institutions and the attendant actions of the regulatory authorities
all have an impact on the performance of the Bank and the Company.

       This Annual Report, including certain statements made in Management's
Discussion and Analysis of Financial Condition and Results of Operations, may
include "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Any statements with regard to the
Company's expectations as to its financial results, other aspects of its
business, and general economic conditions, may constitute forward-looking
statements. Although the Company makes such statements based on assumptions
which it believes to be reasonable, there can be no assurance that actual
results will not differ materially from the Company's expectations. Accordingly,
the Company hereby identifies the following important factors, among others,
which could cause its results to differ from any results which might be
projected, forecasted or estimated based on such forward-looking statements: (i)
general economic and competitive conditions in the markets in which the Company
operates, and the risks inherent in its operations; (ii) the Company's ability
to continue to control its provision for credit losses and non-interest
expenses, increase earning assets and non-interest income, and maintain its
margins; and (iii) the level of consumer demand for new and existing products.
Should one or more of these risks or uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may vary materially from
those described in the forward-looking statements. The Company does not intend
to update forward-looking statements.

       Although the Company is a small business issuer, it has elected to make
certain disclosures not normally required by small business issuers for the
benefit of the Company's stockholders.


                               LENDING ACTIVITIES

        The lending activities of Skaneateles are affected principally by the
demand for loans, competition from other financial institutions and the supply
of funds available for lending purposes. These factors are in turn affected by
general economic conditions, the monetary policies of the Federal government
(including the Federal Reserve Board) legislative tax policies and governmental
budgetary matters.

        RESIDENTIAL REAL ESTATE LENDING. Most of Skaneateles' residential loan
portfolio is secured by first mortgages on real estate located in the greater
Syracuse area and, to a minor extent, the greater Rochester, New York area. Most
residential loans are originated directly by Skaneateles. The Bank has also
purchased loans for its portfolio from time to time, although no such purchases
were made in 1998 or 1997.

        It is Skaneateles' policy to require borrowers to obtain title insurance
naming the Bank as the insured party on certain real estate loans. Borrowers are
required to obtain hazard insurance prior to closing. Borrowers typically are
required to advance funds on a monthly basis together with each payment of
principal and interest to a mortgage escrow account from which Skaneateles makes
disbursements for items such as real estate taxes, hazard insurance and private
mortgage insurance premiums as they become due.

        The Bank originates both fixed and adjustable rate residential mortgages
with a maximum maturity of 30 years and, for fixed rate loans, a monthly or
bi-weekly payment option. These bi-weekly mortgages require the borrower to
maintain a deposit account with the Bank from which mortgage payments are
automatically deducted. Loans are granted in amounts up to 95% of appraised
value; however, all loans with a loan-to-value ratio in excess of 80% are
required to carry private mortgage insurance sufficient to reduce the Bank's
exposure to 75% of appraised value.

        Fixed rate mortgages are predominantly underwritten in accordance with
secondary market standards, and therefore can be sold at any time in response to
changes in interest rates or to meet liquidity needs. Prior to January, 1998,
fixed rate mortgages with terms of 15 years or less were originated for
portfolio, thereafter, beginning in January, the Bank began selling all
conforming fixed rate mortgages at the time of origination due to the relatively

                                       2
<PAGE>   5


low interest rate environment and the resulting increased interest rate risk
associated with long term fixed rate assets. The Bank generally retains
servicing rights on sold loans.

        The Bank offers adjustable rate loans, indexed to the one-year or
three-year U.S. Treasury Note, with rates that adjust annually (1 year ARM), or
once every three years (3 year ARM). The Bank also offers a 5/1 ARM. The 5/1 ARM
is a loan with a fixed rate of interest for the first five years. On the loan's
fifth anniversary, the rate converts to the current rate for a 1-year ARM, and
adjusts annually over the remaining term of the loan. Adjustable rate loans are
generally retained for portfolio.

        MULTI-FAMILY AND COMMERCIAL REAL ESTATE LENDING. Skaneateles originates
loans secured by multi-family (over four residential units) and commercial
properties, such as small office buildings, which are generally owner-occupied.

        The majority of loans on income-producing property currently offered by
Skaneateles carry an adjustable rate tied to the one-, three- or five-year U.S.
Treasury Note, typically with a maximum amortization period of 20 years. In
setting interest rates and origination fees on new loans and loan extensions,
management considers both current conditions and its analysis of the risk
associated with the particular project.

        The Bank's underwriting policies with respect to loans on income
producing properties are designed to ensure that a project's cash flow will be
sufficient to cover operating expenses and debt service payments. A detailed
analysis of each project is undertaken by the Bank's commercial real estate loan
underwriters. Loan-to-value ratios on commercial real estate loans made by
Skaneateles generally do not exceed 75%. All income producing properties are
appraised by an independent appraiser approved by the Board of Directors.
Skaneateles requires that the borrower obtain title insurance and hazard
insurance in the amount of the loan, naming Skaneateles as loss payee.

        COMMERCIAL LENDING. The Bank makes loans to small and medium-sized
businesses in its primary market area of Onondaga County, eastern Cayuga County,
New York and the city of Oswego, New York, offering mortgages, secured and
unsecured working capital loans, term loans, leases and lines of credit. The
Bank also offers revolving credit lines to local automobile, boat and
recreational vehicle dealerships to finance inventory purchases through its
dealer floor plan program. Rates, terms, compensatory balances, fees and charges
are based upon market conditions and the risk involved for each loan. The risks
involved are determined based upon a credit analysis performed on the potential
borrower which emphasizes economic conditions, the availability of cash flow
from operations to support the credits, and collateral.

         Commercial loans generally involve a higher degree of risk than
residential mortgage loans. Unlike residential mortgage loans, which are
generally made on the basis of the borrower's ability to make repayment from
employment and other income, and which are secured by real property whose value
tends to be easily ascertainable, commercial loans typically are made on the
basis of the borrower's ability to make repayment from the cash flow of the
business, and are generally secured by business assets, such as accounts
receivable, equipment and inventory. As a result, the availability of funds for
the repayment of commercial loans may be substantially dependent on the success
of the business itself. Furthermore, the collateral securing the loans may
depreciate over time, may not be appraised with as much precision as residential
real estate, and may fluctuate in value based on the success of the business.
The Bank attempts to mitigate the risks inherent in commercial lending through
its underwriting, documentation, financial analysis and monitoring of the
borrower's financial performance.

        CONSUMER LENDING. New York State law permits Skaneateles to engage in
various types of consumer lending. Consumer loan products include auto and boat
loans, unsecured personal loans, home equity loans and home equity lines of
credit. All consumer loans offered by the Bank, except home equity lines of
credit, carry fixed rates of interest and terms ranging from three years to
fifteen years. The Bank's home equity line of credit program offers a credit
line secured by a second mortgage of up to 75% of appraised market value less
other mortgages outstanding on residential properties, repricing monthly indexed
to the prime rate. Student loans originated by the Bank are held in its
portfolio while the student is in school, then sold to the Student Loan
Marketing Association under a continuing commitment at the time the loan is to
go into repayment.

                                       3
<PAGE>   6


       The Bank also originates consumer loans through an indirect lending
program through which it receives loan applications from Bank-approved
automobile, boat and recreational vehicle dealerships on behalf of their
customers to finance purchases. These applications are subject to the Bank's
normal consumer loan underwriting criteria.

        LOAN ORIGINATION FEES AND COSTS. Loan origination fees vary with the
volume and type of loans made and with competitive conditions in the mortgage
market. Loan demand, new construction activity and availability of money affect
these market conditions. The Bank defers net loan fees (costs) and amortizes
such net fees (costs) over the life of the loan as an adjustment of yield.

        DELINQUENCIES. When a borrower fails to make a scheduled payment on a
loan, Skaneateles takes steps to have the borrower cure the delinquency. Accrual
of interest is discontinued on a loan when management believes, after
considering economic and business conditions and collection efforts, that the
borrower's financial condition precludes accrual. Generally, interest income is
not recognized on loans which are delinquent over 90 days, and income is
subsequently recognized only to the extent that cash payments are received
until, in management's judgment, the borrower's ability to make periodic
interest and principal payments is back to normal, in which case the loan is
returned to accrual status. If the delinquency exceeds 90 days or is not cured
through Skaneateles' normal collection procedures, Skaneateles will institute
measures to enforce its remedies resulting from the default, including, in the
case of mortgage loans, commencing a foreclosure action. In certain cases, the
Bank will also consider accepting from the mortgagor a voluntary deed to the
mortgaged premises in lieu of foreclosure. Property acquired by Skaneateles as a
result of foreclosure or by deed in lieu of foreclosure is classified as "Real
Estate Owned."

        Other loan delinquencies are remedied in a similar fashion. The
collateral is repossessed and sold with proceeds applied against the loan
balance. In the case of unsecured installment and commercial business loans,
Skaneateles either commences legal action to collect the balance or negotiates a
"work-out" payment schedule over a period which may exceed the original term of
the loan.

                                   SECURITIES

         Skaneateles has authority to purchase a wide range of securities,
subject to various restrictions. See "Regulation - New York Law."

        The Bank's investment strategy is primarily to hold securities for the
purpose of providing liquidity and generating income. The Bank invests primarily
in U.S. Treasury Notes, high grade corporate bonds and mortgage-backed
securities (primarily fixed rate and variable rate pass through certificates
issued and guaranteed by the Federal National Mortgage Association (FNMA) and
the Federal Home Loan Mortgage Corporation (FHLMC)). Pursuant to the Bank's
investment policy, all purchases for the investment portfolio must be investment
grade securities that are included in one of the top four bond rating
categories.

       The Company classifies its debt securities as either available-for-sale
or held-to-maturity, as the Company does not hold any securities considered to
be trading. Equity securities are classified as available-for-sale.
Held-to-maturity securities are those debt securities that the Company has the
ability and intent to hold until maturity. All other securities not included as
held-to-maturity are classified as available-for-sale.

       Available-for-sale securities are recorded at fair value.
Held-to-maturity securities are recorded at amortized cost. Unrealized gains and
losses, net of the related tax effect, on available-for-sale securities are
excluded from earnings and are reported as a separate component of stockholders'
equity until realized. Transfers of securities between categories are recorded
at fair value at the date of transfer. Unrealized gains or losses associated
with transfers of securities from held-to-maturity to available-for-sale are
recorded as a separate component of stockholders' equity until realized. The
unrealized gains or losses included in the separate component of equity for
securities transferred from available-for-sale to held-for-maturity are
maintained and amortized into earnings over the remaining life of the security
as an adjustment to yield in a manner consistent with the amortization or
accretion of premium or discount on the associated security.

                                       4
<PAGE>   7

       Presented below are the carrying values (in thousands) of the securities
portfolio as of the dates indicated.

<TABLE>
<CAPTION>
                                                          December 31,
                                                 ------------------------------
                                                     1998       1997       1996
                                                  ----------   -------    -----
Securities Available for Sale:
<S>                                              <C>          <C>      <C>  

  U.S. government and Federal agency obligations     $13,100     6,026     5,027
  Mortgage-backed securities:
    FNMA                                                 648       752         0
  Asset-backed securities                              1,051     1,638       982
--------------------------------------------------------------------------------
                                                     $14,799     8,416     6,009
================================================================================

Securities Held to Maturity:
U.S. government and Federal agency obligations       $ 1,019     3,007     4,992
Mortgage-backed securities:
  FNMA                                                   103       130       145
  FHLMC                                                2,087     2,998     3,674
Obligations of states and political subdivisions         806     1,470     1,782
Corporate bonds, notes and debentures                      0       100       300
--------------------------------------------------------------------------------
                                                     $ 4,015     7,705    10,893
--------------------------------------------------------------------------------
</TABLE>

                                    DEPOSITS

        Skaneateles attracts both short-term and long-term deposits of
individuals and businesses by providing a wide assortment of accounts. Included
among these products are savings accounts, demand deposit accounts, NOW
accounts, money market deposit accounts (MMDA) and certificates of deposit.
Skaneateles has no brokered deposits. The Bank's most direct competition for
deposits has historically come from commercial banks and other savings
institutions located in its market area. The Bank faces additional significant
competition for investors' funds from short-term money market mutual funds and
issuers of corporate and government securities. Skaneateles competes for
deposits principally by offering depositors a wide variety of deposit programs
with competitive terms, convenient branch locations and hours, tax deferred
retirement programs and other services. Skaneateles does not rely upon any
individual group or entity for a material portion of its deposits.

        Skaneateles offers fixed rate certificates of deposit with maturities of
91 days to seven years. A minimum of $500 is required to open a certificate of
deposit. Generally, interest rates on these certificates are determined by the
combination of open market interest rates, rates offered by competitors, and the
Bank's liquidity needs. Interest is compounded and credited monthly on such
certificates.

        The Bank currently offers a tiered money market deposit account.
Accounts with balances $50,000 and over earn an annual yield equal to 90% of the
average discount rate set weekly at the 91-day Treasury Bill auction. Accounts
with lower balances earn interest based on a graduated scale. Interest is
compounded and credited monthly on these accounts.

        Regular savings accounts currently earn interest at an annual rate of
2.50%, which accrues daily and is compounded and credited monthly. No minimum
balance is required to earn interest on these accounts.

        Skaneateles offers a wide array of checking accounts, including a
non-interest bearing account which has no minimum balance requirement, no
monthly maintenance fee and no per check charge. The Bank also offers interest
bearing checking accounts whose rates and fees vary based on the type of the
account and amount on deposit.

        Skaneateles also offers non-deposit products including annuities and
mutual funds through an arrangement with a third party agent. These products are
not insured by the Federal Deposit Insurance Corporation ("FDIC").


                                       5
<PAGE>   8


                                   REGULATION

        As a bank holding company, Skaneateles Bancorp, Inc. is subject to
regulation by the Board of Governors of the Federal Reserve System (the "Federal
Reserve Board"). The Company is also required to file certain reports and
otherwise comply with the rules and regulations of the Securities and Exchange
Commission (the "Commission") under the federal securities laws. Skaneateles
Savings Bank is a banking corporation chartered under the laws of the State of
New York, and its deposits are insured by the Bank Insurance Fund ("BIF"), as
administered by the FDIC. It is also a member of the Federal Home Loan Bank
System. As such, Skaneateles is subject to the regulation, examination and
supervision of the Banking Department of the State of New York (the
"Department") and the FDIC. The Bank is further subject to the regulation of the
Federal Reserve Board with respect to reserves required to be maintained against
deposits and certain other matters. The Federal Reserve Board, the Department
and the FDIC issue regulations and require the filing of reports describing the
activities and financial condition of the institutions under their jurisdiction.
Each agency conducts periodic examinations to test compliance with various
regulatory requirements and generally supervises the operations of such
institutions. This supervision and regulation is intended primarily for the
protection of depositors. Certain of the regulatory requirements applicable to
the Company and to Skaneateles are referred to below or elsewhere herein.

        FEDERAL BANK HOLDING COMPANY REGULATION. Skaneateles Bancorp, Inc. is
required to file with the Federal Reserve Board annual reports and such
additional information as the Federal Reserve Board may require pursuant to the
Bank Holding Company Act of 1956, as amended (the "BHCA"). The Federal Reserve
Board may conduct examinations of Skaneateles Bancorp, Inc. and its subsidiary.
Under the BHCA and regulations adopted by the Federal Reserve Board, a bank
holding company and its subsidiaries are prohibited from requiring certain
tie-in arrangements in connection with any extension of credit, lease, or sale
of property or furnishing of services.

        Under the BHCA, Federal Reserve Board approval is required for any
action which causes a bank or other company to become a bank holding company and
for any action which causes a bank to become a subsidiary of a bank holding
company. A bank holding company must obtain Federal Reserve Board approval
before it acquires direct or indirect ownership or control of any voting shares
of any bank if, after such acquisition, it will own or control directly or
indirectly more than 5% of the voting stock of such bank unless it already owns
a majority of the voting stock of such bank. Federal Reserve Board approval must
also be obtained before a bank holding company acquires all or substantially all
of the assets of a bank or merges or consolidates with another bank holding
company. Any acquisition, directly or indirectly, by a bank holding company or
its subsidiaries of more than 5% of the voting shares of, or interest in, or all
or substantially all of the assets of any bank located outside of the state in
which the operations of the bank holding company's banking subsidiaries are
principally conducted may not be approved by the Federal Reserve Board unless
the laws of the state in which the bank to be acquired is located expressly
authorize such an acquisition.

        A bank holding company is prohibited, except in certain statutorily
prescribed instances, from acquiring direct or indirect ownership or control of
more than 5% of the voting shares of any company which is not a bank or bank
holding company, and from engaging directly or indirectly in activities other
than those of banking, managing or controlling banks, or furnishing services to
its subsidiaries.

        The Federal Reserve Board has adopted capital adequacy guidelines
pursuant to which it assesses the adequacy of capital in examining and
supervising a bank holding company and in analyzing its applications to the
Federal Reserve Board. In addition, the Federal Reserve Board has the power to
issue capital directives (having the force of cease and desist orders) to
mandate the maintenance of adequate capital levels. The Company is in compliance
with Federal Reserve Board capital requirements.

        FEDERAL DEPOSIT INSURANCE CORPORATION. Skaneateles' deposit accounts are
insured by the FDIC up to a maximum of $100,000 per insured depositor. As an
insured bank, Skaneateles is subject to certain FDIC requirements designed to
maintain the safety and soundness of individual banks and the banking system.
The FDIC periodically conducts examinations of insured institutions and, based
upon evaluations, may revalue assets of an insured institution and require
establishment of specific reserves in amounts equal to the difference between
such revaluation and the book value of the assets. In addition, the FDIC has
adopted regulations and a statement of 

                                       6
<PAGE>   9


policy which define and establish certain minimum requirements for capital
adequacy. Under the regulations, insured state nonmember banks such as
Skaneateles are required to maintain minimum risk-based capital and leverage
capital. The Bank is in compliance with FDIC capital requirements.

       The annual premium charge for FDIC insurance is based on the level of
capital maintained by the institution and results of periodic regulatory
examinations. The following table sets forth the annual premium charge for the
periods indicated for FDIC insurance per $100 of the Bank's total deposits.

<TABLE>
<CAPTION>
                  Date                      Premium per $100 of total deposits
-------------------------------------------------------------------------------
<S>                                                        <C> 
January 1, 1996 to present (*)                             $.00
June 1, 1995 to December 31, 1995                          $.04
January 1, 1995 to May 30, 1995                            $.23
January 1, 1993 to December 31, 1994                       $.26
</TABLE>

         (*)      The Bank's FDIC insurance premium was reduced to the legal
                  minimum of $2,000 per year effective January 1, 1996.
                  Effective January 1, 1997 the FDIC eliminated the $2,000 per
                  year legal minimum. Beginning January 1, 1997, the Bank is
                  paying a fee for Financing Corporation (FICO) debt service at
                  an annual rate of $.013 per $100 of insurable deposits. This
                  fee is not an FDIC insurance premium.

        FEDERAL RESERVE SYSTEM. Skaneateles is subject to regulation of certain
matters by the Federal Reserve Board. The Federal Reserve Board requires
depository institutions, including savings banks the deposits of which are
insured by the FDIC, to maintain reserves in accordance with applicable
regulations for the purpose of facilitating the implementation of monetary
policy by the Federal Reserve System. Generally, the Federal Reserve Board
establishes reserve requirements for net transaction accounts. It also has
authority, subject to the satisfaction of certain conditions, to impose
emergency reserve and supplemental reserve requirements. As of December 31,
1998, net transaction accounts (transaction accounts, primarily NOW and regular
checking accounts, less certain permitted deductions) in the amount of $0 to
$46.5 million are subject to a reserve requirement of 3% of said amount. Net
transaction accounts over $46.5 million are subject to a reserve requirement of
$1,395,000 plus 10% of the total in excess of $46.5 million. However, $4.9
million of otherwise reservable liabilities are subject to an exemption from
reserve requirements. The amount of this exemption is subject to adjustment by
the Federal Reserve Board each calendar year. The Bank was in compliance with
its reserve requirements throughout 1998.

        FEDERAL HOME LOAN BANK SYSTEM. In 1986, Skaneateles became a member of
the Federal Home Loan Bank System, which consists of twelve regional Federal
Home Loan Banks each subject to Federal Housing Finance Board supervision and
regulation. The Federal Home Loan Banks provide a central credit facility
primarily for member institutions. Skaneateles, as a member of the FHLB of New
York, is required to acquire and hold shares of capital stock in that Bank in an
amount at least equal to 1% of the aggregate principal amount of its unpaid
residential mortgage loans, home purchase contracts, and similar obligations at
the beginning of each year, or 5% of its advances (borrowings) from the FHLB,
whichever is greater. Skaneateles is in compliance with this requirement.

        NEW YORK LAW. The Bank derives its lending and investment authority
primarily from the applicable provisions of the New York Banking Law and the
General Regulations of the Banking Board of the State of New York. Under these
laws and regulations, savings banks may invest in real estate mortgage,
commercial and consumer loans, home improvement and educational loans, certain
types of debt securities, including certain corporate debt securities and the
federal and state government and agency obligations, certain types of corporate
equity securities and certain other assets.

        Savings banks have the power to make commercial, corporate and business
loans, to make secured and unsecured installment loans for personal, family and
household purposes, and to exercise trust powers upon approval of the Banking
Board. These lending powers are not subject to percentage of asset limitations,
although there are limits applicable to single borrowers.

                                       7
<PAGE>   10


                  FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                            December 31,
                                                1998            1997             1996            1995            1994
----------------------------------------------------------------------------------------------------------------------
                                                                            (In Thousands)
Balance Sheet Data:
<S>                                        <C>               <C>              <C>             <C>             <C>    
Total assets                               $ 276,148         256,101          242,182         210,647         201,841
Net loans                                    212,578         212,462          204,830         168,967         163,921
Securities                                    18,814          16,121           16,902          21,457          21,871
Federal funds sold                            24,300           6,700            3,800           3,400           1,200
Deposits, including escrow                   237,333         218,018          205,029         179,119         170,696
Borrowings                                    15,979          18,057           18,181          14,386          13,984
Stockholders' equity                          19,101          17,671           16,230          14,939          13,791
----------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
                                                               Years ended December 31,
                                                1998            1997             1996            1995            1994
----------------------------------------------------------------------------------------------------------------------
                                                               (Dollars in Thousands, Except Per Share Data)
<S>                                      <C>                  <C>              <C>             <C>             <C>   
Operations Data:

Total interest income                    $    20,055          18,965           17,162          15,871          12,940
Total interest expense
                                               9,519           9,435            9,111           8,608           6,349
----------------------------------------------------------------------------------------------------------------------
Net interest income                           10,536           9,530            8,051           7,263           6,591

Provision for loan losses                        675             500              175             235             360
Other operating income                         2,338           1,849            1,116             587             509
Other operating expenses                       9,676           8,308            7,418           6,211           5,580
----------------------------------------------------------------------------------------------------------------------
Net income                               $     1,649           1,662            1,481           1,052             983
----------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Share data:
<S>                                       <C>                   <C>              <C>              <C>             <C>
Net income - basic                        $     1.14            1.16             1.05             .76             .71
Net income - diluted                            1.11            1.13             1.03             .74             .70
Dividends declared                               .28             .27              .19             .13             .08
Book value                                     13.17           12.31            11.41           10.70            9.93
Shares outstanding                         1,450,712       1,435,992        1,422,138       1,396,379       1,388,616
----------------------------------------------------------------------------------------------------------------------

Selected other data:

Tier I Capital (to average assets)             6.78%           6.91%            6.46%           7.00%           7.16%
Total Capital (to risk weighted assets)       11.30%          11.31%           11.23%          12.68%          12.17%
Nonperforming assets to total assets           1.48%           1.90%            1.61%           1.20%           2.10%
Net loans charged off to average loans         0.17%           0.03%            0.62%           0.36%           0.17%
Loan loss allowance to nonperforming             90%             65%              67%            125%             94%
loans
Earning asset yield                            8.05%           8.17%            8.01%           8.07%           7.31%
Cost of interest bearing liabilities           4.32%           4.51%            4.63%           4.71%           3.90%
Interest rate spread                           3.73%           3.66%            3.38%           3.36%           3.41%
Net interest margin                            4.23%           4.11%            3.76%           3.69%           3.72%
Full service banking offices                       9               9                8               7               5
----------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       8
<PAGE>   11


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

                               FINANCIAL CONDITION

GENERAL
        Skaneateles Bancorp, Inc. (the "Company") is a bank holding company,
with Skaneateles Savings Bank ("Skaneateles" or the "Bank") being its sole
subsidiary. The financial condition and operating results of the Company are
largely dependent on the Bank, its primary investment.

        Total assets of the Company were $276.1 million at December 31, 1998,
compared with $256.1 million at December 31, 1997, an increase of $20 million,
or 7.8%. Net loans were virtually unchanged, while federal funds sold increased
$17.6 million and securities increased $2.7 million in 1998.

        The pending acquisition of the Company by BSB Bancorp, Inc., scheduled
to close in the Summer of 1999, is expected to negatively impact the Company's
earnings in the first and second quarters in 1999 as merger related expenses are
incurred.

LOANS
        Net loans were $212.6 million at December 31, 1998, an increase of
$116,000, or .1% from December 31, 1997. The Company experienced strong growth
in its consumer and commercial loan portfolios in 1998, while the residential
mortgage portfolio decreased by $18.7 million due to an increased level of loan
sales, coupled with a historically high level of refinancings and prepayments.
Consumer and commercial loans grew a combined $18.9 million.

        Loan originations for 1998 totaled $72.3 million, an increase of 44.6%
from 1997's originations of $50 million. Residential mortgage originations were
$18.8 million in 1998, an increase of 94.5% from 1997's originations.
Residential mortgages represented 26% of 1998's total loan originations, up from
19.3% in 1997. Much of the growth was fueled by a surge in refinancings due to
the historically low level of interest rates in 1998.

        Approximately $17.5 million or 93% of the residential loans originated
in 1998 were for fixed rates of interest, compared with $7.9 million and 81.4%,
respectively, in 1997. Fixed rate mortgages with terms of 15 years or less were
originated for portfolio prior to January 1998. Beginning in January 1998, the
Bank began selling all conforming fixed rate mortgages at the time of
origination due to the relatively low interest rate environment and the
resulting increased interest rate risk associated with long term fixed rate
assets. As a result, sales of residential mortgages increased to $13.5 million
in 1998, compared with $4 million in 1997. The Bank generally retains servicing
rights on sold loans.

        Absent a marked increase in interest rates, it is likely that consumer
demand will continue to be overwhelmingly in favor of fixed rate loans for the
foreseeable future, thereby continuing to impede the Company's ability to grow
its residential portfolio.

        Consumer loan originations were $27.5 million, or 38% of total loan
originations in 1998, compared with $20.8 million, or 41.6% in 1997. The Bank
has seen a substantial increase in deposit customers through its Checking
Account Marketing Program ("CHAMP"), which has directly correlated with the
strong consumer loan growth in 1998.

        Also contributing to the 38% increase in consumer loan originations is
the Bank's indirect lending program. Through the indirect program, the Bank
receives consumer loan applications from Bank-approved automobile, boat and
recreational vehicle dealerships on behalf of their customers to finance
purchases from the dealers. These applications are subject to the Bank's normal
consumer loan underwriting criteria. Indirect consumer loans accounted for
approximately 50% of the Bank's total consumer loan originations in 1998,
compared with 33.5% in 1997.

                                       9
<PAGE>   12

        Commercial loan and commercial mortgage originations were $26 million,
or 36% of total loan originations in 1998, up from $19.6 million or 39.1% in
1997. The increase resulted largely from greater penetration in the Bank's local
market area due to an active calling program.

       LOAN PORTFOLIO COMPOSITION. The following table sets forth the
composition of Skaneateles' loan portfolio by loan type as of the dates
indicated.

<TABLE>
<CAPTION>
                                                                 At December 31,
                             ---------------------------------------------------------------------------------------------
                                   1998                1997                1996                1995             1994
                          -------------------   ----------------    ----------------   -----------------  ----------------
                            Amount        %     Amount         %     Amount     %       Amount      %      Amount      %
                          --------      -----   ------     -----    -------   -----    -------    -----   -------    ----- 
                                                             (Dollars in Thousands)
<S>                       <C>          <C>      <C>        <C>      <C>       <C>      <C>        <C>      <C>       <C>   
Loans secured by first
mortgages
  on real estate:
   Residential            $100,685     46.89%   119,350    55.63%   129,651   62.74%   116,320    67.80%   110,404   66.10%
   Commercial               34,676     16.15%    33,962    15.83%    31,728   15.35%    27,357    15.94%    28,175   16.87%
Other loans:
   Commercial               27,788     12.94%    22,995    10.72%    18,861    9.13%    10,631     6.20%    13,274    7.95%
   Home equity and
      improvement           20,658      9.62%    20,624     9.61%    17,599    8.52%    14,578     8.50%    13,219    7.92%
   Guaranteed student          910      0.42%     1,059     0.49%       882    0.43%       858     0.50%       789    0.47%
   Other consumer           30,028     13.98%    16,565     7.72%     7,924    3.83%     1,821     1.06%     1,148    0.69%
----------------------------------------------------------------------------------------------------------------------------
          Total           $214,745    100.00%   214,555   100.00%   206,645  100.00%   171,565   100.00%   167,009  100.00%
=============================================================================================================================
</TABLE>




        The following table sets forth the contractual maturity of the
commercial loan portfolio and real estate construction loans at December 31,
1998.

<TABLE>
<CAPTION>
                                                       Within             One to            After
                                                     one year           five years       five years         Total
--------------------------------------------------------------------------------------------------------------------
                                                                          (in Thousands)

<S>                                                 <C>                    <C>              <C>              <C>   
Commercial loans - adjustable rate                  $   7,670              6,763            2,552            16,985
Commercial loans - fixed rate
                                                          973              8,885              945            10,803
Real estate construction loans - adjustable rate
                                                        1,892                  0                0             1,892
--------------------------------------------------------------------------------------------------------------------
     Total                                         $   10,535             15,648            3,497            29,680
====================================================================================================================
</TABLE>

DEPOSITS
        Total deposits, including escrow, were $237.3 million at December 31,
1998, an increase of $19.3 million or 8.9% from the end of 1997. However, the
Bank experienced an increase of $6.1 million in December 1998 alone, much of
which were short-term increases in personal and commercial demand accounts that
were withdrawn in January 1999, resulting in a rate of growth for 1998 somewhat
lower than indicated.

        The Bank's strategy for deposit growth is focused on savings and
checking accounts, which carry lower rates of interest than time accounts and
tend to be less sensitive to changes in interest rates. The Bank offers seven
checking account products, each targeted to specific demographic groups and
supported by an active direct mail marketing campaign (CHAMP). Total checking
account balances (NOW and demand) increased $14.6 million, or 31.5% in 1998,
following a $9.5 million or 27.1% increase in 1997. The Bank opened more than
8,300 new checking accounts in 1998 as a result of the CHAMP program.

       Savings account balances increased $7.9 million or 18.7% in 1998,
compared with an increase of $3.8 million or 9.7% in 1997. The gains resulted
primarily from cross-sales to new checking account customers.

                                       10
<PAGE>   13

        Time certificates of deposit totaled $100.1 million at December 31,
1998, compared with $105.1 million at the end of 1997. The Bank generally kept
its rates on time certificates in the mid range of rates offered in its market
area during 1998, which, as expected, resulted in a decrease in these accounts.
The Bank expects to continue this practice in 1999. Premium rates may be offered
from time to time for specific branch promotions or in the event loan demand so
justifies.


        The following table sets forth deposits by type of account as of the
dates indicated:

<TABLE>
<CAPTION>
                                                                     December 31,
                                        ---------------------------------------------------------------------------
                                                1998                     1997                       1996
                                        ----------------------   ----------------------   -------------------------
                                                   Percent of                Percent of                Percent of
                                                       total                    total                    total
                                          Amount     deposits        Amount    deposits       Amount    deposits
                                        ---------------------------------------------------------------------------
                                                                      (Dollars in Thousands)
<S>                                      <C>           <C>            <C>       <C>            <C>          <C>     
Savings and club accounts                $  50,399     21.23%         42,451    19.47%         38,690       18.86%  
Time certificates                          100,072     42.16%        105,072    48.19%        107,429       52.40%  
Money market accounts                       26,050     10.98%         24,234    11.12%         21,991       10.73%  
NOW and escrow accounts                     33,457     14.10%         26,025    11.94%         22,058       10.76%  
Demand accounts                             27,355     11.53%         20,236     9.28%         14,861        7.25%  
---------------------------------------------------------------------------------------------------------------------
          Total                          $ 237,333    100.00%        218,018   100.00%        205,029      100.00%  
=====================================================================================================================
</TABLE>


        The Bank offers preferred rates on certificates of deposit of $100,000
or more. These rates are determined daily based upon the factors noted above.
The Bank does not rely heavily on these deposits. At December 31, 1998, 1997 and
1996, the aggregate amounts of certificates of deposit in denominations of
$100,000 or more were approximately $15,224,000, $13,427,000 and $13,065,000,
respectively.

         The following table presents the amounts of certificates of deposit in
denominations of $100,000 or more at December 31, 1998 which mature during the
periods indicated (in thousands):

<TABLE>
<CAPTION>
Maturity                                                Amount
--------                                                ------
<S>                                                     <C>    
3 months or less                                        $ 4,536
3 to 6 months                                             3,773
6 to 12 months                                            1,846
Over 12 months                                            5,069
----------------------------------------------------------------
Total                                                 $  15,224
----------------------------------------------------------------
</TABLE>


                                       11
<PAGE>   14



        The following table sets forth the average amount of and the average
rate paid on each category of interest-bearing deposits:

<TABLE>
<CAPTION>
                                                                  Year ended December 31,
                                                   1998                     1997                     1996
                                          ------------------------ -----------------------  -----------------------
                                            Average     Average      Average     Average      Average    Average
                                            Balance       Rate       Balance      Rate        Balance      Rate
                                          ------------------------ -----------------------  -----------------------
                                                                        (Dollars in Thousands)

<S>                                          <C>            <C>          <C>        <C>          <C>         <C>  
  Savings and club accounts                  $  45,955      2.80%        41,004     2.85%        36,576      2.84%
                                                                        
  Time certificates                            103,562      5.43%       104,447     5.53%       104,023      5.68%
                                                                        
  Money market accounts                         25,189      3.64%        22,551     3.64%        21,919      3.33%
                                                                        
  NOW and escrow accounts                       27,760      2.05%        22,911     2.10%        18,007      2.18%
</TABLE>


                                  ASSET QUALITY

        Nonperforming assets are comprised of nonaccrual loans and other real
estate owned (REO). Management's policy is to place a loan on nonaccrual status
with respect to interest income recognition when collection of the interest is
doubtful. Generally, this occurs when principal or interest payments are ninety
days or more past due, although interest accruals may continue for certain loans
that are adequately secured. The classification of a loan as nonaccruing does
not necessarily indicate that the principal and interest ultimately will be
uncollectable. The Bank's historical experience suggests that a portion of
assets so classified will eventually be recovered. All nonperforming loans are
in various stages of workout, settlement or foreclosure.

        Nonperforming assets totaled $4.1 million or 1.5% of total assets at
December 31, 1998, compared with $4.9 million or 1.9% of total assets at
December 31, 1997. Included in nonperforming assets at December 31, 1998 were
nonaccrual loans of $3.2 million or 1.5% of gross loans, compared with $3.9
million or 1.8% of gross loans at December 31, 1997.

        The allowance for loan losses was $2.9 million at December 31, 1998
compared with $2.6 million at December 31, 1997. The ratio of the allowance to
nonperforming loans was 90% at December 31, 1998, compared with 65% at the end
of 1997. Loan loss provisions totaled $675,000 in 1998, compared with $500,000
in 1997. The loan loss provision was increased to reflect the higher credit risk
inherent in consumer and commercial lending. Charge-offs net of recoveries
amounted to $373,000 in 1998, compared with $54,000 in 1997, when the Bank
recovered $311,000 on a loan charged off in 1996.

       Skaneateles uses the allowance method of accounting for loan losses.
Under this method, provisions for loan losses are charged to operations and
actual loan losses (recoveries) are charged (credited) to the allowance. The
allowance for loan losses represents amounts provided to absorb probable future
loan losses in the existing loan portfolio. The adequacy of the allowance for
loan losses is evaluated monthly, and is determined primarily by management's
informed judgment concerning the amount of risk inherent in the portfolio.
Management's judgment is based upon a number of factors, including historical
loan loss experience, the present and prospective financial condition of
borrowers, estimated value of underlying collateral, industry and geographic
concentrations, and current and prospective economic conditions.

        The Bank utilizes a risk rating system in its credit quality evaluation
process. This system involves an ongoing review of business loans and commercial
real estate loans that culminates in loans being assigned a risk rating based
upon various credit criteria. If the review indicates a sufficient level of
risk, an allowance is established proportionate to the perceived risk for each
loan. Loans not having an individually established allowance are aggregated by
the type of loan and an allowance is estimated based upon aging statistics, past
experience and economic factors.

                                       12
<PAGE>   15

        Generally, all commercial mortgage loans and commercial loans in a
delinquent payment status (90 days or more delinquent) are considered impaired.
The Bank estimates losses on impaired loans based on the present value of
expected future cash flows (discounted at the loan's effective interest rate) or
the fair value of the underlying collateral if the loan is collateral dependent.
An impairment loss exists if the recorded investment in a loan exceeds the value
of the loan as measured by the aforementioned methods. A loan is considered
impaired when it is probable that the Bank will be unable to collect all amounts
due according to the contractual terms of the loan agreement. Residential
mortgage loans, consumer loans, home equity lines of credit and education loans,
respectively, are evaluated collectively since they are homogenous and generally
carry smaller individual balances.

        As with any financial institution, poor economic conditions, high
interest rates, high unemployment and other matters outside of the Bank's
control may lead to increased losses in the loan portfolio. Management has
various controls in place which it designed in an effort to limit losses, such
as: (i) a comprehensive "watch list" of possible loan problems; (ii) a fully
documented policy concerning loan administration (loan file documentation,
disclosures, approvals, etc.); and (iii) an independent loan review function to
audit for adherence to established Bank controls and to review the quality and
anticipated collectibility of the portfolio. Loan review reports are presented
monthly to the Executive Committee of the Board of Directors, which in turn,
reports to the full Board of Directors. Charge-offs are authorized by the Board
of Directors based on management's recommendations after applying the credit
review process described above.

        Management believes the allowance for loan losses as of December 31,
1998 was adequate based upon the quality of the loan portfolio at that date.
Future additions to the allowance will be based, among other factors, on changes
in economic conditions and financial stress of the Company's borrowers.


                                       13
<PAGE>   16


         The following table sets forth information with respect to loans
delinquent 90 days or more, nonaccrual loans, restructured loans, and real
estate owned as of the dates indicated.

<TABLE>
<CAPTION>
                                                                          December 31,
                                              -----------------------------------------------------------------------
                                                 1998            1997           1996            1995          1994
                                              -----------    ------------   ------------    -----------    ----------
                                                                      (Dollars in Thousands)
<S>                                             <C>                <C>            <C>              <C>           <C>
Nonaccruing loans
     Residential real estate mortgages          $  1,112           1,091          1,359            271           317
     Commercial (1)                                1,763           2,573          1,626          1,757         2,894
     Consumer                                        305             253            186            110            40
---------------------------------------------------------------------------------------------------------------------
Total                                              3,180           3,917          3,171          2,138         3,251
=====================================================================================================================

Other loans past due 90 days or more and still 
  accruing:
     Consumer (2)                                      0               0             29              1             0

     Commercial (1)                                    0               0            370              0           447
---------------------------------------------------------------------------------------------------------------------
Total                                                  0               0            399              1           447
=====================================================================================================================

Restructured loans, not included above                 0               0              0          1,125           932
=====================================================================================================================

Real estate owned                                    900             951            717            397           984
=====================================================================================================================

Total assets containing specific risk
elements                                           4,080           4,868          4,287          3,661         5,614
=====================================================================================================================

Ratio of total loans past due
90 days or more to gross loans                      1.48%           1.83%          1.73%          1.25%         2.21%
=====================================================================================================================

Ratio of assets containing specific
risk elements to total assets                       1.48%           1.90%          1.77%          1.74%         2.78%
=====================================================================================================================
</TABLE>

(1) Includes commercial real estate loans.
(2) Consists primarily of Guaranteed Student Loans.


        The following table sets forth the amounts of interest income not
recognized on nonaccruing loans during each period (not including the effect of
loans charged off during the period).

<TABLE>
<CAPTION>
                                                                     Year ended December 31,
                                              ----------------------------------------------------------------------
                                                 1998           1997          1996           1995           1994
                                              -----------    -----------   -----------    -----------    -----------
                                                                           (in Thousands)
<S>                                            <C>                <C>           <C>            <C>            <C>
Income that would have been accrued
at original contract rates                     $   298            274           283            155            172
</TABLE>

        Potential problem loans at December 31, 1998 amounted to $1.2 million.
"Potential problem loans" are defined as loans which are not included with past
due and non-accrual loans discussed above, but about which management, through
normal internal credit review procedures, has information about possible credit
problems that may result in the borrower's inability to comply with the present
loan repayment terms. There have been no loans classified for regulatory
purposes as loss, doubtful, or substandard that are not included above or which
caused management to have serious doubts as to the ability of the borrower to
comply with repayment terms. In addition, there were no material commitments to
lend additional funds to borrowers whose loans were classified as
non-performing.

                                       14
<PAGE>   17

       Impaired loans, which included troubled debt restructured loans, were
$1.5 million and $2.1 million at December 31, 1998 and 1997, respectively.
Included in these amounts are $554,000 and $1.9 million of impaired loans for
which the related allowance for loan losses is $205,000 and $219,000,
respectively. The average recorded investment in impaired loans during 1998,
1997 and 1996 was approximately $2.1 million, $1.5 million, and $2.9 million,
respectively. The amount of interest income recognized on impaired loans in
1998, 1997 and 1996 was approximately $91,000, $84,000, and $166,000,
respectively. The Bank is not committed to lend additional funds to these
borrowers.

        The Company recognizes interest income on impaired loans using the cash
basis of income recognition. Cash receipts on impaired loans are generally
applied according to the terms of the loan agreement, or as a reduction of
principal, based upon management judgment and other factors.


        The following table sets forth the activity in the allowance for loan
losses for the periods indicated.
<TABLE>
<CAPTION>
                                                                    Year ended December 31,
                                            --------------------------------------------------------------------

                                               1998          1997          1996           1995          1994
                                            -----------    ---------    -----------    -----------    ----------
                                                                      (Dollars in Thousands)
<S>                                          <C>              <C>            <C>            <C>           <C>  
Beginning Balance                            $  2,560        2,114          2,667          3,040         2,938

Provision                                         675          500            175            235           360

CHARGE-OFFS
   Residential mortgages                          (92)         (92)           (74)             0           (18)
   Commercial mortgages                           (95)        (237)          (168)          (569)            0
   Commercial                                    (126)        (137)          (999)          (153)         (331)
   Credit card                                     (4)          (1)             0              0             0
   Other consumer                                (150)        (106)           (60)           (10)          (17)
----------------------------------------------------------------------------------------------------------------
                                                 (467)        (573)        (1,301)          (732)         (366)
----------------------------------------------------------------------------------------------------------------
RECOVERIES
   Residential mortgages                            0            2              0              0             0
   Commercial mortgages                            34            5              0              0             0
   Commercial                                      39          496            118            118            96
   Other consumer                                  21           16              8              6            12
----------------------------------------------------------------------------------------------------------------
                                                   94          519            126            124           108
----------------------------------------------------------------------------------------------------------------
Net Charge-offs                                  (373)         (54)        (1,175)           (608)        (258)
----------------------------------------------------------------------------------------------------------------
Allowance of acquired bank                          0            0            447               0            0
----------------------------------------------------------------------------------------------------------------
Ending Balance                              $   2,862        2,560          2,114           2,667        3,040
================================================================================================================

Ratio of net charge-offs during the year
  to average loans outstanding during the        0.17%        0.03%          0.62%          0.36%         0.17%
year
==================================================================================================================
</TABLE>


                                       15

<PAGE>   18


       The following table sets forth the allocation of the allowance for loan
losses as of the dates indicated.
  
<TABLE>
<CAPTION>
                                                                        December 31,
                                              --------------------------------------------------------------------
                                                 1998          1997           1996          1995          1994
                                              -----------   -----------    -----------   -----------   -----------
                                                                         (In Thousands)
<S>                                           <C>                  <C>            <C>            <C>           <C>
Consumer                                      $      661           428            178            80            59
                                                            
Commercial (1)                                     1,932         2,039          1,822         2,517         2,926
                                                            
Residential                                          269            93            114            70            55

------------------------------------------------------------------------------------------------------------------
                                               $   2,862         2,560          2,114         2,667         3,040
------------------------------------------------------------------------------------------------------------------
</TABLE>

 (1) Includes commercial real estate loans.

                           ASSET/LIABILITY MANAGEMENT

        The goal of asset/liability management is to reduce the volatility of
net interest income during periods of changing market interest rates (interest
rate risk). The Company uses three methods to measure its interest rate risk:
(i) gap; (ii) income simulation; and (iii) market value of equity analysis. Gap
analysis measures the difference between assets and liabilities which reprice
and/or mature within a given time frame, typically the cumulative one-year
horizon. An asset-sensitive gap position could lead to an increase in net
interest income in a rising rate environment, and a decrease in net interest
income in a falling rate environment, as assets reprice or mature quicker than
liabilities. Conversely, a liability-sensitive gap position could lead to a
decrease in net interest income in a rising rate environment and an increase in
net interest income in a falling rate environment. Income simulation measures
the potential impact on net interest income of hypothetical changes in interest
rates. Market value of equity analysis measures the potential impact on
stockholders' equity of hypothetical changes in interest rates.

        In February 1996, the Bank purchased an interest rate floor with a
notional amount of $18 million, to hedge a portion of its prime-based loan
portfolio. Under the agreement, which expired in February 1999, the Bank
received payments on a quarterly basis when the prime rate dropped below 8.25%
(the "strike rate"), in the amount by which the prime rate fell below the strike
rate multiplied by the notional amount of the floor. The fee paid for the floor
was included in other assets and was amortized to interest income using the
interest method over the life of the floor. The Bank did not replace this
instrument upon its expiration.

        The Company's cumulative one-year ratio of rate sensitive assets to rate
sensitive liabilities (one-year gap) was 1.15 at December 31, 1998.


                                       16
<PAGE>   19


        The following table sets forth the amortization, maturity and repricing
schedule of the Company's interest earning assets and interest bearing
liabilities for all future time periods as of December 31, 1998.


<TABLE>
<CAPTION>
                                      0 to           Over 3        Over 1         Over 5         Over
                                    3 Months      to 12 Months    to 5 Years    to 10 Years    10 Years      Total
---------------------------------------------------------------------------------------------------------------------
                                                                 (Dollars in Thousands)
<S>                                  <C>              <C>          <C>            <C>           <C>         <C>   
Interest-earning assets:
  Federal funds sold                 $ 24,300                0            0              0             0      24,300
  Securities                            2,239            6,877        7,901          1,432           346      18,795
  Federal Home Loan Bank stock          1,561                0            0              0             0       1,561
  Mortgage loans                       18,893           57,155       42,864         14,307         2,142     135,361
  Consumer loans                       10,965            8,766       29,167          2,698             0      51,596
  Commercial loans                     17,255            2,331        8,128              0            74      27,788
---------------------------------------------------------------------------------------------------------------------
Total                                  75,213           75,129       88,060         18,437         2,562     259,401
---------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
  Deposits:
     Savings and club accounts          5,040           15,120       20,155         10,084             0      50,399
     Time certificates                 25,953           40,727       32,077          1,315             0     100,072
     Money market accounts             26,050                0            0              0             0      26,050
     NOW and escrow accounts            1,599            5,595       22,021          4,242             0      33,457
  Borrowings                            7,773            3,000        4,265            665           276      15,979
-----------------------------------------------------------------------------------------------          ------------
                                                                                               ----------
Total                                  66,415           64,442       78,518         16,306           276     225,957
---------------------------------------------------------------------------------------------------------------------
Gap                                  $  8,798           10,687        9,542          2,131         2,286      33,444
=====================================================================================================================
Cumulative gap                       $  8,798           19,485       29,027         31,158        33,444
=====================================================================================================================
Cumulative gap as a
     Percentage of
     Interest-earning
     Assets                             3.39%            7.51%       11.19%         12.01%        12.89%
=====================================================================================================================
</TABLE>


                              STOCKHOLDER'S EQUITY

        Stockholders' equity totaled $19.1 million at December 31, 1998,
compared with $17.7 million at December 31, 1997. The change is the result of:
(i) net income of $1.6 million; (ii) proceeds of $179,000 from issuance of stock
under stock plans; (iii) cash dividends of $404,000; and (iv) a $6,000 increase
in the fair value of securities, net of taxes.

        The Company's and Bank's leverage capital ratio was 6.78% at December
31, 1998 compared with 6.91% at December 31, 1997. Total capital to
risk-adjusted assets was 11.30% and 11.31%, respectively, at December 31, 1998
and 1997. Both capital measurements exceed the regulatory requirements of 5% and
10%, respectively, to be classified as a well-capitalized institution.


                                       17
<PAGE>   20


                         LIQUIDITY AND CAPITAL RESOURCES

        The purpose of liquidity management is to assure sufficient cash flow to
meet all of the Company's financial requirements and to be able to capitalize on
opportunities for increasing income. Liquidity is mainly provided by cash,
securities available for sale, principal and interest collections on loans and
mortgage-backed securities, deposits and borrowing facilities from correspondent
banks. The Bank has overnight line of credit facilities with the Federal Home
Loan Bank of New York ("FHLB") totaling $25.6 million which can be used to meet
the Bank's daily cash needs. In addition, the Bank can borrow additional amounts
on a term basis from the FHLB.

        The Bank occasionally borrows funds to invest in assets to manage its
asset/liability position and its net interest income. Additionally, the Bank
also borrowed $2.0 million from the Federal Home Loan Bank of New York (FHLB) in
1987 at 10.51% for 15 years to fund the purchase of the downtown Syracuse
banking center.

        The following table sets forth the borrowings of Skaneateles as of the
dates indicated.

<TABLE>
<CAPTION>
                                                                                    December 31,
                                                                 ---------------------------------------------------
                                                                     1998              1997               1996
                                                                 -------------     --------------     --------------
                                                                               (Dollars in Thousands)
<S>                                                                 <C>                    <C>                <C>  
Securities sold under repurchase agreements                         $   1,773              2,204              2,516
Line of credit advances from the FHLB of New York                       6,000                  0                  0
Advances from the FHLB of New York                                      7,465             14,486             14,000
Municipal securities sold with put options                                741              1,367              1,665
--------------------------------------------------------------------------------------------------------------------
                                                                     $ 15,979             18,057             18,181
=====================================================================================================================
Weighted average interest cost of
  borrowings during the year                                            6.25%               6.47%              6.48%
=====================================================================================================================
</TABLE>

        The Bank's liquidity position is monitored daily, and the
Asset/Liability Committee of the Board of Directors is responsible for setting
general guidelines to ensure maintenance of prudent levels of liquidity. At
December 31, 1998, the Bank's approved commitments to extend credit amounted to
$27.1 million. Further information on commitments is in note 10 of Notes to
Consolidated Financial Statements. The Company's liquidity is considered
adequate to meet all of its cash flow requirements.


                              RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997

GENERAL
        The Company's and Bank's earnings are largely dependent upon net
interest income, and are also affected by its provision for loan losses, other
operating income and expenses, and taxes. All earnings per share information is
calculated assuming dilution pursuant to Statement of Financial Accounting
Standards No. 128, Earnings Per Share.

        Net income was $1.65 million or $1.11 per diluted share in 1998,
compared with $1.66 million or $1.13 per diluted share in 1997. A $1 million
increase in net interest income and a $489,000 increase in other operating
income was offset by a $175,000 increase in loan loss provisions and a $1.4
million increase in other expenses.


                                       18
<PAGE>   21


NET INTEREST INCOME
        Net interest income is affected by the difference between the yield
earned on interest earning assets and the rates paid on deposits and borrowings.
The relative amounts of interest earning assets, deposits, and borrowings also
impact net interest income levels.

        Net interest income was $10.5 million in 1998, an increase of $1
million, or 10.6% from 1997. Interest income increased $1.1 million or 5.7% in
1998 due to a $17 million increase in average interest earning assets which was
partially offset by a 12 basis point decrease in the yield on those assets.
Total average loans increased $4.5 million or 2.1% while federal funds sold
increased $12.4 million or 352%.

        The rate of growth in interest income and net interest income, although
healthy, slowed compared with 1997 due to a sharp decline in the growth rate of
average loans. Average loans increased 2.1% in 1998, compared with 11.4% in
1997. The impact of the slowdown in loan growth was partially mitigated by a
significant change in the mix of the loan portfolio. The average balance of
higher yielding consumer and commercial loans increased $18.6 million or 35.3%
in 1998, while mortgages decreased $14.1 million or 9%. This trend is expected
to continue into 1999 if interest rates do not rise appreciably in the near
future.

        The yield on loans was 8.41% in 1998, compared with 8.36% in 1997. The
increase was due mainly to the increase in the average balance of other loans
(consumer and commercial), which yielded 9.25% in 1998, compared with 9.22% in
1997.

        Interest expense increased $84,000 or .9% in 1998. An $11.1 million
increase in average interest-bearing liabilities was substantially offset by a
19 basis point decrease in the cost of these funds. The Bank's deposit mix
continued to change in 1998 due to its strategy of emphasizing and promoting
savings and checking accounts. Average interest-bearing transaction accounts
(savings and NOW accounts) as a percentage of total interest-bearing deposits
(including escrow) were 36.4% in 1998, compared with 33.5% in 1997. The average
cost of interest-bearing transaction accounts was 2.52% in 1998, while the
average cost of time deposits was 5.43%. This compares with 2.58% and 5.53%,
respectively, in 1997. The overall cost of funds, including non interest-bearing
demand accounts, was 3.93% in 1998, down from 4.17% in 1997.

        Interest rates were, on average, lower in 1998 compared with 1997. The
Bank's prime rate, which is directly impacted by movements in short term rates
by the Federal Reserve, averaged 8.36% in 1998, compared with 8.44% in 1997.
Treasury yields on maturities of 5 years or more decreased on average more than
100 basis points, while yields on shorter maturities declined by a lesser
degree.

        Market interest rates alone do not dictate the rates the Bank pays for
its funds, although they are an important factor. Other factors that impact the
Bank's cost of funds include liquidity needs, the desired mix of deposits and
borrowings, local market competition and asset growth objectives.

        The net interest margin,  which is computed by dividing net interest 
income by average interest earning assets, increased to 4.23% in 1998, compared
with 4.11% in 1997.



                                       19
<PAGE>   22


                         ANALYSIS OF NET INTEREST INCOME

        The following table sets forth, for the periods indicated, information
regarding: (i) the total dollar amount of interest income from interest-earning
assets and the resulting average yields; (ii) the total dollar amount of
interest expense on interest-bearing liabilities and the resultant average cost;
(iii) net interest income; (iv) interest rate spread; (v) net interest-earning
assets; (vi) net yield on interest-earning assets; and (vii) ratio of
interest-earning assets to interest-bearing liabilities. Nonaccruing loans,
which are immaterial, have been included in interest earning assets. No tax
equivalent adjustments were made.



<TABLE>
<CAPTION>
                                                                            Year ended December 31,
                                                        1998                                                   1997                
                                      -----------------------------------------------    ------------------------------------------
                                              Average                       Yield/            Average                       Yield/ 
                                             Balance             Interest    Rate             Balance        Interest        Rate  
                                      -----------------------------------------------    ------------------------------------------
                                                                             (Dollars In Thousands)
<S>                                        <C>                     <C>         <C>            <C>              <C>            <C>  
Interest-earning assets:
  Mortgage loans                           $  143,052              11,431      7.99%          157,177          12,681         8.07%
  Other loans                                  71,468               6,610      9.25%           52,836           4,872         9.22%
-----------------------------------------------------------------------------------------------------------------------------------
Total loans                                   214,520              18,041      8.41%          210,013          17,553         8.36%
-----------------------------------------------------------------------------------------------------------------------------------
  Securities                                   18,652               1,148      6.15%           18,537           1,198         6.46%
  Federal funds sold                           15,930                 866      5.44%            3,524             214         6.07%

-----------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets                 249,102              20,055      8.05%          232,074          18,965         8.17%

-----------------------------------------------------------------------------------------------------------------------------------
Non-interest earning assets                    15,271                   0                      13,417               0              
-----------------------------------------------------------------------------------------------------------------------------------
Total assets                               $  264,373              20,055                     245,491          18,965              
-----------------------------------------------------------------------------------------------------------------------------------

Interest-bearing liabilities:
  Deposits:
     Savings and club accounts            $    45,955               1,287      2.80%           41,004           1,169         2.85%
     Time certificates                        103,562               5,628      5.43%          104,447           5,774         5.53%
     Money market accounts                     25,189                 916      3.64%           22,551             821         3.64%
     NOW and escrow accounts                   27,760                 568      2.05%           22,911             480         2.10%
-----------------------------------------------------------------------------------------------------------------------------------
  Total interest-bearing deposits             202,466               8,399      4.15%          190,913           8,244         4.32%
-----------------------------------------------------------------------------------------------------------------------------------
  Borrowings                                   17,930               1,120      6.25%           18,406           1,191         6.47%
-----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities            220,396               9,519      4.32%          209,319           9,435         4.51%
Non-interest-bearing deposits                  21,537                   0                      16,892               0              
Non-interest-bearing liabilities                3,945                   0                       2,067               0              
-----------------------------------------------------------------------------------------------------------------------------------
Total liabilities                             245,878               9,519                     228,278           9,435              
Stockholders' equity                           18,495                   0                      17,213               0              
-----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
  stockholders' equity                     $  264,373               9,519                     245,491           9,435              
-----------------------------------------------------------------------------------------------------------------------------------
Net interest income/
  interest rate spread                                             10,536      3.73%                            9,530         3.66%
-----------------------------------------------------------------------------------------------------------------------------------
Net interest-earning assets/
  net yield on interest-earning
  assets                                  $    28,706                          4.23%           22,755                         4.11%
-----------------------------------------------------------------------------------------------------------------------------------
Ratio of interest-earning assets
  to interest-bearing liabilities                                               1.13                                           1.11
-----------------------------------------------------------------------------------------------------------------------------------


<CAPTION>
                                                                Year ended December 31,
                                                                          1996
                                          -------------------------------------------------------
                                                 Average                                 Yield/
                                                  Balance                Interest         Rate
                                          -------------------------------------------------------
                                                                 (Dollars In Thousands)
<S>                                                 <C>                     <C>            <C>  
Interest-earning assets:
  Mortgage loans                                    152,455                 12,156         7.97%
  Other loans                                        36,053                  3,346         9.28%
--------------------------------------------------------------------------------------------------
Total loans                                         188,508                 15,502         8.22%
-------------------------------------------------------------------------------------------------
  Securities                                         22,166                  1,461         6.59%
  Federal funds sold                                  3,591                    199         5.54%

------------------------------------------------------------------------------------------------
Total interest-earning assets                       214,265                 17,162         8.01%

-------------------------------------------------------------------------------------------------
Non-interest earning assets                          12,998                      0
-------------------------------------------------------------------------------------------------
Total assets                                        227,263                 17,162
-------------------------------------------------------------------------------------------------

Interest-bearing liabilities:
  Deposits:
     Savings and club accounts                       36,576                  1,040         2.84%
     Time certificates                              104,023                  5,908         5.68%
     Money market accounts                           21,919                    730         3.33%
     NOW and escrow accounts                         18,007                    392         2.18%
-------------------------------------------------------------------------------------------------
  Total interest-bearing deposits                   180,525                  8,070         4.47%
-------------------------------------------------------------------------------------------------
  Borrowings                                         16,054                  1,041         6.48%
-------------------------------------------------------------------------------------------------
Total interest-bearing liabilities                  196,579                  9,111         4.63%
Non-interest-bearing deposits                        12,310                      0
Non-interest-bearing liabilities                      2,665                      0
-------------------------------------------------------------------------------------------------
Total liabilities                                   211,554                  9,111
Stockholders' equity                                 15,709                      0
-------------------------------------------------------------------------------------------------
Total liabilities and
  stockholders' equity                              227,263                  9,111
-------------------------------------------------------------------------------------------------
Net interest income/
  interest rate spread                                                       8,051         3.38%
-------------------------------------------------------------------------------------------------
Net interest-earning assets/
  net yield on interest-earning
  assets                                             17,686                                3.76%
-------------------------------------------------------------------------------------------------
Ratio of interest-earning assets
  to interest-bearing liabilities                                                           1.09
-------------------------------------------------------------------------------------------------
</TABLE>


                                       20

<PAGE>   23


                              RATE/VOLUME ANALYSIS

        The following table presents changes in interest income and expense
attributable to (i) changes in volume (change in volume multiplied by old rate),
and (ii) changes in rate (change in rate multiplied by old volume). The net
change attributable to the combined impact of volume and rate has been allocated
in proportion to the absolute change due to volume and the change due to rate.
Interest earned on non-accruing loans is included in interest income on loans
only when collected, but the average balances of such loans are included in the
average balances of loans.

<TABLE>
<CAPTION>
                                                              1998 vs. 1997                          1997 vs. 1996
                                                    ----------------------------------- ---------------------------------------
                                                             Increase (Decrease)                  Increase (Decrease)
                                                      Volume        Rate        Net       Volume         Rate       Net
                                                    --------------------------------------------------------------------------
                                                                                  (In Thousands)
<S>                                                  <C>            <C>       <C>            <C>         <C>         <C>
Interest income on interest-earning assets:
     Mortgage loans                                  $(1,126)       (124)     (1,250)        374         151         525
     Other loans                                       1,722          16       1,738       1,548         (22)      1,526
     Securities                                            7         (57)        (50)       (235)        (28)       (263)
     Federal funds sold                                  676         (24)        652          (4)         19          15
-------------------------------------------------------------------------------------------------------------------------
  Total                                                1,279        (189)      1,090       1,683         120       1,803
=========================================================================================================================
Interest expense on interest-bearing liabilities:
Deposits:
     Savings and club accounts                       $   139         (21)        118         125           4         129
     Time certificates                                   (47)        (99)       (146)         24        (158)       (134)
     Money market accounts                                95           0          95          21          70          91
     NOW and escrow accounts                             100         (12)         88         103         (15)         88
-------------------------------------------------------------------------------------------------------------------------
  Total deposits                                         287        (132)        155         273         (99)        174
Borrowings                                               (31)        (40)        (71)        152          (2)        150
-------------------------------------------------------------------------------------------------------------------------
  Total                                                  256        (172)         84         425        (101)        324
=========================================================================================================================
Net interest income                                  $ 1,023         (17)      1,006       1,258         221       1,479
=========================================================================================================================
</TABLE>


OTHER OPERATING INCOME
        Other operating income includes gain or loss from sale of loans and
securities, and service charges and other income. Other operating income in 1998
was $2.3 million, compared with $1.8 million in 1997, an increase of $489,000 or
26.4%. Much of the increase is attributable to higher service charges on
deposits, which increased $340,000 or 24.4% in 1998. This is a direct result of
the growth in the Company's checking accounts. In addition, net gain on sale of
loans increased $125,000 or 154.3% in 1998 due to a higher volume of loan sales.

OTHER OPERATING EXPENSES
        Other operating expenses were $9.7 million in 1998, compared with $8.3
million in 1997, an increase of $1.4 million or 16.5%.

        Salaries and employee benefits expense was $4.1 million in 1998,
compared with $3.7 million in 1997, an increase of $407,000 or 11.1%. The
increase is attributable to staffing of a new branch opened in the North Medical
Plaza in Liverpool in September 1997, higher benefits expense due to greater
employee participation in the Company's benefit plans and normal salary
increases.

        Building, occupancy and equipment expense increased $210,000 or 16.4%
due to the cost of operating the new branch, and to depreciation on computer
equipment purchased in early 1998. In addition, a $38,000 write-off was recorded
upon the disposition of obsolete equipment in 1998.

                                       21
<PAGE>   24


        Data processing expense increased $294,000 or 67.9% in 1998.
Approximately 51% of the increase was due to cost of the Bank's Year 2000
program, with the rest of the increase due to the Bank's growth.

        Correspondent bank fees increased $160,000 or 37.5% due to higher
transaction volume resulting from the growth in the Bank's customer base.

        Professional services increased $140,000 or 65.7% in 1998, due to
increased reliance on outside firms for information technology, internal audit
and services related to the formation of a Real Estate Investment Trust
subsidiary.

        Other expenses increased $113,000 or 10% in 1998. Real estate owned
expense accounted for approximately 55% of the increase, due to anticipated
losses in the portfolio.

        The Company's efficiency ratio was 75.7% in 1998, compared with 71.5% in
1997. The efficiency ratio is equal to total operating expenses (net of real
estate owned expense and amortization of intangibles) divided by net interest
income plus other operating income (excluding securities gains). The degradation
in the efficiency ratio reflects the high cost to the Company of offering
competitive products and services in a fast changing banking environment.

INCOME TAXES
        Income tax expense was $874,000 for 1998 and $909,000 for 1997. The
decrease generally corresponds to lower income before income taxes. Effective
income tax rates were 34.6% for 1998 and 35.4% for 1997. At December 31, 1998,
the Company has deferred tax assets of $1.3 million and deferred tax liabilities
of $698,000. Management has determined that a valuation allowance for the
deferred tax assets is not needed at December 31, 1998. Additional information
on income taxes is provided in the notes to consolidated financial statements.


YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996

GENERAL
        Net income was $1.66 million, or $1.13 per diluted share in 1997,
compared with $1.48 million, or $1.03 per diluted share in 1996. A $1.48 million
increase in net interest income and a $733,000 increase in other operating
income was partially offset by a $325,000 increase in loan loss provisions and
an $890,000 increase in other operating expenses. Income taxes increased
$816,000.

NET INTEREST INCOME
        Net interest income was $9.5 million in 1997, an increase of $1.5
million, or 18.4% from 1996. Interest income increased $1.8 million, or 10.5% in
1997 due to a $17.8 million increase in average interest earning assets and a 16
basis point increase in the yield on those assets. Total average loans increased
$21.5 million, or 11.4% while securities and federal funds sold decreased $3.7
million, or 14.4%.

        The yield on loans was 8.36% in 1997, compared with 8.22% in 1996. The
increase was due mainly to a $16.8 million, or 46.6% increase in the average
balance of other loans (consumer and commercial), which yielded 9.22% in 1997.

        Interest rates were, on average, little changed between 1997 and 1996.
The Bank's prime rate averaged 8.44% in 1997, compared with 8.27% in 1996.
Treasury yields on maturities of 5 years or less increased on average less than
20 basis points, while yields were down slightly on longer maturities.

        Interest expense increased $324,000 or 3.6% in 1997 due to a $12.7
million increase in average interest-bearing liabilities partially offset by a
12 basis point decrease in the cost of funds. Average interest-bearing
transaction 

                                       22
<PAGE>   25




accounts (savings and NOW accounts) as a percentage of total interest-bearing
deposits (including escrow) were 33.5% in 1997, compared with 30.2% in 1996. The
average cost of interest-bearing transaction accounts was 2.58% in 1997, while
the average cost of time deposits was 5.53%. This compares with 2.62% and 5.68%,
respectively, in 1996. The overall cost of funds, including non interest-bearing
demand accounts, was 4.17% in 1997, down from 4.36% in 1996.

        The net interest margin increased to 4.11% in 1997, compared with 3.76%
in 1996.

OTHER OPERATING INCOME
        Other operating income in 1997 was $1.8 million, compared with $1.1
million in 1996, an increase of $733,000 or 65.7%. Much of the increase is
attributable to higher service charges on deposits, which increased $655,000 or
88.4% in 1997. This is a direct result of the growth in the Company's checking
accounts.

OTHER OPERATING EXPENSES

        Other operating expenses were $8.3 million in 1997, compared with $7.4
million in 1996, an increase of $890,000 or 12%. The increase in expenses was
primarily growth related.

        Salaries and employee benefits expense was $3.7 million in 1997,
compared with $3.2 million in 1996, an increase of $408,000 or 12.6%. Most of
the increase is attributable to a full year of salary expense in 1997 for
employees of the Cicero Bank branch that was acquired on July 1, 1996, and the
hiring of 6 new full-time equivalent employees to staff the new North Medical
branch, which opened in September, 1997. The remainder of the increase resulted
primarily from salary adjustments and incentive bonuses.

        Building, occupancy and equipment expense increased $73,000 or 6.1% due
primarily to a full year of depreciation and maintenance in 1997 on the branch
acquired from Cicero Bank and to four months of expense on the North Medical
branch.

        Data processing and correspondent bank fees increased a combined
$238,000 or 38.3% in 1997 due primarily to transaction processing costs on the
Bank's larger customer base.

        Real estate owned expense was $83,000 in 1997, compared with $2,000 in
1996. The Bank recorded a provision totaling $50,000 in the fourth quarter of
1997 on certain commercial properties.

        The Company's efficiency ratio was 71.5% in 1997, down from 81% in 1996.
The improvement in the efficiency ratio was driven by growth in net interest
income and other operating income exceeding the increase in operating expenses.

INCOME TAXES
        Statement of Financial Accounting Standards No. 109 was adopted by the
Company in 1992. The statement requires that a valuation allowance be provided
when it is more likely than not that some portion of deferred tax assets will
not be realized. The Company recognized no immediate financial statement effect
from adopting Statement No. 109 because a valuation allowance was provided on
the deferred tax asset. The Company generated sufficient earnings in 1996 to
fully recognize the deferred tax assets. The Company recorded income tax expense
of $909,000 in 1997, compared with $93,000 in 1996. Additional information on
income taxes is provided in the notes to consolidated financial statements.


                     IMPACT OF INFLATION AND CHANGING PRICES

        The consolidated financial statements presented in the Annual Report
have been prepared in accordance with generally accepted accounting principles.
Measurement of financial position and operating results have been made in terms
of historical dollars. Changes in the relative purchasing power of money due to
inflation are not reflected.

        In as much as virtually all of the assets and liabilities of a financial
institution are monetary in nature, banks are more affected by changes in
interest rates than by inflation. Interest rates do not necessarily reflect the
direction or magnitude of changes in the price of goods and services which are
primarily affected by inflation. In the current 

                                       23
<PAGE>   26


interest rate environment, liquidity and the maturity structure of the Company's
assets and liabilities are of major importance in maintaining acceptable levels
of performance.

                      RECENTLY ISSUED ACCOUNTING STANDARDS

        In June, 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This statement establishes comprehensive
accounting and reporting requirements for derivative instruments and hedging
activities. The statement requires companies to recognize all derivatives as
either assets or liabilities, with the instruments measured at fair value. The
accounting for gains and losses resulting from changes in fair value of the
derivative instrument depends on the intended use of the derivative and the type
of risk being hedged. This statement is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999, although earlier adoption is
permitted. The Company does not have significant investments in derivative
instruments, therefore the provisions of SFAS No. 133 are not expected to have a
significant effect on the financial statements of the Company. SFAS No. 133 also
permits certain reclassifications of securities among the trading,
available-for-sale and held-to-maturity classifications. The Company has no
current intention to reclassify any securities pursuant to SFAS No.
133.

                                 YEAR 2000 ISSUE

        The Year 2000 issue stems from date coding practices in both software
and hardware. Specifically, hardware and software developers have often used
two-digit numbers rather than four-digit numbers to represent years. This was
done in a conscious effort to provide cost-effective and efficient business
solutions, given resource constraints and requirements in the past.
Consequently, when the year turns to 2000, the software may calculate the date
as 1900 because the century has not been properly defined.

        The Year 2000 problem creates risk for the Company from both unforeseen
problems in its own information technology ("IT") systems and from problems in
the IT systems of third parties (including vendors and service providers) with
whom the Company deals on financial transactions. Failures of the Company's
and/or third parties' IT systems could have a material adverse impact on the
Company's ability to conduct its business. The Company has been actively
communicating with third parties concerning the status of their Year 2000
readiness by, among other things, sending written Year 2000 inquiries, and has
undertaken to evaluate the Year 2000 readiness of its commercial borrowers. The
Company believes that its reasonably likely worst case Year 2000 scenario is:
(i) a material increase in the Company's credit losses due to Year 2000 problems
for the Company's borrowers and obligors; and (ii) disruption in financial
markets causing liquidity stress to the Company. The magnitude of these
potential credit losses or disruption cannot be determined at this time.

        The Company's non-IT systems used to conduct business at its facilities
consist primarily of office equipment (other than computer and communications
equipment) and other equipment at the Company's leased office facilities. The
Company has inventoried its non-IT systems and has sent Year 2000 questionnaires
to its office equipment vendors and landlords to determine the status of their
Year 2000 readiness.

        The Company has an enterprise-wide program to prepare its IT systems for
the year 2000. A senior management committee directs the Company's Year 2000
activities under the framework of the Federal Financial Institutions Examination
Council's Five Step Program: (i) Awareness; (ii) Assessment; (iii) Renovation;
(iv) Validation; and (v) Implementation. Approximately $350,000 has been
expended on the Year 2000 project as of December 31, 1998. This amount includes
the costs of additional hardware, software and technology consultants necessary
to achieve Year 2000 compliance for the Company's systems.

        The Company's pending merger with BSB, expected to close by Summer 1999,
has changed the scope of the Company's Year 2000 project. Most, if not all, of
the Company's systems will be converted to BSB's systems prior to year-end. BSB
has replaced or upgraded most of its mission critical IT systems, including its
core processing systems, which has been certified Year 2000 compliant by the
Information Technology Association of America. The weekend of July 10 and 11,
1999 has been tentatively reserved for the conversion of the Company's core data

                                       24
<PAGE>   27

processing system to BSB's system. This date assumes the merger is closed by
July 1. Contingency plans are being developed by BSB and will be completed in
1999.

        As a result of the Company's pending merger with BSB, the Company has
suspended remediation and testing of systems that will not be in use following
the merger, and has ceased development of Year 2000 related contingency plans.
The Company plans to continue to monitor the readiness of its larger commercial
customers, and vendors as well as correspondents with whom the Company expects a
continuing relationship following the merger.

        In the unlikely event the acquisition of the Company by BSB Bancorp is
not consummated, the Company would resume its Year 2000 project as originally
planned. The Company does not expect that such a situation would negatively
impact its ability to achieve Year 2000 compliance in a timely manner, nor does
the Company believe that such costs would have a material impact on its
financial position.

                     STATEMENT OF MANAGEMENT RESPONSIBILITY

        Management of Skaneateles Bancorp, Inc. is responsible for the accuracy
and content of the financial information in this Annual Report. In order to meet
this responsibility, the consolidated financial statements have been prepared in
accordance with generally accepted accounting principles applied on a consistent
basis.

        The accounting systems which record, summarize and report financial data
are supported by a system of internal controls, augmented by written policies,
internal audits and an organizational structure which provides for an effective
division of responsibilities. The system is also designed to provide reasonable
assurance that transactions are executed in accordance with management's
authorizations, and that assets are safeguarded from significant loss or
unauthorized use.

        The Examining Committee of the Board of Directors reviews the activities
of the internal audit function and meets regularly with representatives of KPMG
LLP, the Company's independent auditors. KPMG LLP has been appointed, upon
recommendation of the Board of Directors, to conduct an independent audit and to
express an opinion as to the fairness of the presentation of the consolidated
financial statements of Skaneateles, in conformity with generally accepted
accounting principles.


                                       25
<PAGE>   28



                   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



                          INDEPENDENT AUDITORS' REPORT


The Board of Directors and Stockholders
Skaneateles Bancorp, Inc.:

We have audited the accompanying consolidated balance sheets of Skaneateles
Bancorp, Inc. and subsidiary as of December 31, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity and comprehensive
income, and cash flows for each of the years in the three-year period ended
December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Skaneateles Bancorp,
Inc. and subsidiary at December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1998, in conformity with generally accepted accounting
principles.


/s/ KPMG LLP

Syracuse, New York
January 8, 1999



                                       26
<PAGE>   29


                    SKANEATELES BANCORP, INC. AND SUBSIDIARY
                           CONSOLIDATED BALANCE SHEETS

                                                                              
<TABLE>
<CAPTION>
ASSETS                                                                                       December 31,
                                                                             1998                              1997
-----------------------------------------------------------------------------------------------------------------------
                                                                                 (In Thousands, Except Share Data)
<S>                                                                                <C>                           <C>  
Cash and due from banks                                                        $    9,338                        9,658
Federal funds sold                                                                 24,300                        6,700
Securities available-for-sale, at fair value                                       14,799                        8,416
Securities held-to-maturity, fair value of
  $4,171 in 1998 and $7,935 in 1997                                                 4,015                        7,705
Federal Home Loan Bank stock, at cost                                               1,561                        1,561
Loans, including deferred origination costs                                       215,440                      215,022
Allowance for loan losses                                                          (2,862)                      (2,560)
-----------------------------------------------------------------------------------------------------------------------
       Net loans                                                                  212,578                      212,462
Premises and equipment, net                                                         5,763                        6,155
Real estate owned, net                                                                900                          951
Accrued interest receivable                                                         1,534                        1,372
Other assets                                                                        1,360                        1,121
-----------------------------------------------------------------------------------------------------------------------
                                                                               $  276,148                      256,101
=======================================================================================================================

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
   Interest bearing deposits                                                   $  209,978                      197,782
   Demand deposits                                                                 27,355                       20,236
-----------------------------------------------------------------------------------------------------------------------
       Total deposits                                                             237,333                      218,018

   Borrowings                                                                      15,979                       18,057
   Other liabilities                                                                3,735                        2,355
-----------------------------------------------------------------------------------------------------------------------
            Total liabilities                                                     257,047                      238,430
-----------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
   Preferred stock, par value $.01 per share, authorized
      500,000 shares, none issued                                                       0                            0
   Common stock, par value $.01 per share, authorized 4,000,000 shares,
      1,450,712 and 1,435,992 shares issued in 1998 and 1997, respectively             15                           14
   Additional paid-in capital                                                       9,297                        9,119
   Retained earnings                                                                9,818                        8,573
   Accumulated other comprehensive income                                             (29)                         (35)
-----------------------------------------------------------------------------------------------------------------------
            Total stockholders' equity                                             19,101                       17,671
-----------------------------------------------------------------------------------------------------------------------
                                                                               $  276,148                      256,101
=========================================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.


                                       27
<PAGE>   30


                    SKANEATELES BANCORP, INC. AND SUBSIDIARY
                        CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
                                                                                    Years ended December 31,

                                                                                1998               1997               1996
---------------------------------------------------------------------------------------------------------------------------
                                                                              (In Thousands, Except Per Share Data)
<S>                                                                        <C>                   <C>                <C>   
Interest income:
  Mortgage loans                                                           $  11,431             12,681             12,156
  Other loans                                                                  6,610              4,872              3,346
  Securities                                                                   1,148              1,198              1,461
  Federal funds sold                                                             866                214                199
---------------------------------------------------------------------------------------------------------------------------
            Total interest income                                             20,055             18,965             17,162
---------------------------------------------------------------------------------------------------------------------------

Interest expense:
  Deposits                                                                     8,399              8,244              8,070
  Borrowings                                                                   1,120              1,191              1,041
---------------------------------------------------------------------------------------------------------------------------
            Total interest expense                                             9,519              9,435              9,111
---------------------------------------------------------------------------------------------------------------------------

            Net interest income                                               10,536              9,530              8,051
Provision for loan losses                                                        675                500                175
---------------------------------------------------------------------------------------------------------------------------
            Net interest income after provision
               for loan losses                                                 9,861              9,030              7,876
---------------------------------------------------------------------------------------------------------------------------

Other operating income:
   Service charges                                                             1,734              1,394                739
   Net gain on security transactions                                               0                  0                 77
   Net gain on sale of loans                                                     206                 81                 34
   Other                                                                         398                374                266
---------------------------------------------------------------------------------------------------------------------------
            Total other operating income                                       2,338              1,849              1,116
---------------------------------------------------------------------------------------------------------------------------
                                                                              12,199             10,879              8,992
---------------------------------------------------------------------------------------------------------------------------

Other operating expenses:
   Salaries and employee benefits                                              4,062              3,655              3,247
   Building, occupancy and equipment                                           1,488              1,278              1,205
   Data processing                                                               727                433                372
   Correspondent bank fees                                                       587                427                250
   Advertising and promotions                                                    245                225                262
   Postage and delivery                                                          472                546                517
   Stationery and supplies                                                       233                206                216
   ATM service fees                                                              272                201                133
   Professional services                                                         353                213                203
   Other                                                                       1,237              1,124              1,013
---------------------------------------------------------------------------------------------------------------------------
            Total other operating expenses                                     9,676              8,308              7,418
---------------------------------------------------------------------------------------------------------------------------

            Income before income tax expense                                   2,523              2,571              1,574
Income tax expense                                                               874                909                 93
---------------------------------------------------------------------------------------------------------------------------
            Net income                                                     $   1,649              1,662              1,481
===========================================================================================================================

Net income per common share - basic
                                                                           $    1.14               1.16               1.05
Net income per common share - diluted                                           1.11               1.13               1.03
===========================================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.

                                       28

<PAGE>   31


                    SKANEATELES BANCORP, INC. AND SUBSIDIARY
    CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
<TABLE>
<CAPTION>

                                                                                            Accumulated
                                                                    Additional                other
                                                            Common   paid-in-   Retained   comprehensive  Treasury
                                                            stock     capital   earnings      income        Stock        Total
------------------------------------------------------------------------------------------------------------------------------
                                                                                    (In Thousands)
------------------------------------------------------------------------------------------------------------------------------
<S>                                                      <C>           <C>        <C>            <C>      <C>       <C>   
Balance at December 31, 1995                             $       10      9,526      6,083           33       (713)     14,939

Comprehensive income:
  Net income                                                      0          0      1,481            0           0      1,481

 Change in net unrealized gain on securities, net of taxes        0          0          0          (90)          0        (90)
------------------------------------------------------------------------------------------------------------------------------
     Total comprehensive income                                                                                         1,391
------------------------------------------------------------------------------------------------------------------------------

Sale of 20,775 shares under option
                                                                  0        117          0            0           0        117

Issuance of 4,985 shares of stock under
 1995 Non-employee Director's Stock Plan                          0         47          0            0           0         47

 Cash dividend declared on Common stock ($.19 per share)          0          0       (264)           0           0       (264)

Retirement of 154,050 shares of treasury stock                   (1)      (712)         0            0         713          0

------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996                            $        9       8,978      7,300          (57)          0     16,230
==============================================================================================================================
Comprehensive income:
  Net income                                                      0          0      1,662            0           0      1,662

 Change in net unrealized gain on securities, net of
taxes                                                             0          0          0           22           0         22
------------------------------------------------------------------------------------------------------------------------------
     Total comprehensive income                                                                                         1,684
------------------------------------------------------------------------------------------------------------------------------

Sale of 7,350 shares under option                                 1         46          0            0           0         47

Issuance of 3,473 shares of stock under
 1995 Non-employee Director's Stock Plan                          0         47          0            0           0         47

 Issuance of 2,688 shares of stock under Dividend
Reinvestment Plan                                                 0         36          0            0           0         36

Issuance of 728 shares of stock under
 1997 Employee Stock Purchase Plan                                0         12          0            0           0         12

3-for-2 stock split                                               4          0         (4)           0           0          0

Cash paid for fractional shares on stock split                    0          0         (4)           0           0         (4)

 Cash dividend declared on Common stock ($.27 per share)          0          0       (381)           0           0       (381)
------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997                             $       14      9,119      8,573          (35)          0     17,671
==============================================================================================================================

Comprehensive income:
  Net income                                                      0          0      1,649            0           0      1,649

 Change in net unrealized gain on securities, net of taxes        0          0          0            6           0          6
------------------------------------------------------------------------------------------------------------------------------
     Total comprehensive income                                                                                         1,655
------------------------------------------------------------------------------------------------------------------------------

Sale of 6,280 shares under option                                 1         41          0            0           0         42

Issuance of 3,619 shares of stock under
 1995 Non-employee Director's Stock Plan                          0         65          0            0           0         65

Issuance of 1,500 shares of stock under
 1995 Non-employee Director's Warrant Plan
                                                                  0         19          0            0           0         19

 Issuance of 2,322 shares of stock under Dividend
Reinvestment Plan                                                 0         37          0            0           0         37

Issuance of 999 shares of stock under
 1997 Employee Stock Purchase Plan                                0         16          0            0           0         16

 Cash dividend declared on Common stock ($.28 per share)          0          0       (404)           0           0       (404)
------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998                             $       15      9,297      9,818          (29)          0     19,101
==============================================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.

                                       29

<PAGE>   32


                    SKANEATELES BANCORP, INC. AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                        Years ended December 31,
                                                                     1998          1997         1996
----------------------------------------------------------------------------------------------------
                                                                             (In Thousands)
<S>                                                                      <C>         <C>         <C>
Operating activities
Net Income
                                                                    $  1,649       1,662       1,481
Adjustments to reconcile net income to net cash provided
  by operating activities:
  Provision for loan losses                                              675         500         175
  Provision for losses on real estate owned                              110          50           0
  Depreciation and amortization                                          846         692         628
  Mortgage loans originated for sale                                 (15,225)     (3,363)     (4,454)
  Proceeds from sale of mortgage loans originated for sale            13,720       4,090       4,861
  Net gain on sale of loans                                             (206)        (81)        (34)
  Net gain on security transactions                                        0           0         (77)
  Net increase in interest receivable                                   (162)       (101)        (16)
  Net increase (decrease) in other liabilities                         1,380        (387)        549
  Receipt of balance due from Nationar                                     0           0       1,057
  Other, net                                                            (552)       (132)       (105)
-----------------------------------------------------------------------------------------------------
        Total adjustments                                                586       1,268       2,584
-----------------------------------------------------------------------------------------------------
        Net cash provided by operating activities                      2,215       2,930       4,065
Investing activities
  Proceeds from maturities of securities available for sale            4,000       3,000       3,004
  Proceeds from sale of securities available for sale                      0           0       2,462
  Proceeds from maturities of securities held to maturity              2,836       2,490       6,175
  Purchase of securities held to maturity                                (70)          0      (5,135)
  Purchase of securities available for sale                          (11,124)     (5,756)     (3,096)
  Principal collected on asset-backed securities
    available for sale                                                 1,680       1,113       1,110
  Purchase of Federal Home Loan Bank stock                                 0        (151)       (107)
  Net decrease (increase) in loans made to customers                     804      (8,982)    (22,664)
  Net cash received from acquired bank                                     0           0       4,024
  Proceeds from sale of real estate owned                                284         164         196
  Purchase of property and equipment, net                               (377)       (602)       (298)
-----------------------------------------------------------------------------------------------------
        Net cash used in investing activities                         (1,967)     (8,724)    (14,329)
Financing activities
  Net decrease in time certificates                                   (5,000)     (2,357)     (1,913)
  Net increase in other deposits                                      24,315      15,346       8,719
  Increase (decrease) in overnight borrowings                          5,569        (312)        865
  Increase in long-term borrowings                                         0       2,500       4,000
  Repayment of long-term borrowings                                   (7,647)     (2,312)     (1,070)
  Proceeds from issuance of stock pursuant to stock plans                179         142         164
  Dividends paid                                                        (404)       (381)       (264)
-----------------------------------------------------------------------------------------------------
       Net cash provided by financing activities                      17,012      12,626      10,501
-----------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents                             17,280       6,832         237
Cash and cash equivalents at beginning of year                        16,358       9,526       9,289
-----------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year                            $ 33,638      16,358       9,526
=====================================================================================================
Interest paid                                                       $  9,554       9,433       9,116
=====================================================================================================
Income taxes paid                                                   $    820       1,075          92
=====================================================================================================
Supplemental schedule of noncash investing activities:
   Mortgage loans foreclosed and transferred to real 
    estate owned                                                    $    365         452         515
=====================================================================================================
</TABLE>



See accompanying notes to consolidated financial statements.

                                       30


<PAGE>   33


SKANEATELES BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL 
STATEMENTS

Years ended December 31, 1998, 1997 and 1996

(1) Summary of Significant Accounting Policies

Business
Skaneateles Bancorp, Inc. (the "Company") is a bank holding company registered
under the Bank Holding Company Act of 1956. The results of the Company are
largely dependent upon the results of Skaneateles Savings Bank (the "Bank"), its
sole subsidiary. Skaneateles Savings Bank is a full service retail bank.

The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. Certain prior year amounts have been
reclassified to conform to current year classifications. A description of the
significant accounting policies is presented below. In preparing the
consolidated financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
disclosure of contingent assets and liabilities, as of the date of the balance
sheet and revenues and expenses for the period. Actual results could differ from
those estimates.

(a) Basis of Presentation
The consolidated financial statements include the accounts of the Company and
the Bank. All significant intercompany balances and transactions are eliminated
in consolidation.

(b) Securities
The Company classifies its debt securities as either available-for-sale or
held-to-maturity, as the Company does not hold any securities considered to be
trading. Held-to-maturity securities are those debt securities that the Company
has the ability and intent to hold until maturity. All other securities not
included as held-to-maturity are classified as available-for-sale.


Available-for-sale securities are recorded at fair value. Held-to-maturity
securities are recorded at amortized cost. Unrealized gains and losses, net of
the related tax effect, on available-for-sale securities are excluded from
earnings and are reported as accumulated other comprehensive income, a component
of stockholders' equity, until realized. The unrealized gains or losses included
in the separate component of equity for securities transferred from
available-for-sale to held-to-maturity are maintained and amortized into
earnings over the remaining life of the security as an adjustment to yield in a
manner consistent with the amortization or accretion of premium or discount on
the associated security.

A decline in the fair value of any available-for-sale or held-to-maturity
security below cost that is deemed other than temporary is charged to earnings
resulting in the establishment of a new cost basis for the security.

Premiums and discounts are amortized or accreted over the life of the related
security as an adjustment to yield using the interest method. Interest income is
recognized when earned. Purchases and sales are recorded on a trade date basis
with settlement occurring shortly thereafter. Realized gains and losses on
securities sold are derived using the specific identification method for
determining the cost of securities sold.

(c) Loans
Loans are reported at the principal amount outstanding, net of deferred
origination fees and costs. Interest on loans is accrued and included in income
at contractual rates applied to principal outstanding. Accrual of interest on a
loan, including impaired loans, is discontinued when management believes, after
considering economic and business conditions and collection efforts, that the
borrower's financial condition precludes accrual. Generally, interest income is
not recognized on loans which are delinquent over 90 days, and income is
subsequently recognized only to the extent that cash payments are received
until, in management's judgment, the borrower's ability to make periodic
interest and principal payments has improved, in which case the loan is returned
to accrual status.

                                       31
<PAGE>   34

Net loan origination fees and costs are deferred as an adjustment of loan
principal and amortized over the life of the related loan as an adjustment of
yield using the interest method.

The Company has the ability and intent to hold its loans to maturity except for
education loans which are sold to a third party upon reaching repayment status.

Also, the Company originates some mortgage loans with the intent to sell. These
loans are carried at the lower of aggregate cost or fair value. Gains or losses
on sales of mortgages are recorded equal to the difference between sales
proceeds and the carrying value of the loans. The Bank typically retains the
servicing rights to mortgages sold.

(d) Allowance for Loan Losses
The allowance for loan losses is based on management's evaluation of the loan
portfolio considering past loan loss experience, review of specific loans,
current economic conditions and such other factors that require current
recognition in estimating loan losses. The allowance for loan losses is
increased by the provision for loan losses charged to operations. Loan losses
and recoveries of loans previously written-off are charged or credited to the
allowance as incurred or realized, respectively.

Management believes that the allowance for loan losses is adequate. The
allowance for loan losses is maintained at a level believed by management to be
sufficient to absorb probable future losses related to loans outstanding as of
the balance sheet date. Management's determination of the adequacy of the
allowance is based on periodic evaluations of the loan portfolio and other
relevant factors and requires material estimates including the amounts and
timing of expected future cash flows on impaired loans. Management uses
presently available information to recognize losses on loans; however, future
additions to the allowance may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Company's allowance for loan
losses and may require the Company to recognize additions to the allowance based
on their judgment of information available to them at the time of their
examination.

The Company estimates losses on impaired loans based on the present value of
expected future cash flows (discounted at the loan's effective interest rate) or
the fair value of the underlying collateral if the loan is collateral dependent.
An impairment loss exists if the recorded investment in a loan exceeds the value
of the loan as measured by the aforementioned methods. Impairment losses are
included as a component of the allowance for loan losses. A loan is considered
impaired when it is probable that the Company will be unable to collect all
amounts due according to the contractual terms of the loan agreement. Generally,
all commercial mortgage loans and commercial loans in a delinquent payment
status (90 days or more delinquent) are considered impaired. Residential
mortgage loans, consumer loans, home equity lines of credit and education loans
are evaluated collectively since they are homogenous and generally carry smaller
individual balances. The Company recognizes interest income on impaired loans
using the cash basis of income recognition. Cash receipts on impaired loans are
generally applied according to the terms of the loan agreement, or as a
reduction of principal, based upon management judgment.

(e) Premises and Equipment
Land is carried at cost and buildings and improvements, furniture and equipment,
and leasehold improvements are carried at cost less allowances for depreciation
and amortization. Depreciation and amortization are provided on the
straight-line method over the estimated service lives of the respective assets
(40 years for building and improvements and 3 to 10 years for furniture and
equipment) or lease terms.

(f) Real Estate Owned
Real estate acquired in settlement of loans is carried at the lower of the
impaired loan balance at the date of acquisition or fair value less selling
expenses of the property received. Write-downs from cost to fair value which are
required at the time of foreclosure are charged to the allowance for loan
losses. Subsequent write-downs to fair value, net of disposal costs, or the
establishment of allowances are charged to other operating expenses.


                                       32
<PAGE>   35
(g) Other Assets
On July 1, 1996, the Bank acquired substantially all the assets and assumed the
deposit liabilities of Cicero Bank. The excess of the purchase price over the
fair value of assets acquired ("goodwill") amounted to $494,000 and is included
in other assets. Goodwill is being amortized over the expected period of benefit
of seven years on a straight line basis. The amortization period is monitored to
determine if events and circumstances require the estimated useful life to be
reduced. Periodically, the Company reviews the goodwill for events or changes in
circumstances that may indicate the carrying amount of the goodwill is impaired.

(h) Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases, and operating loss and tax credit carryforwards. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which temporary differences are expected
to be recovered or settled and tax carryforwards are expected to be utilized.
The effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.

(i) Per Common Share Data
Basic earnings per share is calculated by dividing net income available to
common shareholders by the weighted average number of shares outstanding during
the year. Diluted earnings per share also includes the maximum dilutive effect
of stock issuable upon conversion of stock options and warrants.

 (j) Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash,
amounts due from banks and federal funds sold.

(k) Stock-Based Compensation
The Company continues to apply the intrinsic value-based method of accounting
prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," in accounting for its stock-based compensation plans.
Disclosures in the footnotes to the financial statements provide pro forma net
income and earnings per share information as if the Company had adopted the fair
value-based method of Statement of Financial Accounting Standards (SFAS) No.
123, "Accounting for Stock Based Compensation."

(l) Financial Instruments with Off-Balance Sheet Risk
The Company entered into an interest rate floor in 1996 as part of its interest
rate risk management strategy. Interest rate floors are used to hedge exposure
to falling interest rates and are accounted for at amortized cost. Fees paid by
the Company at inception of interest rate floors are deferred and amortized
using the interest method over the life of the floor. Income and expense on the
floors are recorded in the same category as that of the related balance sheet
item.

(m) Comprehensive Income
On January 1, 1998, the Company adopted the provisions of SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components. At the
Company, comprehensive income represents net income and the net change in
unrealized gains or losses on securities available for sale, net of taxes, and
is presented in the Consolidated Statements of Stockholders' Equity and
Comprehensive Income. Prior year consolidated financial statements have been
reclassified to conform to the requirements of SFAS No. 130

(n) Segment Reporting
During 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 requires public companies to
report certain financial and other information about key revenue-producing
segments for which such information is available and is utilized by the chief
operating decision maker. Specific information to be reported for individual
segments include profit and loss, certain revenue and expense items, and total
assets. As a community-oriented financial institution, substantially all of the
Company's operations involve the delivery of loans and deposit products to
customers. Management makes operating decisions 

                                       33
<PAGE>   36


and assesses performance based on an ongoing review of these community banking
operations, which constitute the Bank's only operating segment for financial
reporting purposes. Therefore, adoption of SFAS No. 131 did not result in any
changes in the Company's reporting.

(2) Securities

Securities available for sale at December 31 are summarized as follows (in
thousands):

<TABLE>
<CAPTION>
                                                                                         1998
                                                        ---------------------------------------------------------
                                                                            Gross         Gross

                                                            Amortized    unrealized    unrealized        Fair

                                                               cost         gains         losses         value
-----------------------------------------------------------------------------------------------------------------
<S>                                                        <C>                   <C>         <C>          <C>   
    U.S. government and Federal agency obligations         $   13,116            40          (56)         13,100
    Mortgage-backed securities-FNMA                               622            26             0            648
    Asset-backed securities                                     1,042             9             0          1,051
-----------------------------------------------------------------------------------------------------------------
                                                          $    14,780            75          (56)         14,799
=================================================================================================================
</TABLE>

<TABLE>
<CAPTION>
                                                                                         1997
                                                        ---------------------------------------------------------
                                                                            Gross         Gross

                                                            Amortized    unrealized    unrealized        Fair

                                                               cost         gains         losses         value

-----------------------------------------------------------------------------------------------------------------
<S>                                                        <C>                   <C>           <C>         <C>  
    U.S. government and Federal agency obligations         $    6,013            13            0           6,026
    Mortgage-backed securities-FNMA                               733            19            0             752
    Asset-backed securities                                     1,630            10           (2)          1,638
-----------------------------------------------------------------------------------------------------------------
                                                           $    8,376            42           (2)          8,416
=================================================================================================================
</TABLE>



                                       34


<PAGE>   37



Securities held to maturity at December 31 are summarized as follows ( dollars
in thousands):

<TABLE>
<CAPTION>
                                                                                                    1998
                                                                    ---------------------------------------------------------
                                                                                       Gross         Gross
                                                                        Carrying     unrealized    unrealized       Fair
                                                                         value         gains         losses         value
----------------------------------------------------------------------------------------------------------------------------
<S>                                                                     <C>          <C>           <C>        <C>  
  U.S. government and Federal agency obligations                        $  1,019             4             0          1,023
    Mortgage-backed securities:
       FNMA                                                                  103             4             0            107
       FHLMC                                                               2,087            87             0          2,174
  Obligations of states and political subdivisions                           806            61             0            867
----------------------------------------------------------------------------------------------------------------------------
                                                                        $  4,015           156             0          4,171
----------------------------------------------------------------------------------------------------------------------------
<CAPTION>
                                                                                                    1997
                                                                   ---------------------------------------------------------
                                                                                       Gross         Gross
                                                                       Carrying     unrealized    unrealized           Fair
                                                                         value         gains         losses            value
----------------------------------------------------------------------------------------------------------------------------
<S>                                                                     <C>          <C>           <C>        <C>  
  U.S. government and Federal agency obligations                       $   3,007            10             0          3,017
    Mortgage-backed securities:
       FNMA                                                                  130             4             0            134
       FHLMC                                                               2,998           168             0          3,166
  Obligations of states and political subdivisions                         1,470            48             0          1,518
  Corporate bonds, notes and debentures                                      100             0             0            100
----------------------------------------------------------------------------------------------------------------------------
                                                                        $  7,705           230             0          7,935
============================================================================================================================
</TABLE>

On January 1, 1995 the Company reclassified its entire portfolio of
mortgage-backed securities from available-for-sale to held-to-maturity, at the
securities' fair value of $8.3 million. The $234,000 unrealized loss on the
securities was maintained and is being amortized into earnings over the
remaining life of the securities as an adjustment to yield in a manner
consistent with the amortization or accretion of premium or discount on the
associated securities.

There were no realized gains or losses in 1998 or 1997. Gross realized gains on
the sale of securities were approximately $77,000 in 1996.

                                       35
<PAGE>   38


The contractual maturity distribution of securities at December 31, 1998 is as
follows (in thousands):

<TABLE>
<CAPTION>
                                                                           One to      Five to               
                                                          Within           five          ten          After ten     
                                                          one year         years        years           years       Total
----------------------------------------------------------------------------------------------------------------------------
<S>                                                      <C>               <C>           <C>               <C>       <C>   
Securities available for sale:
  U.S. government and Federal agency obligations         $   5,023         7,093         1,000             0         13,116
  Mortgage-backed securities:
     FNMA                                                        0             0             0           622            622
  Asset-backed securities                                        0           357           685             0          1,042
----------------------------------------------------------------------------------------------------------------------------
                                                         $   5,023         7,450         1,685           622         14,780
============================================================================================================================
Fair value                                               $   5,035         7,421         1,694           649         14,799
============================================================================================================================
Weighted average yield of securities                          5.22%         4.88%         6.08%         6.55%          5.20%
============================================================================================================================

Securities held to maturity:
  U.S. government and Federal agency obligations          $    999           20             0             0          1,019

  Mortgage-backed securities:
     FNMA                                                        0             0             0           103            103
     FHLMC                                                       0             0            68         2,019          2,087
  Obligations of states and political subdivisions               0           257           215           334            806
----------------------------------------------------------------------------------------------------------------------------
                                                             $ 999           277           283         2,456          4,015
============================================================================================================================
Fair value                                                  $1,003           298           311         2,559          4,171
============================================================================================================================
Weighted average yield of securities                          6.10%         6.43%         7.19%         7.14%          6.88%
============================================================================================================================
</TABLE>

Securities carried at $7,346,000 at December 31, 1998 were pledged for
borrowings and other purposes required by law.

Accrued interest receivable on securities was $201,000 and $177,000 at December
31, 1998 and 1997, respectively.

The following summarizes the components of other comprehensive income for the
years ended December 31, 1998, 1997 and 1996 (in thousands):

<TABLE>
<CAPTION>
                                                          1998          1997          1996
----------------------------------------------------- ------------- ------------ --------------
<S>                                                       <C>              <C>           <C> 
 Net unrealized holding gains (loss) on securities        $   10           36            (73)
 Reclassification adjustment for net realized gains            0            0            (77)
included in    net income
----------------------------------------------------- ------------- ------------- -------------
Other comprehensive, before tax                               10           36           (150)
 Income tax expense                                           (4)         (14)            60
----------------------------------------------------- ------------- ------------- -------------
Other comprehensive income, net of tax                    $    6           22            (90)
===================================================== ============= ============= =============
</TABLE>


                                       36

<PAGE>   39


(3) Loans

Major categories of loans at December 31 are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
                                                                               1998         1997
-----------------------------------------------------------------------------------------------------
<S>                                                                         <C>             <C>    
Loans secured by first mortgages on real estate:
  Residential                                                               $  100,685      119,350
  Commercial
                                                                                34,676       33,962
----------------------------------------------------------------------------------------------------

                                                                               135,361      153,312
----------------------------------------------------------------------------------------------------
Other loans:
  Commercial                                                                    27,788       22,995
  Guaranteed student                                                               910        1,059
  Home equity and improvement                                                   20,658       20,624
  Other consumer                                                                30,028       16,565
----------------------------------------------------------------------------------------------------
                                                                                79,384       61,243
----------------------------------------------------------------------------------------------------
                                                                               214,745      214,555
  Net deferred origination costs                                                   695          467
----------------------------------------------------------------------------------------------------
                                                                             $ 215,440    $ 215,022
====================================================================================================
</TABLE>



Changes in the allowance for loan losses for the years ended December 31 were as
follows (in thousands):
<TABLE>
<CAPTION>
                                                          1998         1997         1996
-----------------------------------------------------------------------------------------
<S>                <C>                                <C>             <C>          <C>  
Balance at January 1                                  $  2,560        2,114        2,667
Provision charged to operations                            675          500          175
Recoveries                                                  94          519          126
Loans charged off                                         (467)        (573)      (1,301)
Allowance of acquired bank                                   0            0          447
-----------------------------------------------------------------------------------------
Balance at December 31                                 $ 2,862        2,560        2,114
=========================================================================================
</TABLE>

The principal balances of loans not accruing interest, including impaired loans,
amounted to approximately $3,180,000 and $3,917,000 at December 31, 1998 and
1997, respectively. The effect of non-accrual loans on interest income for 1998,
1997 and 1996 was a reduction of approximately $298,000, $274,000 and $283,000,
respectively.

Impaired loans were $1,485,000 and $2,079,000 at December 31, 1998 and 1997,
respectively. Included in these amounts are $554,000 and $1,911,000 of impaired
loans for which the related allowance for loan losses is $205,000 and $219,000,
at December 31, 1998 and 1997, respectively. The average recorded investment in
impaired loans during 1998, 1997 and 1996 was approximately $2,063,000,
$1,480,000, and $2,923,000, respectively. The amount of interest income
recognized on impaired loans in 1998, 1997 and 1996 was approximately $91,000,
$84,000, and $166,000, respectively. The Bank is not committed to lend
additional funds to these borrowers.

Accrued interest receivable on loans was $1,333,000 and $1,194,000 at December
31, 1998 and 1997, respectively.

The Bank serviced loans for others aggregating approximately $35,047,000,
$25,487,000 and $23,820,000 at December 31, 1998, 1997 and 1996, respectively.
Originated mortgage servicing rights of approximately $127,000 are recorded on
the balance sheet as of December 31, 1998. No mortgage servicing rights were
recorded as of December 31, 1997 due to immateriality.


                                       37
<PAGE>   40


From time to time, the Bank entered into loan transactions with the Company's
directors and officers (related parties). Such transactions were made on
substantially the same terms as those prevailing at the same time for comparable
loans to other customers, and did not, in the opinion of management, involve
more than normal credit risk or present other unfavorable features. An analysis
of related party loan activity follows (in thousands):
<TABLE>
<CAPTION>
                                                             1998          1997
--------------------------------------------------------------------------------
<S>                                                      <C>              <C>  
Balance at January 1                                     $  1,017         1,172
Increases                                                     158           113
Decreases                                                    (114)         (268)
--------------------------------------------------------------------------------
Balance at December 31                                   $  1,061         1,017
================================================================================
</TABLE>


<TABLE>
<CAPTION>
(4) Premises and Equipment

A summary of premises and equipment at December 31 is as follows (in thousands):

                                                             1998          1997
--------------------------------------------------------------------------------
<S>                                                      <C>                <C>
Land                                                     $    532           532
Buildings and improvements                                  5,223         5,146
Furniture and equipment                                     3,609         3,539
Leasehold improvements                                      1,798         1,796
--------------------------------------------------------------------------------
                                                           11,162        11,013
Less accumulated depreciation and amortization              5,399         4,858
--------------------------------------------------------------------------------
                                                         $  5,763         6,155
================================================================================
</TABLE>


Depreciation and amortization of premises and equipment included in building,
occupancy and equipment expense amounted to $760,000, $632,000 and $584,000 for
the years ended December 31, 1998, 1997 and 1996, respectively.

(5) Deposits

Deposits at December 31 are summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                                1998           1997
-------------------------------------------------------------------------------------
<S>                                                       <C>                <C>   
Savings and club accounts                                 $   50,399         42,451
Time certificates                                            100,072        105,072
Money market accounts                                         26,050         24,234
NOW and escrow accounts                                       33,457         26,025
Demand accounts                                               27,355         20,236
--------------------------------------------------------------------------------------
                                                            $237,333        218,018
======================================================================================
</TABLE>

At December 31, 1998 and 1997, the aggregate amounts of time time certificate
accounts in denominations of $100,000 or more were approximately $15,224,000 and
$13,427,000, respectively.


                                       38
<PAGE>   41


The following table presents the amount of time certificate accounts at December
31, 1998 which mature during the periods indicated (in thousands):

<TABLE>
<CAPTION>
                                                    Maturing
              --------------------------------------------------------------------------------------
                     Within                                                                   After
                   One Year     Two Years    Three Years    Four Years     Five Years    Five Years          Total
              -----------------------------------------------------------------------------------------------------
<S>              <C>               <C>             <C>           <C>            <C>           <C>          <C>    
                 $   66,073        15,462          5,354         8,556          3,233         1,394        100,072
              =====================================================================================================
</TABLE>


Interest expense on deposits for the years ended December 31 is summarized as
follows (in thousands):

<TABLE>
<CAPTION>
                                                    1998           1997          1996
--------------------------------------------------------------------------------------
<S>                                             <C>               <C>           <C>  
Savings and club accounts                       $  1,287          1,169         1,040
Time certificates                                  5,628          5,774         5,908
Money market accounts                                916            821           730
NOW and escrow accounts                              568            480           392
--------------------------------------------------------------------------------------
                                                $  8,399          8,244         8,070
======================================================================================
</TABLE>

 (6) Borrowings

Borrowings at December 31 are summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                                     1998                                  1997
                                                          ----------------------------         -----------------------------
                                                             Amount         Rate                  Amount          Rate
----------------------------------------------------------------------------------------------------------------------------
<S>                                                             <C>             <C>                   <C>           <C>  
Securities sold under repurchase                  
agreements                                                      $ 1,773         4.06%                  2,204          4.76%
Advances from the FHLB of New York,
 Line of credit                                                   6,000         5.63%                      0
 due 1998                                                             0            0                   7,000     5.45-6.45%
 due 1999                                                         3,000         6.63%                  3,000          6.63%
 due 2000                                                         2,000    6.26-6.31%                  2,000     6.26-6.31%
 due 2002                                                         2,000        10.51%                  2,000         10.51%
 due 2007                                                           465         7.08%                    486          7.08%
Municipal securities sold with put options                          741         5.99%                  1,367          6.25%
----------------------------------------------------------------------------------------------------------------------------
                                                                $15,979         6.40%                 18,057          6.40%
============================================================================================================================
</TABLE>

The Bank enters into repurchase agreements with commercial demand deposit
customers under which balances greater than $25,000 earn interest at a rate of
90% of the weekly average auction yield of the 90 day U.S. Treasury Bill. These
transactions are recorded as borrowings. At December 31, 1998, the Bank pledged
U.S. Treasury Notes totaling $2,500,000 as collateral for the repurchase
agreements.

At December 31, 1998, Federal Home Loan Bank of New York (the "FHLB") advances
are collateralized by the investment in stock of the FHLB of $1,561,000 and
residential mortgage loans with a carrying value approximating $14,812,000.
These advances carry fixed rates of interest.

The Bank maintains two lines of credit with the FHLB of New York. Borrowings
under the lines bear interest at 0.125% above the federal funds rate. Additional
borrowings of $19,618,000 were available under the lines at December 31, 1998.
The amount of each line is equal to 5% of the Bank's total assets and is set
each year at March 31, the renewal date of the lines.

                                       39
<PAGE>   42

In 1985, the Bank sold certain municipal securities to a Municipal Investment
Trust Fund which have a par value at December 31, 1998 of $741,000. The trust
has put options which require the Bank to repurchase the securities at par value
on annual repurchase dates and on fourteen days' notice if any debt obligation
is deemed to be taxable or in default. The put options are collateralized by
approximately $741,000 of municipal bonds and U.S. Treasury Notes of
approximately $1,000,000. This transaction has been recorded as a borrowing. The
borrowing is reduced with proceeds from the maturity or call of the municipal
securities, which have maturity dates ranging from May 2001 to November 2017.

 (7) Income Taxes

Total income taxes for the year ended December 31 were allocated as follows (in
thousands):
<TABLE>
<CAPTION>

                                                                               1998        1997         1996
-------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>              <C>           <C>
Income from operations                                                     $    874         909           93
Stockholders' equity, for change in
unrealized gain (loss) on securities                                              4          14          (60)
-------------------------------------------------------------------------------------------------------------
                                                                           $    878         923           33
=============================================================================================================
</TABLE>

Actual income taxes applicable to income from operations differ from expected
taxes, computed by applying the Federal corporate tax rate of 34% to income
before income taxes as follows (in thousands):


<TABLE>
<CAPTION>
                                                                               1998        1997         1996
-------------------------------------------------------------------------------------------------------------
<S>                                                                         <C>             <C>          <C>
Expected tax expense                                                        $   858         874          535
State income taxes, net of Federal benefit                                       81         105           42
Change in valuation allowance for deferred tax assets                             0           0         (572)
Other                                                                          (65)         (70)          88
-------------------------------------------------------------------------------------------------------------
Income tax expense                                                          $   874         909           93
=============================================================================================================
</TABLE>

The components of income tax expense applicable to operations are as follows (in
thousands):
<TABLE>
<CAPTION>
                                                                               1998        1997         1996
-------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>             <C>            <C>
Current:
  Federal                                                                  $    934        817            72
  State                                                                         153         (7)           14
-------------------------------------------------------------------------------------------------------------
                                                                              1,087        810            86
-------------------------------------------------------------------------------------------------------------
Deferred:
  Federal                                                                     (182)        (67)          179
  State                                                                        (31)        166          (172)
-------------------------------------------------------------------------------------------------------------
                                                                              (213)         99             7
-------------------------------------------------------------------------------------------------------------
                                                                           $    874        909            93
-------------------------------------------------------------------------------------------------------------
Deferred tax expense (benefit), exclusive of the change 
    in valuation  allowance                                                 $ (213)         99           579
Change in valuation allowance                                                     0           0         (572)
-------------------------------------------------------------------------------------------------------------
                                                                            $ (213)          99            7
-------------------------------------------------------------------------------------------------------------
</TABLE>

                                       40

<PAGE>   43


The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at December 31 are
presented below (in thousands).


<TABLE>
<CAPTION>
                                                                               1998        1997
------------------------------------------------------------------------------------------------
<S>                                                                        <C>            <C>
Deferred tax assets:
  Allowance for loan losses                                                $  1,126         948
  Unrealized loss on securities                                                  20          24
  Other                                                                         108          86
-------------------------------------------------------------------------------------------------
Total deferred tax assets                                                     1,254       1,058
-------------------------------------------------------------------------------------------------

Deferred tax liabilities:
  Deferred loan origination costs                                               278         186
  Increase in tax bad debt reserve over base                                    205         322
  Accumulated depreciation                                                      120         168
  Capitalized servicing rights                                                   51           0
  Other                                                                          44          35
------------------------------------------------------------------------------------------------
Total deferred tax liabilities                                                  698         711
                                                                                                
-------------------------------------------------------------------------------------------------
Net deferred tax asset                                                       $  556         347
=================================================================================================
</TABLE>

Realization of deferred tax assets is dependent upon the generation of future
taxable income or the existence of sufficient taxable income within the
carryback period. A valuation allowance is provided when it is more likely than
not that some portion of the deferred tax assets will not be realized. In
assessing the need for a valuation allowance, management considers the scheduled
reversal of the deferred tax liabilities, the level of historical taxable income
and projected future taxable income over the periods in which the temporary
differences comprising the deferred tax assets will be deductible. The Company
generated sufficient earnings in 1996 to fully recognize the deferred tax
assets.

Based on its assessment, management determined that no valuation allowance was
necessary for 1998 and 1997.

Included in retained earnings at December 31, 1998 is approximately $987,000
representing aggregate provisions for loan losses taken under the Internal
Revenue Code. Use of these reserves to pay dividends in excess of earnings and
profits or to redeem stock, or the failure of the institution to qualify as a
bank for Federal income tax purposes, would result in taxable income. However,
it is not contemplated that the reserves will be used in a manner that will
create tax liabilities.

(8) Stockholders' Equity and Regulatory Matters

The Company's principal source of funds to pay dividends on the Company's common
stock is dividends received from the Bank. In any calendar year, approval of the
Superintendent of Banks of the State of New York is required prior to the Bank
declaring dividends in an amount in excess of net income for that year plus net
income retained in the preceding two years. Under the regulations, the Bank has
approximately $4,149,000 available for payment of dividends to the Company at
December 31, 1998.

FDIC regulations require banks to maintain minimum levels of regulatory capital.
Under the regulations in effect at December 31, 1998, the Bank was required to
maintain a minimum Tier I capital (as defined in the regulations) to average
assets ratio of 4%, and minimum ratios of Tier I capital and total capital to
risk weighted assets (as defined) of 4% and 8%, respectively.

Under its prompt corrective action regulations, the FDIC is required to take
certain supervisory actions (and may take additional discretionary actions) with
respect to an undercapitalized institution. Such actions could have a direct
material effect on an institution's financial statements. The regulations
establish a framework for the classification of savings institutions into five
categories: well-capitalized, adequately-capitalized, under-capitalized,
significantly under-capitalized and critically under-capitalized. Generally, an
institution is considered well-capitalized if it has a Tier I capital ratio (to
average assets) of at least 5%, a Tier I capital ratio (to risk weighted assets)
of at least 6%, and a total capital ratio (to risk weighted assets) of at least
10%.

                                       41
<PAGE>   44
The foregoing capital ratios are based in part on specific quantitative measures
of assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. Capital amounts and classifications are also
subject to qualitative judgments by the FDIC about capital components, risk
weighting and other factors.

Management believes that as of December 31, 1998, the Bank meets all capital
adequacy requirements to which it is subject. Further, the most recent FDIC
notification categorized the Bank as a well-capitalized institution under the
prompt corrective action regulations. There have been no conditions or events
since the notification that management believes have changed the Bank's capital
classification.

The following is a summary of the Bank's actual capital amounts and ratios as of
December 31, compared with the FDIC minimum capital adequacy requirements and
the FDIC requirements for classification as a well-capitalized institution
(dollars in thousands):

<TABLE>
<CAPTION>
                                                                                         For Classification
                                               Actual           Minimum Adequacy         As Well-Capitalized
                                     -----------------------  -----------------------  -----------------------
                                        Amount      Ratio        Amount      Ratio        Amount      Ratio
                                        ------      -----        ------      -----        ------      -----
<S>                                     <C>           <C>        <C>         <C>          <C>         <C>  
              1998
----------------------------------
Tier I Capital (to average         
assets)                                 $ 18,612      6.78%      10,978      4.00%        13,722      5.00%
Tier I Capital (to risk weighted                                                          
assets)                                   18,612     10.04%       7,415      4.00%        11,123      6.00%
Total Capital (to risk weighted      
assets)                                   20,941     11.30%      14,830      8.00%        18,538     10.00%

              1997
----------------------------------
Tier I Capital (to average                                                                         
assets)                                   17,173      6.91%       9,937      4.00%        12,421      5.00%  
Tier I Capital (to risk weighted                                                                            
assets)                                   17,173     10.06%       6,830      4.00%        10,246      6.00% 
Total Capital (to risk weighted                                                                             
assets)                                   19,319     11.31%      13,661      8.00%        17,076     10.00% 
</TABLE>


The Company's capital amounts and ratios as of December 31, 1998 and 1997 were
not materially different than those of the Bank.

(9) Employee Benefits and Stock Plans

The Company adopted a Stock Option Plan which was approved by the stockholders
in 1987 (the "1987 Plan"). Under the 1987 Plan, 76,765 shares of authorized but
unissued common stock were reserved for the granting of options to officers and
key employees. Options are granted at the market price of shares at the date of
grant, adjusted when applicable for the effect of stock dividends, become
exercisable 20% per year after the date of grant and must be exercised within 10
years of the date of grant. All options available under the plan have been
granted.

To supplement the 1987 Plan, the Company adopted a Stock Option Plan which was
approved by the stockholders in 1991 (the "1991 Plan"). Under the 1991 Plan,
69,350 shares of authorized but unissued common stock were reserved for future
issuance. The terms, conditions, and provisions of the 1991 Plan are
substantially the same as those of the 1987 Plan described above, except that
the vesting of options is determined by the Company's board of directors at the
time of grant. At December 31, 1998, there were 4,313 options available for
grant.

The Company adopted an additional Stock Option Plan which was approved by the
stockholders in 1998 (the "1998 Plan"). Under the 1998 Plan, 71,500 shares of
authorized but unissued common stock were reserved for future issuance. The
terms, conditions, and provisions of the 1998 Plan are substantially the same as
those of the 1991 Plan. At December 31, 1998, all 71,500 options were available
for grant.

The 1995 Non-Employee Directors Warrant Plan (the "1995 Warrant Plan") was
established to attract, retain and compensate for the services of highly
qualified individuals who are not employees of Company or the Bank, as members
of their respective boards of directors, and to enable them to increase their
ownership in the Company's common stock. Shares subject to warrants granted may
be authorized-but-unissued shares, treasury shares, shares 

                                       42
<PAGE>   45

purchased on the open market or shares issued pursuant to a rights offering or
dividends. If any warrant is surrendered before exercise, or lapses without
exercise, or for any other reason ceases to be exercisable, in whole or in part,
the shares reserved for the unexercised portion thereof shall continue to be
available for the grant of warrants hereunder. Each warrant that is granted
vests and becomes exercisable over a three-year period in increments of
one-third on each anniversary of the grant date. In 1998 and 1997, 15,000 and
13,500 warrants, respectively, were granted at exercise prices of $19.59 and
$12.83, respectively. There were no warrants issued in 1996. The 1995 Warrant
Plan expired on April 1, 1998.

The 1998 Non-Employee Directors Warrant Plan (the "1998 Warrant Plan") was
established to replace the 1995 Warrant Plan. The total number of shares that
may be issued pursuant to warrants granted under the 1998 Warrant Plan shall not
exceed 65,000. The terms, conditions, and provisions of the 1998 Warrant Plan
are substantially the same as those of the 1995 Warrant Plan described above.
There were no warrants issued under the 1998 Warrant Plan in 1998.

Stock option and warrant activity during the periods indicated is summarized as
follows:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
                                                                      Number of          Weighted
                                                                     shares under         average
                                                                        option           exercise
                                                                                           price
-----------------------------------------------------------------------------------------------------
<S>                                                                     <C>              <C>   
Outstanding, December 31, 1995                                          88,050           $ 6.39
  Granted                                                               22,000             9.17
  Exercised                                                            (20,775)            5.65
-----------------------------------------------------------------------------------------------------
Outstanding, December 31, 1996                                          89,275             7.24
-----------------------------------------------------------------------------------------------------
  Granted                                                               27,300             11.82
  Exercised                                                             (7,350)             6.24
  Forfeited                                                             (6,375)             8.27
-----------------------------------------------------------------------------------------------------
Outstanding, December 31, 1997                                         102,850              8.46
-----------------------------------------------------------------------------------------------------
Granted                                                                 26,000             19.45
Exercised                                                              (7,780)              7.81
Forfeited                                                              (2,520)             15.15
-----------------------------------------------------------------------------------------------------
Outstanding December 31, 1998                                          118,550           $ 10.77
=====================================================================================================
</TABLE>

The range of exercise prices and weighted average remaining contractual life of
outstanding options and warrants at December 31, 1998 is summarized as follows:

<TABLE>
<CAPTION>
                               Exercise    Weighted Average   Weighted Average
   Number of Shares               Price         Exercise        Contractual
     Under Option                 Range          Price          Life (Years)
------------------------------------------------------------------------------
<S>      <C>                  <C>              <C>                   <C> 
         2,625           $         3.50        $    3.50             1.95
        42,725             5.66 -  6.83             6.39             5.07
        36,700             9.16 - 10.83             9.93             7.45
        12,000                    12.83            12.83             8.25
        24,500            19.25 - 19.59            19.44             9.20
</TABLE>

At December 31, 1998, 61,255 options and warrants were exercisable, and the
weighted-average exercise price was $7.62.

The fair value of the stock options and warrants granted was arrived at using
the Black Scholes option-pricing model. The results and the assumptions used for
the options and warrants granted during 1998, 1997 and 1996 are summarized as
follows:

<TABLE>
<CAPTION>
                                                            1998      1997    1996
------------------------------------------------------------------------------------
<S>                                                     <C>          <C>      <C> 
                      Weighted-average fair value       $  5.76      3.56     2.38
                      Expected dividend yield              1.92%     1.32%    2.55%
                      Risk free interest rate              5.50%     5.70%    6.10%
                      Expected life (years)                   5         5        5
                      Volatility ratio                    26.61%    26.61%   25.42%
</TABLE>

                                       43
<PAGE>   46

The Company applies APB Opinion No. 25 in accounting for its option and warrant
plans, and accordingly, no compensation cost has been recognized for stock
options and warrants in the accompanying consolidated financial statements. Had
the Company determined compensation cost based on the fair value of its stock
options and warrants at the grant date under SFAS No. 123, the Company's net
income and earnings per share would have been reduced to pro forma amounts
indicated below:

<TABLE>
<CAPTION>
                                                                               1998     1997      1996
------------------------------------------------------------------------------------------------------
<S>                                                                         <C>         <C>      <C>  
                       Net income (in thousands):
                       As reported                                          $  1,649    1,662    1,481
                       Pro forma                                               1,552    1,599    1,431

                       Earnings per share:
                       Basic
                       As reported                                             $1.14     1.16   1.05
                       Pro forma                                                1.07     1.12   1.01

                       Diluted
                       As reported                                              1.11     1.13   1.03
                       Pro forma                                                1.04     1.08   0.99
</TABLE>

The full impact of calculating compensation for stock options and warrants under
SFAS No. 123 is reflected in the pro forma net income amounts because options
and warrants are generally granted based upon past service.

The Company maintains an Employee Stock Ownership Plan (the "ESOP") which covers
substantially all employees who have completed one year of service, with
participants vesting in shares purchased by the ESOP based upon a graduated
scale over a 7 year period. The Company pays all administrative expenses
associated with the ESOP. In 1997, the Company contributed $25,000 to the ESOP
trust. No contributions were made by the Company in 1998 and 1996. At December
31, 1998, all shares in the plan were allocated to plan participants.

The Bank has a 401(k) Savings Plan which covers all full time salaried employees
who have completed one year of service and are at least 21 years old. Expense of
the Plan in 1998, 1997 and 1996 was approximately $223,000, $113,000 and
$109,000, respectively.

The 1995 Non-Employee Directors Stock Plan (the "Plan") was approved by
stockholders and adopted by the Company in 1995. The Plan was established to
attract, retain and compensate for the services of highly qualified individuals
who are not employees of the Company or the Bank, as members of their respective
boards of directors, and to enable them to increase their ownership in the
Company's common stock through automatic, non-discretionary awards of shares in
lieu of cash meeting fees otherwise payable to them. The total number of shares
that may be awarded pursuant to the plan shall not exceed 37,500. Shares awarded
may be authorized-but-unissued shares, treasury shares or shares purchased on
the open market. The Plan terminates on December 31, 1999 unless terminated
earlier by the board of directors or extended by the board with the approval of
stockholders. During 1998, 1997 and 1996, 3,619, 3,473 and 4,985 shares were
awarded, respectively. At December 31, 1998, 23,450 shares were available for
award. The cost of shares issued in lieu of cash payments under the Plan was
$65,000, $47,000 and $47,000 in 1998, 1997 and 1996, respectively.

The Company maintains an Employee Stock Purchase Plan which allows, subject to
certain limitations, eligible Company employees to purchase shares of
Skaneateles Bancorp common stock for 95% of the market value of such stock
through payroll deductions.

                                       44
<PAGE>   47


 (10) Commitments

The Bank occupies six branches and other office space under noncancellable
operating leases with remaining terms through 2010. A summary of future minimum
rental commitments under the terms of such leases at December 31, 1998 follows
(in thousands):

<TABLE>
<CAPTION>
Year                                                               Amount
--------------------------------------------------------------------------
<S>                                                            <C> 
1999                                                           $      396
2000                                                                  417
2001                                                                  380
2002                                                                  387
2003                                                                  387
Subsequent years                                                    1,325
--------------------------------------------------------------------------
                                                                  $ 3,292
==========================================================================
</TABLE>

Rent expense amounted to approximately $408,000, $349,000, and $371,000 for
1998, 1997 and 1996, respectively.

The Company is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce exposure to fluctuations in interest rates. Those financial
instruments include commitments to extend credit and an interest rate floor.
Those instruments involve, to varying degrees, elements of credit and market
risk in excess of the amount recognized in the consolidated balance sheets.
Credit risk represents the accounting loss that would be recognized at the
reporting date if obligated counterparties failed completely to perform as
contracted. Unless noted otherwise, the Company does not require collateral or
other security to support off-balance sheet financial instruments with credit
risk. Market risk represents the risk that future changes in market prices make
a financial instrument less valuable.

Commitments to fund loans (including lines of credit) and outstanding letters of
credit were approximately $27,106,000 and $171,000, respectively, at December
31, 1998, and $20,479,000 and $168,000, respectively, at December 31, 1997.
Approximately $4,339,000 of the loan commitments at December 31, 1998 were for
fixed rates of interest.

The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instruments is represented by the contractual or
notional amount of these instruments. The Company uses the same credit policies
in making commitments as it does for on-balance sheet instruments. The Company
controls its credit risk through credit approvals, limits, and monitoring
procedures.

Loan commitments are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Loan commitments
generally have fixed expiration dates or other termination clauses, and may
require payment of a fee. The Company evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Company upon extension of credit, is based on management's
credit evaluation. Collateral held varies, but may include real estate, accounts
receivable, inventory, property, plant and equipment and income-producing
commercial properties.

The Bank has an interest rate floor outstanding on $18,000,000 of prime-based
loans at December 31, 1998. Interest rate floors require the payment of a fee
for the right to receive interest payments on the contract notional amount when
a floating rate (typically prime) falls below a strike rate. The original term
of the floor was three years with an expiration date of February 1999. Under the
agreement, which expired in February 1999, the Bank received payments on a
quarterly basis when the prime rate dropped below 8.25% (the "strike rate"), in
the amount by which the prime rate fell below the strike rate multiplied by the
notional amount of the floor ($18,000,000). The impact on net interest income is
the excess of the strike rate over the floating rate less the periodic
amortization of the fee paid.


                                       45
<PAGE>   48


In the normal course of business, there are various outstanding legal
proceedings. In the opinion of management, the proceedings should not have a
material effect on the financial condition or results of operations of the
Company.

(11) Concentrations of Credit

A substantial portion of the Company's loans are secured by real estate in
Central New York State. Accordingly, the ultimate collectibility of a
substantial portion of the Company's loan portfolio is susceptible to changes in
market conditions in this area. Other than general economic risks, management is
not aware of any material concentrations of credit risk to any industry or
individual borrower.

(12) Fair Values of Financial Instruments

The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:

Cash and cash equivalents: The carrying amounts reported in the balance sheet
for cash and cash equivalents approximate those assets' fair values.

Securities: Fair values of securities are based on quoted market prices, where
available. If quoted market prices are not available, fair values are based on
quoted market prices of comparable instruments.

Loans: For variable rate loans that reprice frequently and loans due on demand
with no significant change in credit risk, fair values are based on carrying
values. The fair values for certain mortgage loans (i.e. one-to-four family
residential) and other consumer loans are based on quoted market prices of
similar loans sold on the secondary market, adjusted for differences in loan
characteristics. The fair values of other loans (i.e. commercial real estate,
rental property mortgage loans and business loans) are estimated using
discounted cash flow analyses based on interest rates currently being offered
for loans with similar terms to borrowers of similar credit quality. The
carrying amount of accrued interest approximates its fair value.

Off-balance-sheet instruments: Fair values for the Company's off-balance-sheet
instruments (letters of credit, commitments to fund loans and an interest rate
floor contract) are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
counterparties' credit standing. The fair values of loan origination
commitments, lines of credit, standby letters of credit, and interest rate floor
contracts were estimated based on an analysis of the interest rates, fees
currently charged and market quotes, if available, for similar transactions.
These fair values were not significantly different from the carrying amounts,
which were not material, at December 31, 1998 and 1997.

Deposits: The fair values disclosed for demand deposits (interest and
non-interest checking, savings accounts, and money market accounts) are, by
definition, equal to the amount payable on demand at the reporting date (i.e.
their carrying amounts). Fair values for fixed-rate time certificates are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated expected
monthly maturities of the time deposits.

These estimated fair values do not include the value of core deposit
relationships which comprise a significant portion of the Company's deposit
base. Management believes that the Company's core deposit relationships provide
a relatively stable, low-cost funding source which has a substantial intangible
value separate from the deposit balances.

Borrowings: The carrying amounts reported in the balance sheet for overnight
borrowings approximate the fair values of those liabilities. The fair values of
the Company's long-term borrowings are estimated using discounted cash flow
analyses based on the Company's current incremental borrowing rates for similar
types of borrowing arrangements.

                                       46

<PAGE>   49


The following is a summary of the carrying values and estimated fair values of
the Company's financial instruments at December 31, 1998 and 1997 (in
thousands):
<TABLE>
<CAPTION>
                                                                1998                                  1997
                                                     ---------------------------           ---------------------------
                                                          Carrying       Fair                  Carrying         Fair
                                                            Value        Value                   Value         Value
----------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>                <C>                <C>               <C>
Financial assets:
     Cash and cash equivalents                        $     33,638       33,638
                                                                                                 16,358        16,358
     Securities available for sale                          14,799       14,799
                                                                                                  8,416         8,416
     Securities held to maturity                             4,015        4,171
                                                                                                  7,705         7,935
     Federal Home Loan Bank stock                            1,561        1,561
                                                                                                  1,561         1,561
     Loans                                                 212,578      215,594
                                                                                                212,462       213,736

Financial liabilities:
     Demand, NOW, savings, escrow, and
       Money market accounts                               137,261      137,261                 112,946       112,946
     Time certificates                                     100,072      100,789
                                                                                                105,072       105,565
     Borrowings                                             15,979       16,546
                                                                                                 18,057        18,607
</TABLE>

Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and, therefore, cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.


                                       47
<PAGE>   50


(13) Parent Company Financial Information

The following presents the condensed balance sheets of the Company (parent only)
as of December 31, 1998 and 1997 and its condensed statements of income and cash
flows for the years ended December 31, 1998, 1997 and 1996 (in thousands):

Condensed Balance Sheets
<TABLE>
<CAPTION>
                                                                            1998          1997
-------------------------------------------------------------------------------------------------------------
Assets:
<S>                                                                  <C>              <C>
  Cash                                                               $       133            56
  Investment in subsidiary                                                18,968        17,615
-------------------------------------------------------------------------------------------------------------
    Total Assets                                                     $    19,101        17,671
=============================================================================================================
  Stockholders' equity                                               $    19,101        17,671
=============================================================================================================
Condensed Statements of Income
</TABLE>

<TABLE>
<CAPTION>
                                                                            1998          1997          1996
-------------------------------------------------------------------------------------------------------------
Income:
<S>                                                                  <C>                   <C>           <C>
  Dividends from subsidiary                                           $      302           190           151
  Equity in undistributed income of subsidiary                             1,347         1,472         1,330
-------------------------------------------------------------------------------------------------------------
    Net income                                                        $    1,649         1,662         1,481
=============================================================================================================
</TABLE>

<TABLE>
<CAPTION>

Condensed Statements of Cash Flows

                                                                            1998          1997          1996
-------------------------------------------------------------------------------------------------------------
<S>                                                                   <C>                <C>           <C>  
Operating activities:
  Net income                                                          $    1,649         1,662         1,481
Adjustments to reconcile net income to net cash provided by operating
  activities:
  Equity in undistributed income of subsidiary                            (1,347)       (1,472)       (1,330)
-------------------------------------------------------------------------------------------------------------
    Net cash provided by operating activities                                302           190           151
-------------------------------------------------------------------------------------------------------------
Financing activities:
  Cash dividends paid on common stock                                       (404)         (385)         (264)
  Proceeds from issuance of stock pursuant to stock plans                    179           142           164
-------------------------------------------------------------------------------------------------------------
    Net cash used in financing activities                                   (225)         (243)         (100)
-------------------------------------------------------------------------------------------------------------

Net increase (decrease) in cash                                               77           (53)           51
Cash at beginning of year                                                     56           109            58
-------------------------------------------------------------------------------------------------------------
Cash at end of year                                                          133            56           109
=============================================================================================================
</TABLE>

                                       48

<PAGE>   51


(14) Earnings Per Share

The following table presents a reconciliation of the numerator and denominator
of the earnings per share computations (in thousands except share and per-share
amounts):

<TABLE>
<CAPTION>
                                                                        Year ended December 31, 1998
                                                             ----------------------------------------------------
                                                                 Income            Shares          Per-share
                                                               (Numerator)     (Denominator)         Amount
                                                             ---------------- ----------------- -----------------
Basic earnings per share:
<S>                                                              <C>             <C>                 <C>   
Net income                                                       $ 1,649         1,444,264           $ 1.14
Effect of assumed exercise of stock options and warrants               0            47,908

Diluted earnings per share:
Income available to common shareholders
                                                             ---------------- ----------------- -----------------
and assumed exercise of stock options and warrants               $ 1,649         1,492,172           $ 1.11
                                                             ====================================================
</TABLE>

<TABLE>
<CAPTION>
                                                                        Year ended December 31, 1997
                                                             ----------------------------------------------------
                                                                 Income            Shares          Per-share
                                                               (Numerator)     (Denominator)         Amount
                                                             ---------------- ----------------- -----------------
<S>                                                              <C>             <C>                 <C>   
Basic earnings per share:
Net income                                                       $ 1,662         1,430,177           $ 1.16
Effect of assumed exercise of stock options and warrants               0            45,647

Diluted earnings per share:
Income available to common shareholders
                                                             ---------------- ----------------- -----------------
and assumed exercise of stock options and warrants               $ 1,662         1,475,824           $ 1.13
                                                             ====================================================
</TABLE>

<TABLE>
<CAPTION>
                                                                        Year ended December 31, 1996
                                                             ----------------------------------------------------
                                                                 Income            Shares          Per-share
                                                               (Numerator)     (Denominator)         Amount
                                                             ---------------- ----------------- -----------------
<S>                                                              <C>             <C>                 <C>   
Basic earnings per share:
Net income                                                       $ 1,481         1,411,565           $ 1.05
Effect of assumed exercise of stock options                            0            33,322

Diluted earnings per share:
Income available to common shareholders
                                                             ---------------- ----------------- -----------------
and assumed exercise of stock options                            $ 1,481         1,444,887           $ 1.03
                                                             ====================================================
</TABLE>


                                       49
<PAGE>   52
Selected Quarterly Financial Data (Unaudited)

The following table sets forth selected quarterly data for the years ended
December 31, 1998 and 1997 (in thousands, except for per share data):

<TABLE>
<CAPTION>

                                                                     1998 Quarter Ended                        Total
--------------------------------------------------------------------------------------------------------------
                                                March 31      June 30     September 30       December 31        Year
--------------------------------------------------------------------------------------------------------------------
<S>                                             <C>             <C>              <C>               <C>        <C>
Total interest income                           $  4,884        5,065            5,083             5,023      20,044

Total interest expense                             2,376        2,391            2,425             2,327       9,519
--------------------------------------------------------------------------------------------------------------------
   Net interest income                             2,508        2,674            2,658             2,696      10,536

Provision for loan losses                            100          150              200               225         675
--------------------------------------------------------------------------------------------------------------------
Net interest income after

  provision for loan losses                        2,408        2,524            2,458             2,471       9,861

Net gain on sale of loans                             21           24              122                39         206

Other operating income                               449          525              554               604       2,132

Other operating expense                            2,341        2,422            2,480             2,433       9,676
--------------------------------------------------------------------------------------------------------------------
Income before income taxes                           537          651              654               681       2,523

Income tax expense                                   190          233              233               218         874
--------------------------------------------------------------------------------------------------------------------
   Net income                                  $     347          418              421               463       1,649
====================================================================================================================
Net income per common share - basic            $     .24          .29              .29               .32        1.14

Net income per common share - diluted          $     .23          .28              .28               .31        1.11
====================================================================================================================
<CAPTION>

                                                                     1997 Quarter Ended
                                                                                                               Total
---------------------------------------------------------------------------------------------------------
                                                March 31      June 30     September 30       December 31        Year
--------------------------------------------------------------------------------------------------------------------

Total interest income                           $  4,572        4,710            4,853             4,830      18,965

Total interest expense                             2,330        2,330            2,381             2,394       9,435
--------------------------------------------------------------------------------------------------------------------
   Net interest income                             2,242        2,380            2,472             2,436       9,530

Provision for loan losses                            100          100              200               100         500
--------------------------------------------------------------------------------------------------------------------
Net interest income after

  provision for loan losses                        2,142        2,280            2,272             2,336       9,030

Net gain on sale of loans                             50           15                8                 8          81

Other operating income                               371          434              457               506       1,768

Other operating expense                            1,939        2,035            2,076             2,258       8,308
--------------------------------------------------------------------------------------------------------------------
Income before income taxes                           624          694              661               592       2,571

Income tax expense                                   222          247              231               209         909
--------------------------------------------------------------------------------------------------------------------
   Net income                                   $    402          447              430               383       1,662
====================================================================================================================
Net income per common share - basic             $    .28          .31              .30               .27        1.16

Net income per common share - diluted           $    .28          .30              .29               .26        1.13
====================================================================================================================
</TABLE>

Summation of the quarterly earnings per common share does not necessarily equal
the annual amount due to the averaging effect of the number of shares throughout
the year.

Subsequent Events (Unaudited)

        On January 25, 1999, the Company entered into a definitive Agreement and
Plan of Merger with BSB Bancorp, Inc. ("BSB"), which provides for the
acquisition of the Company by BSB in a tax-free, stock-for-stock exchange to be
accounted for as a pooling of interests. In the transaction, Skaneateles
Bancorp, Inc. stockholders 

                                       50
<PAGE>   53

will receive 0.970 shares of BSB stock for each share of Skaneateles stock.
Based on BSB's closing price on January 22, 1999 (the last trading day before
the Agreement and Plan of Merger was signed), Skaneateles stockholders will
receive $27.89 per share in BSB stock, for a total transaction value of
approximately $41 million.

     The definitive Agreement and Plan of Merger, which has been approved by
both BSB's and the Company's boards of directors, is subject to approval by the
Skaneateles stockholders as well as by regulatory authorities. The transaction
is expected to close in Summer of 1999. In connection with the Agreement and
Plan of Merger, Skaneateles Bancorp also granted BSB an option to purchase
290,142 newly issued shares (19.9% of the Company's outstanding stock).







                                       51
<PAGE>   54


                           SELECTED PERFORMANCE RATIOS

           Selected performance ratios of the Company are as follows:
<TABLE>
<CAPTION>

                                                                     Year ended December 31,
                                                            ------------------------------------------
                                                                1998           1997           1996
                                                            ------------   ------------   ------------
<S>                                                              <C>             <C>            <C>
Return on Assets
     Net Income/Average Total Assets                                .62%           .68%           .65%

Return on Equity
     Net Income/Average Stockholders' Equity                       8.92%          9.66%          9.43%

Dividend Payout Ratio
     Cash Dividends Declared/Net Income                           24.50%         22.92%         17.83%

Equity to Asset Ratio
     Average Stockholders' Equity/Average Total Assets             7.00%          7.01%          6.91%

</TABLE>

                                    PERSONNEL

     As of December 31, 1998 Skaneateles had 122 full-time equivalent employees.
The employees are not represented by a collective bargaining unit, and
Skaneateles considers its relationship with its employees to be good.



                                       52
<PAGE>   55

Item 2.        PROPERTIES

     Skaneateles conducts its business from nine full-service banking offices
and one administrative office. The following table sets forth certain
information relating to each of Skaneateles' offices as of December 31, 1998.
<TABLE>
<CAPTION>

                                                                  Lease Expiration          Net Book

                                              Owned                Date Including           Value at

                                            or Leased                 Options           December 31, 1998
                                     -------------------------------------------------------------------------------
Branch Office Location                                                                   (In Thousands)
------------------------------
<S>                                           <C>                  <C>                        <C>
33 E. Genesee Street
Skaneateles, New York   13152                 Owned                Not Applicable             $ 408

431 E. Fayette Street
Syracuse, New York   13202                    Owned                Not Applicable             2,870

5791 East Seymour Street
Cicero, New York 13039                        Owned                Not Applicable              570

100 Kasson Road
Camillus, New York   13031                    Leased                    2000                    27

Teall Ave. & Grant Blvd.
Syracuse, New York   13206                    Leased                    2014                   146

3803 Brewerton Road
North Syracuse, New York 13212                Leased                    2009                   165

7785 Frontage Road
Cicero, New York 13039                        Leased                    2010                   161

137 East State Street
Oswego, New York 13126                        Leased                    2010                   176

5100 West Taft Road
Liverpool, New York  13088                    Leased                    2007                   174



Administrative Office
------------------------------

27 Fennell Street
Skaneateles, New York                         Leased                    2005                   191
13152
</TABLE>

                                       53
<PAGE>   56

Item 3.        LEGAL PROCEEDINGS

     The Company is not involved in any material legal proceedings other than
routine legal proceedings undertaken in the ordinary course of business. In the
opinion of management, after consultation with counsel, the aggregate amount
involved in such proceedings is not material to the financial condition or
results of operations of the Company.

Item 4.        SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     During the fourth quarter of 1998, there were no matters submitted to a
vote of the stockholders of Skaneateles Bancorp, Inc.


PART II.

Item 5.   MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER 
          MATTERS

     The common stock of Skaneateles Bancorp, Inc. trades on the NASDAQ National
Market System under the ticker symbol "SKAN".

     The following table shows the range of high and low closing stock prices
for each quarter of 1998 and 1997:

<TABLE>
<CAPTION>

                           1998                               1997
                  -----------------------            -----------------------
Quarter             High        Low                     High        Low
-------             -----       ----                    -----       ----
<S>               <C>           <C>                     <C>        <C>  
Fourth            $ 16.00       12.50                   22.13      18.00
Third               18.50       11.19                   19.67      13.59
Second              20.75       17.19                   14.00      12.25
First               22.38       18.75                   13.33      10.67
</TABLE>


     On March 10, 1999, there were 1,452,372 shares of Common Stock issued and
outstanding, held of record by 533 stockholders, and the Company had no other
class of equity securities outstanding.

Quarterly cash dividends totaling $.28 and $.27 per share were declared in 1998
and 1997, respectively.

On January 22, 1999, the last day of trading prior to the announcement by
Skaneateles of the proposed merger with BSB, the closing price of Skaneateles'
common stock was $19.00.

The effect of Skaneateles' proposed merger with BSB will have on: (i) ownership
of common stock by any person (including any "group" as that term is used in
section 13(d)(3) of the Securities Exchange Act of 1934, as amended) who is
known to be the beneficial owner of more than 5% of the common stock of
Skaneateles; (ii) each director; and (iii) all officers and directors as a group
is set forth at Item 12 on page 62 under the caption "Principal Holders of
Common Stock."





                                       54
<PAGE>   57

Item 6.        SELECTED FINANCIAL DATA

     The information required by this item is included in the section captioned
"Five Year Summary of Selected Financial Data" in this report.

Item 7.        MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
               RESULTS OF OPERATIONS

     The information required by this item is included in the section captioned
"Management's Discussion And Analysis Of Financial Condition And Results Of
Operations" in this report.

Item 7A.       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The information required by this item is included in the section captioned
"Asset/Liability Management" in this report.

Item 8.        FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The information required by this item is included in the section captioned
"Financial Statements And Supplementary Data" beginning at page 26 of this
report.

Item 9.        CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
               FINANCIAL DISCLOSURE

     None.


PART III.

Item 10.       DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     DIRECTORS. The following information is supplied with respect to the
directors of the Company as of December 31, 1998. Additional information
required by this item is included in the section captioned "Security Ownership
Of Certain Beneficial Owners And Management".
<TABLE>
<CAPTION>

Directors with a Term Expiring in 1999


                                       Position with the Company and Principal         Director of
Name                             Age   Occupation During the Past Five Years (1)        Bank Since 
-----------------------------------------------------------------------------------------------------
<S>                              <C>   <C>                                                   <C> 
David E. Blackwell               60    Director; Retired, President, Auburn Steel         1993
                                       Company, Inc., a steel manufacturer.

Howard J. Miller                 66    Director; Retired, Vice President,                 1993
                                       Distribution Crucible Service Centers, 
                                       a steel manufacturer.

Raymond C. Traver, Jr., M.D.     56    Director; Retired, Orthopedic Surgeon,             1990
                                       Raymond C. Traver, Jr., M.D. P.C.
</TABLE>

(1) None of the companies listed are affiliated with the Company.


                                       55
<PAGE>   58
<TABLE>
<CAPTION>

Directors with a Term Expiring in 2000


                                                                                       Director 
                                       Position with the Company and Principal          of Bank 
Name                             Age   Occupation During the Past Five Years (1)         Since  
-------------------------------------------------------------------------------------------------
<S>                              <C>   <C>                                              <C> 
Israel Berkman                   70    Director; Retired, Examining Officer of the      1992
                                       Federal Reserve Bank of New York.

Ann G. Higbee                    56    Director; Managing Partner, Public Relations     1993
                                       Services, Eric Mower and Associates, an
                                       advertising agency.

Anne E. O'Connor                 63    Director; Corporate Secretary, Kopp Billing      1995
                                       Agency, a medical billing agency.
</TABLE>

(1) None of the companies listed are affiliated with the Company.


<TABLE>
<CAPTION>

Directors with a Term Expiring in 2001


                                       Position with the Company and Principal        Director of 
Name                             Age   Occupation During the Past Five Years          Bank Since (2)
----------------------------------------------------------------------------------------------------
<S>                              <C>   <C>                                                   <C> 
Walter D. Copeland               65    Director; Retired, President, Walter D.            1994
                                       Copeland Organization, Inc. (1), a real
                                       estate consulting company.

John P. Driscoll                 59    Chairman, President and Chief Executive            1992
                                       Officer of the Company.

Carl W. Gerst, Jr.               61    Director; Vice President and Chief Technical       1982
                                       Officer, Anaren Microwave, Inc. (1), a
                                       manufacturer of microwave and electronic
                                       subsystems for commercial and defense
                                       applications.

John Bernard Henry               70    Director; Distinguished Service Professor,         1989
                                       State University of New York Health Science
                                       Center at Syracuse. (1)
</TABLE>

(1) Not affiliated with the Company.
(2) Includes terms as Trustee prior to the Bank's conversion from a mutual to
    stock form of organization on May 30, 1986.


                                       56
<PAGE>   59

<TABLE>
<CAPTION>

     EXECUTIVE OFFICERS. The following information is supplied with respect to
the executive officers of the Company:

                                                                                                    Number of
                                                                                                      Years
                                                                                                        in
                                         Position with the Company and Principal                      Current
Name                           Age       Occupation During the Past Five Years                       Position
-------------------------------------------------------------------------------------------------------------
<S>                            <C>       <C>                                                             <C>
John P. Driscoll               59        Chairman, President and Chief Executive Officer.                 6
J. David Hammond               54        Executive Vice President & Secretary. Vice President
                                         Chase Manhattan Bank, NA.                                        3
J. Daniel Mohr                 33        Vice President and Treasurer                                     6
William J. Welch               49        Vice President, Asst. Secretary & Asst. Treasurer                6
</TABLE>

   Officers of the Company are re-elected annually by the Board of Directors.

Compliance with Section 16(a) of the Exchange Act
-------------------------------------------------

     Section 16 of the Securities Exchange Act of 1934 (the "Exchange Act")
requires the reporting of transactions by insiders in the Company's Common Stock
to the Securities and Exchange Commission (the "Commission") within required
time frames. All filings required under Section 16 of the Exchange Act during
1998 were made in a timely manner, except for a Form 4 due for the month of
April 1998 for the following directors: Israel Berkman, David E. Blackwell,
Walter D. Copeland, Carl W. Gerst, Jr., Ann G. Higbee, John Bernard Henry,
Howard J. Miller, Anne E. O'Connor and Raymond C. Traver, Jr. The forms,
reporting the issuance of stock by the Company pursuant to its 1995 Non-Employee
Directors Stock Plan, were filed late due to an oversight. In making these
statements, the Company has relied solely on a review of the forms submitted to
it during 1998 and on written representations of its incumbent executive
officers and directors.

Item 11.       EXECUTIVE COMPENSATION

     Since the formation of Skaneateles Bancorp, Inc., none of its executive
officers has received any separate form of compensation from the Company.
Officers receive compensation in their positions as officers of the Bank.







                                       57
<PAGE>   60

     The following table sets forth the compensation paid by the Bank to the
Company's Chairman, President and Chief Executive Officer and to each executive
officer whose aggregate annual salary and bonus exceeded $100,000 for services
rendered in all capacities during the last three fiscal years.
<TABLE>
<CAPTION>

                           SUMMARY COMPENSATION TABLE

                                                                                                Long Term
                                                      Annual Compensation                      Compensation
                                           --------------------------------------------      --------------
                                                                                                Securities 
                                                                                                Underlying 
                                                                            Other Annual        Options (#)          All Other
Name and Principal Position     Year        Salary (1)        Bonus        Compensation                             Compensation
----------------------------------------------------------------------------------------------------------------------------------
<S>                             <C>       <C>              <C>              <C>                   <C>                <C>
John P. Driscoll                1998      $ 169,129(2)     $ 27,600(3)      $ 11,713(4)           5,000              $ 18,004(5)
Chairman, President & CEO       1997        143,691          34,588           11,635              5,700                21,233
                                1996        141,969          30,670           17,936              4,667                18,475

J. David Hammond                1998        101,924           9,857(3)          0                 1,500                10,878(6)
Executive Vice President &      1997         94,248          13,436             0                 3,000                 6,165
Secretary                       1996         92,777           9,170             0                 1,500                 1,492
</TABLE>

(1)  Includes the cost of shares allocated under the Company's Employee Stock
     Ownership Plan.
(2)  Includes $14,200 payable under a defined contribution Supplemental
     Retirement Agreement dated January 1, 1998.
(3)  Bonuses were paid for the year ended December 31, 1998 in February 1999.
(4)  Comprised entirely of country club dues.
(5)  Includes contributions to the Company's 401(k) plan totaling $10,877 and
     premium payments on an individual flexible premium deferred variable
     annuity totaling $7,127.
(6)  Comprised entirely of contributions to the Company's 401(k) plan.






                                       58
<PAGE>   61

                              OPTION GRANTS IN 1998

     The following table sets forth stock options granted to the Company's
Chairman, President and Chief Executive Officer and named executive officers
during 1998.

<TABLE>
<CAPTION>

                                                       Individual Grants
-------------------------------------------------------------------------------------------------------------------------------
                          Number of      
                          Securities          % of Total
                          Underlying       Options Granted
                        Options Granted    to Employees in       Exercise Price      Expiration          Grant Date Present
Name                          (1)                1998              Per Share            Date                    Value (2)
-------------------------------------------------------------------------------------------------------------------------------
<S>                          <C>                  <C>                <C>             <C>                      <C>
John P. Driscoll             5,000                45.5               $ 19.25         February 2008            $ 28,495
J. David Hammond             1,500                13.6                 19.25         February 2008               8,548
</TABLE>

(1)  Options were granted on February 11, 1998 under the Company's 1991 Long
     Term Incentive and Capital Accumulation Plan, and are exercisable 50% per
     year after date of grant.

(2)  The Black-Scholes option pricing model was used to calculate the grant date
     present value. Significant assumptions are as follows:
             -  expected stock price volatility                26.61%
             -  risk-free rate of return                        5.50%
             -  expected dividend yield                         1.92%
             -  Expected time of exercise                      5 years


       AGGREGATED OPTION EXERCISES IN 1998 AND 1998 YEAR END OPTION VALUES

     The following table sets forth information with respect to the Chief
Executive Officer and named executive officers, concerning exercises of stock
options during 1998 and the number and value of unexercised options held at
December 31, 1998.
<TABLE>
<CAPTION>

                                                               Number of Securities               Value of Unexercised      
                                                          Underlying Unexercised Options    In-the-Money Options at December
                           Shares                              at December 31, 1998                   31, 1998 (2)          
                          Acquired            Value       --------------------------------  ---------------------------------
         Name          on Exercise(#)      Realized(1)     Exercisable      Unexercisable     Exercisable       Unexercisable
-----------------------------------------------------------------------------------------------------------------------------
<S>                          <C>            <C>               <C>              <C>              <C>                <C>   
John P. Driscoll             100            $ 822             34,950           14,450           $ 278,533          55,430
J. David Hammond              0               0                6,900            7,350              32,860          28,293
</TABLE>

(1)  Market value of underlying securities at exercise, minus the exercise
     price.
(2)  Market value of underlying securities at December 31, 1998, minus the
     exercise price.

COMPENSATION OF DIRECTORS
     Directors who are not executive officers of the Company receive a fee of
$500 per Board meeting attended. In addition, non-officer members of committees
of the Board receive a fee of $250 per committee meeting attended. Directors who
are also officers of the Company receive no compensation for attendance at Board
or committee meetings.

     The 1995 Non-Employee Directors Warrant Plan (the "1995 Warrant Plan") was
established to attract, retain and compensate for the services of highly
qualified individuals who are not employees of Company or the Bank, as members
of their respective boards of directors, and to enable them to increase their
ownership in the Company's Common Stock. Under the 1995 Warrant Plan, those
outside directors receive warrants (or options) to 


                                       59
<PAGE>   62

purchase shares of Common Stock only if the Company achieves specified
performance levels. The total number of shares that may be issued pursuant to
warrants granted under the 1995 Warrant Plan shall not exceed 112,500. Each
warrant that is granted vests and becomes exercisable over a three-year period
in increments of one-third on each anniversary of the grant date. In April 1998,
15,000 warrants were granted at an exercise price of $19.59 per share. This plan
expired on April 1, 1998.

     The 1998 Non-Employee Directors Warrant Plan (the "1998 Warrant Plan")
replaced the 1995 Warrant Plan. The terms of the 1998 Warrant Plan are identical
to those of the 1995 Warrant Plan, except for the specific performance
measurements under which warrants are granted. The total number of shares that
may be issued pursuant to warrants granted under the 1998 Warrant Plan shall not
exceed 65,000.

EMPLOYMENT AGREEMENTS

     Mr. Driscoll has an employment agreement with the Company and the Bank
which provides for an annual adjustment in Mr. Driscoll's salary as determined
by the Board of Directors based upon an annual review of his compensation. The
Board of Directors has set Mr. Driscoll's base salary for 1999 at $147,660. Mr.
Driscoll is also entitled to receive cash bonuses based on the Company's
attainment of specific levels of earnings per share, and as the Board, in its
discretion, may award.

     Under his agreement, Mr. Driscoll will receive a continuation of his salary
and benefits for three years if his employment is terminated by the Company for
any reason other than "cause", including a "change in control" of the Company.

     The Company and the Bank also entered into agreements with J. David
Hammond, Executive Vice President, and William Welch, J. Daniel Mohr and Karen
Lockwood, Vice Presidents, pursuant to which they will receive a continuation of
their respective salaries and benefits for eighteen months (twenty-four in the
case of Mr. Hammond) if a "change in control" of the Company occurs.

     The named executive officers, like all eligible employees of the Bank, are
entitled to receive a bonus tied to specified target levels of the Company's
earnings per share, as well as to individual and departmental goals.








                                       60
<PAGE>   63


PERFORMANCE GRAPH

     The following graph compares cumulative total shareholder returns on the
Company's stock over the last five years to the NASDAQ Stock Market Index for
U.S. companies and the NASDAQ Bank Index. Total return values were calculated
assuming a $100 investment on December 31, 1993 and reinvestment of all
dividends. The following graph shall not be deemed incorporated by reference
into any filing under the Securities Act of 1933 or the 1934 Act, and shall not
be deemed filed under either such act.
<TABLE>
<CAPTION>

                                  Total Return
--------------------------------------------------------------------------------
                  SKANEATELES
      DATE           BANCORP                NASDAQ US              NASDAQ Bank
--------------------------------------------------------------------------------
<S>     <C>            <C>                     <C>                     <C>
        1993           100                     100                     100
        1994           120                     98                      100
        1995           156                     138                     148
        1996           183                     170                     196
        1997           381                     209                     328
        1998           274                     293                     325
</TABLE>











                                       61
<PAGE>   64


Item 12.        SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

                        PRINCIPAL HOLDERS OF COMMON STOCK

     The following table (with notes thereto) sets forth information as of the
March 10, 1999 with respect to ownership of Common Stock by any person
(including any "group" as that term is used in Section 13(d)(3) of the
Securities Exchange Act of 1934, as amended) who is known to the Company to be
the beneficial owner of more than 5% of Common Stock and with respect to
ownership of Common Stock by all directors and executive officers of the Company
as a group (such information being based on information filed by or on behalf of
the beneficial holder concerned).
<TABLE>
<CAPTION>

                                                     Amount and Nature of Beneficial    Percent of
Name and Address of Beneficial Owner                          Ownership (1)                Class
--------------------------------------------------------------------------------------------------
<S>                                                             <C>     <C>                <C>
Jeffrey L. Gendell                                              132,300(2)                 8.72%
Tontine Partners, L.P.
31 West 52nd Street, 17th Floor
New York, NY 10019

Dimensional Fund Advisors                                        90,000(3)                 5.93%
1299 Ocean Avenue, 11th Floor
Santa Monica, CA 90401

Directors and executive officers of the Company                 139,509(4)                 9.19%
33 East Genesee Street
Skaneateles, NY 13152
</TABLE>


(1)  In accordance with Rule 13d-3 under the Securities Exchange Act of 1934, as
     amended ("1934 Act"), a person is deemed to be the beneficial owner for
     purposes of this table of any shares of Common Stock (a) over which he or
     she has or shares voting or investment power, or (b) of which he or she has
     the right to acquire beneficial ownership at any time within 60 days from
     March 10, 1999. For purposes of the 1934 Act, "voting power" is the power
     to vote or direct the voting of shares, and "investment power" is the power
     to dispose or direct the disposition of shares. All shares shown in the
     table above have sole voting and investment power, except as otherwise
     indicated. This table includes shares of Common Stock subject to
     outstanding options granted pursuant to the Company's Employee Stock Option
     and Director's Warrant Plans. As of December 31, 1998, executive officers
     as a group held vested options to purchase 62,875 shares. There were 4,000
     vested warrants as of this date. See "Compensation of Executive Officers."

(2)  As reported by Jeffrey L. Gendell and Tontine Financial Partners, L.P., a
     Delaware limited partnership ("Tontine"), in a statement as of September
     28, 1995 on Schedule 13D under the Exchange Act. Of the 132,300 shares
     reported above, Mr. Gendell reported sole dispositive powers as to 52,500
     shares, and both Mr. Gendell and Tontine reported shared voting and
     dispositive powers as to 79,800 shares.








                                       62
<PAGE>   65


(3)  Dimensional Fund Advisors Inc. ("Dimensional"), an investment advisor
     registered under Section 203 of the Investment Advisers Act of 1940,
     furnishes investment advice to four investment companies registered under
     the Investment Company Act of 1940, and serves as investment manager to
     certain other investment vehicles, including commingled group trusts.
     (These investment companies and investment vehicles are the "Portfolios").
     In its role as investment advisor and investment manager, Dimensional
     possesses both voting and investment power over the securities of the
     Issuer that are owned by the Portfolios. All securities of the Issuer are
     owned by the Portfolios, and Dimensional disclaims beneficial ownership of
     such securities.

     Sole Voting Power:           90,000
     Shared Voting Power:         0
     Sole Dispositive Power:      90,000
     Shared Dispositive Power:    0

(4)  Directors and executive officers of Skaneateles Bancorp, Inc. as a group
     reported beneficial ownership of 139,509 shares on Schedule 13D filed on
     February 16, 1999 in connection with the execution of a Stockholder
     Agreement (the "Agreement") with BSB Bancorp, Inc., dated as of January 25,
     1999. Pursuant to the Agreement, each stockholder who executed the
     Agreement agreed to vote in favor of the Agreement and Plan of Merger By
     and Between Skaneateles Bancorp, Inc. and BSB Bancorp, Inc. The members of
     the group, their positions with the Company and their voting and
     dispositive powers is as follows:
<TABLE>
<CAPTION>

--------------------------------------------------------------------------------------------------------------------------
                                                                                                                Pro forma
                                                        Percent     Sole     Shared       Sole     Shared      Percent of
                  Name                 Common Stock       Of      Voting    Voting     Dispositive Dispositive    Class
                Position               Beneficially      Class     Power      Power      Power       Power        After
                                          Owned                                                                 Proposed
                                                                                                               Merger (i)
--------------------------------------------------------------------------------------------------------------------------
<S>                                            <C>         <C>      <C>             <C>    <C>              <C>       <C> 
     John P. Driscoll                          44,341      2.91%    44,341          0      44,341           0         .33%
     Chairman, President and
     Chief Executive Officer
--------------------------------------------------------------------------------------------------------------------------
     J. David Hammond                          14,623        96%    14,623          0      14,623           0         .11%
     Executive Vice President and
     Secretary
--------------------------------------------------------------------------------------------------------------------------
     Karen E. Lockwood                          6,623       .44%     6,623          0       6,623           0         .05%
     Vice President of Skaneateles
     Savings Bank
--------------------------------------------------------------------------------------------------------------------------
     J. Daniel Mohr                             3,168       .21%     3,168          0       3,168           0         .02%
     Vice President and Treasurer
--------------------------------------------------------------------------------------------------------------------------
     William J. Welch                          14,993       .99%    14,993          0      14,993           0         .11%
     Vice President, Assistant
     Secretary and Assistant
     Treasurer
--------------------------------------------------------------------------------------------------------------------------
     Israel Berkman                             3,934       .26%     3,934          0       3,934           0         .03%
     Director
--------------------------------------------------------------------------------------------------------------------------
     David E. Blackwell                         3,071       .20%     3,071          0       3,071           0         .02%
     Director
--------------------------------------------------------------------------------------------------------------------------
     Walter D. Copeland (ii)                    2,488       .16%         0      2,488           0       2,488         .02%
     Director
--------------------------------------------------------------------------------------------------------------------------
     Carl W. Gerst, Jr.                         7,007       .46%     7,007          0       7,007           0         .05%
     Director
--------------------------------------------------------------------------------------------------------------------------
     John Bernard Henry, M.D. (iii)             4,443       .29%         0      4,443           0       4,443         .03%
     Director
--------------------------------------------------------------------------------------------------------------------------
     Ann G. Higbee                              7,103       .47%     7,103          0       7,103           0         .05%
     Director
--------------------------------------------------------------------------------------------------------------------------
</TABLE>







                                       63
<PAGE>   66

<TABLE>
<CAPTION>

--------------------------------------------------------------------------------------------------------------------------
                                                                                                                Pro forma
                                                        Percent     Sole     Shared       Sole     Shared      Percent of
                  Name                 Common Stock       Of      Voting    Voting     Dispositive Dispositive    Class
                Position               Beneficially      Class     Power      Power      Power       Power        After
                                          Owned                                                                 Proposed
                                                                                                               Merger (i)
--------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>         <C>      <C>            <C>     <C>             <C>       <C> 
     Howard J. Miller (iv)                      4,431       .29%     3,681          0       3,681           0         .03%
     Director
--------------------------------------------------------------------------------------------------------------------------
     Francis R. O'Connor (v)                   10,916       .69%    10,416          0      10,416           0         .08%
     Former director; spouse of Anne E.
     O'Connor
--------------------------------------------------------------------------------------------------------------------------
     Anne E. O'Connor                             500       .03%       500          0         500           0           0%
     Director
--------------------------------------------------------------------------------------------------------------------------
     Raymond C. Traver, Jr., M.D.(vi)          12,368       .81%    12,368          0     12,.368           0         .09%
     Director
--------------------------------------------------------------------------------------------------------------------------
     Directors and officers as a group        140,009      9.19%   131,828      6,931     131,828       6,931        1.02%
--------------------------------------------------------------------------------------------------------------------------

     (i)  Calculation is based upon 11,237,470 shares of BSB Common Stock
          outstanding as of December 31, 1998, as described in BSB's 10-K filed
          with the commission, 1,452,372 shares of the Company's Common Stock
          outstanding as of December 31, 1998, using the stated exchange ratio
          of .97 shares of BSB Common Stock for each share of the Company's
          Common Stock.
     (ii) Shares owned by Walter D. Copeland and Concetta M. Copeland Revocable
          Living Trust dated October 11, 1995, Walter D. Copeland and Concetta
          M. Copeland, trustees.
    (iii) All shares held jointly with Mr. Henry's wife, with whom Mr. Henry
          has shared voting and investment power.
     (iv) Mr. Miller reports beneficially ownership of 4,431 shares, including
          750 shares held by Mr. Miller's spouse.
     (v)  Mr. O'Connor reports beneficial ownership of 10,916, including 500
          shares held by Mr. O'Connor's spouse.
     (vi) Includes 6,075 shares held in trust under an employee defined
          contribution pension plan and 786 shares held by Dr. Traver as
          custodian for his children.
--------------------------------------------------------------------------------------------------------------------------
</TABLE>

     Additional information required by this item is included in the section
captioned "Directors And Executive Officers Of The Registrant" at page 54 of
this report.

On January 25, 1999 Skaneateles Bancorp entered into an Agreement and Plan of
Merger with BSB Bancorp, Inc., which provides for the acquisition by BSB
Bancorp, Inc. of Skaneateles in a tax-free, stock-for-stock exchange (the
"merger"). The consummation of the merger is subject to certain conditions,
including the approval of Skaneateles Bancorp, Inc's. stockholders and the
receipt of required regulatory approvals. In connection with the Agreement and
Plan of Merger, BSB Bancorp, Inc. and Skaneateles entered into an option
agreement pursuant to which Skaneateles granted BSB Bancorp an option,
exercisable upon certain circumstances, to purchase an aggregate of 290,142
newly issued shares of Skaneateles Common Stock. Also in connection with the
Agreement and Plan of Merger, certain stockholders of Skaneateles, including its
directors and executive officers, entered into a Stockholder Agreement pursuant
to which each of such stockholders agreed to vote in favor of the Merger, among
other things.

Item 13.       CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The Bank may make loans to directors and any executive officers of the
Company to the extent permitted by banking law. Any extensions of credit, to
directors or executive officers of the Company whether past or future, are made
in the ordinary course of business on substantially the same terms, including
interest rates, collateral and repayment terms, as those prevailing at the time
for comparable transactions with other persons, and do not involve more than the
normal risk of collectibility or present other unfavorable features.







                                       64
<PAGE>   67

PART IV.
--------
Item 14.       EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

The following financial statements are filed as part of this report:

Independent Auditors' Report

Consolidated Balance Sheets as of December 31, 1998 and 1997

Consolidated Statements of Income for the Years Ended December 31, 1998, 1997
and 1996

Consolidated Statements of Stockholders' Equity and Comprehensive Income for the
Years Ended December 31, 1998, 1997 and 1996

Consolidated Statements of Cash Flows for the Years Ended December 31, 1998,
1997 and 1996

Notes to Consolidated Financial Statements

During the three-month period ended December 31, 1998, the Registrant filed no
current reports on Form 8-K. On January 27, 1999, the Registrant filed a Form
8-K announcing a definitive merger agreement with BSB Bancorp, Inc. which
provides for BSB Bancorp to acquire Skaneateles Bancorp, in a tax-free,
stock-for-stock exchange. No financial statements were filed with this report.


The following exhibits are either filed as part of this annual report on Form
  10-K, or are incorporated herein by reference:

No.     Exhibit
---     -------

2.1       Agreement and Plan of Merger, dated January 25, 1999, by and between
          BSB Bancorp and Skaneateles Bancorp, Inc.

3.1       Certificate of Incorporation of Skaneateles Bancorp, Inc.(1)

3.2       Certificate of Amendment of Certificate of Incorporation of
          Skaneateles Bancorp, Inc.(2)

3.3       Bylaws of the Company (3)

10.1      Employment Agreement dated as of January 1, 1998 between Skaneateles
          Savings Bank and John P. Driscoll(2)

10.2      Employment Agreement dated as of March 25, 1998 between Skaneateles
          Savings Bank and J. David Hammond(2)

10.3      Employment Agreement dated as of March 25, 1998 between Skaneateles
          Savings Bank and Karen E. Lockwood(2)

10.4      Employment Agreement dated as of March 25, 1998 between Skaneateles
          Savings Bank and J. Daniel Mohr(2)

10.5      Employment Agreement dated as of March 25, 1998 between Skaneateles
          Savings Bank and William J. Welch(2)

10.6      Supplemental Retirement Agreement dated as of January 1, 1998 between
          Skaneateles Savings Bank and John P. Driscoll(2)

10.7      Trust Under Supplemental Retirement Agreement Dated January 1, 1998
          between Skaneateles Savings Bank and John P. Driscoll(2)

10.8      Amendment to Long Term Incentive And Capital Accumulation Plan dated
          October 28, 1997(2)

10.9      Amendment to Long Term Incentive And Capital Accumulation Plan dated
          October 28, 1997(2)

10.10     Amendment to 1995 Non-Employee Directors Stock Plan dated October 28,
          1997(2)

10.11     Amendment to 1995 Non-Employee Directors Warrant Plan dated October
          28, 1997(2)

10.12     Amendment to Center Banks Incorporated Employee Stock Purchase Plan
          dated October 28, 1997(2)

10.13     Amendment to Center Banks Incorporated Dividend Reinvestment Plan
          dated October 28, 1997(2)

21        List of Registrant's Subsidiaries




                                       65
<PAGE>   68

23        Consent of KPMG LLP

27        Financial Data Schedule

99.1      Option Agreement, dated as of January 25, 1999, by and between
          Skaneateles Bancorp, Inc. and BSB Bancorp, Inc.

99.2      Stockholder Agreement, dated as of January 25, 1999, by and between
          BSB Bancorp, Inc. and certain stockholders of Skaneateles Bancorp,
          Inc.

---------

(1)       Exhibit is incorporated herein by reference to the identically
          numbered exhibit to the 1990 Form 10-K filed by the Company with the
          Securities and Exchange Commission on April 1, 1991.

(2)       Exhibit is incorporated herein by reference to the identically
          numbered exhibit to the 1997 Form 10-K filed by the Company with the
          Securities and Exchange Commission on March 30, 1998.

(3)       Exhibit is incorporated herein by reference to the identically
          numbered exhibit to the 1996 Form 10-K filed by the Company with the
          Securities and Exchange Commission on March 31, 1997.





                                       66
<PAGE>   69

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

SKANEATELES BANCORP, INC.
-------------------------
Registrant

By:     /s/ John P. Driscoll                             Date: March 23, 1999
        ----------------------------                           --------------
        John P. Driscoll
        Chairman, President and Chief Executive Officer

By:     /s/ J. Daniel Mohr                               Date: March 23, 1999
        ----------------------------                           --------------
        J. Daniel Mohr
        Chief Financial Officer and Treasurer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

        /s/ Israel Berkman                               Date: March 23, 1999
        ----------------------------                           --------------
        Israel Berkman
        Director

        /s/ David E. Blackwell                           Date: March 23, 1999
        ----------------------------                           --------------
        David E. Blackwell
        Director

        /s/ Walter D. Copeland                           Date: March 23, 1999
        ----------------------------                           --------------
        Walter D. Copeland
        Director

        /s/ Carl W. Gerst                                Date: March 23, 1999
        ----------------------------                           --------------
        Carl W. Gerst
        Director

        /s/ John Bernard Henry                           Date: March 23, 1999
        ----------------------------                           --------------
        John Bernard Henry
        Director

        /s/ Ann G. Higbee                                Date: March 23, 1999
        ----------------------------                           --------------
        Ann G. Higbee
        Director

        /s/ Howard J. Miller                             Date: March 23, 1999
        ----------------------------                           --------------
        Howard J. Miller
        Director

                                                         Date:
        ----------------------------                           --------------
        Raymond C. Traver, Jr., M.D.
        Director

        /s/ Anne E. O'Connor                      Date: March 23, 1999
        ---------------------                           --------------
        Anne E. O' Connor
        Director

                                       67