<PAGE>   1






                                   EXHIBIT 13


<PAGE>   2
                    Along the road to success               1996
                    --------------------------------------------
                    Peoples Heritage
                    Financial Group, Inc.          Annual Report

Maine
New Hampshire
Massachusetts

                  [ GRAPHIC OF MAP AND THREE INSTANT PHOTOS ]

<PAGE>   3

AT PEOPLES HERITAGE,

we know how to get where we're going. With our community banking approach and
successful expansion strategy, Peoples Heritage continues to grow and prosper.
In 1996 we not only virtually doubled our asset size, but expanded our market
share and earnings potential. All while generating record-breaking earnings for
the third consecutive year.


                                Table of Contents
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FINANCIAL HIGHLIGHTS                                                           1

LETTER TO SHAREHOLDERS                                                         2

MARKETS                                                                        4

PERFORMANCE                                                                    4

STRATEGY                                                                       6

COMMUNITY BANKING SERVICES                                                     9

SELECTED 5-YEAR CONSOLIDATED
FINANCIAL AND OTHER DATA                                                      11

MANAGEMENT'S DISCUSSION
AND ANALYSIS                                                                  12

FINANCIAL STATEMENTS                                                          30

CORPORATE DIRECTORY                                                           55

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                     PEOPLES HERITAGE FINANCIAL GROUP, INC.
       Peoples Heritage Financial Group, Inc. is the banking and financial
               services holding company for Peoples Heritage Bank,
                    Bank of New Hampshire, and Family Bank.

--------------------------------------------------------------------------------

<PAGE>   4
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------

1996 was our third consecutive record earnings year at Peoples Heritage. Our
annual net earnings were up 18% over 1995's record net earnings.

         Just as importantly, we achieved these results while meeting the
challenges of two major bank acquisitions, Bank of New Hampshire and Family
Bank. As with all of our previous acquisitions, our successful expansion was
both prudent and profitable. We delivered a strong financial performance across
the board, while expanding our market area, increasing our earnings potential,
and positioning Peoples Heritage for continued growth.

Earnings Per Share                                               Strong Margins
<TABLE>
<S>                                                                  <C>
[BAR CHART 1 OF EARNINGS PER SHARE]                                  [BAR CHART 2 OF STRONG MARGINS]

</TABLE>



                                                                               1
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Dear Shareholders:
--------------------------------------------------------------------------------

"In achieving both growth and profitability, we set earnings records for a third
consecutive year and realized impressive performance across a wide range of
financial measurements."

[ PHOTO ]

Net Income

[BAR CHART FOR NET INCOME]

         1996 was yet another record-breaking year at Peoples Heritage. In
addition to achieving record earnings, we virtually doubled our asset size
through growth and acquisitions to become the fifth largest bank in New England.

         While expanding in Maine, we grew to become a three-state holding
company with over half our assets outside the state. Building on our successful
record of acquisitions, we significantly expanded our presence in New Hampshire
to become the Granite state's number three bank to complement our number two
market position in Maine. We also entered a vital new market in northern
Massachusetts.

         In achieving both growth and profitability, we set earnings records for
a third consecutive year and realized impressive performance across a wide range
of financial measurements. Our performance is moving us into the top tier of
American banks. At the same time, we have significantly expanded our earnings
potential through our broadened presence in the more vibrant economies of New
Hampshire and Massachusetts.

         Our 1996 acquisitions of Bank of New Hampshire and Family Bank,
represented a natural extension of our market, and a natural fit for our growth
strategy. Peoples Heritage is committed to our customers and our community
banking approach. We understand and appreciate the value of community
involvement, local decision making, and a deep awareness of local banking needs.


2
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         In addition to being strong-performing banks, both Bank of New
Hampshire and Family Bank share long histories of personal service and community
involvement. As part of our community banking approach, both banks are keeping
their management teams, keeping their bank names, and subsequently, keeping
their loyal customers who want to continue banking at their local bank with the
people they know and trust. It's a proven business approach that sets Peoples
Heritage apart from other banks in our markets -- and has helped make us one of
New England's fastest growing banks.

         To ensure that we rapidly achieve profitability and efficiencies
through our acquisitions, we are consolidating operations activities at our
state-of-the-art operations facility in Maine. With the larger resources of
Peoples Heritage behind them, our New Hampshire and Massachusetts banks are
revitalizing their consumer and commercial lending. Additionally, we are sharing
successful banking products and services throughout the holding company to
realize efficiencies and leverage the best each bank has to offer.

         As part of our strategy to enhance shareholder value during our
acquisitions, we completed a "Dutch Auction" self tender offer and repurchased
2.5 million shares of our Common Stock in 1996, in addition to the 751,600
shares repurchased in 1995.

         Looking ahead, we will stay open to new business opportunities as they
arise. We will seek to attract and retain new customers as the potential for
disruptions from branch closings and cutbacks at other financial institutions in
our market areas continues. Above all, we will maintain our commitment to our
community banking focus and enhancing shareholder value.

         Management can seek to expand our company, develop new lines of
business, and define the strategies critical to our success. However, it is the
daily efforts of our dedicated employees that give life to those decisions and
make them a reality. I wish to thank all of our valued employees, as well as our
loyal customers and shareholders, as we look to the future and new opportunities
for success.

Sincerely yours,

/s/ William J. Ryan

William J. Ryan
Chairman, President and
Chief Executive Officer


                                                                               3
<PAGE>   7

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                    ALONG THE ROAD IN                  MAINE

                    As Maine's own in-state bank, we
                    understand the needs of our customers
                    and deliver the kinds of products and
                    services that fit our customers' lives.
                    From our mortgage leadership to our new
                    supermarket branches to our Sunday
                    hours, we're constantly striving to
                    serve our customers better. Peoples
                    Heritage Bank holds the number two
                    market position in Maine with 66
                    branches throughout the state and $2.64
                    billion in assets.

                         66 BRANCHES THROUGHOUT MAINE

                         NO. 2 MARKET POSITION

                         $2.64 BILLION IN ASSETS

                    [ 2 PHOTOS ]
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MARKETS

Peoples' market share continues to expand through acquisitions and growth. When
1995 ended, Peoples Heritage had total assets of just over $3 billion. At the
end of 1996, we had expanded to $5.4 billion in assets with a banking system
that stretches from northern Maine to northeastern Massachusetts, encompassing
132 banking offices operating as Peoples Heritage Bank, Bank of New Hampshire
and Family Bank.

[GRAPHIC OF MAINE]

PERFORMANCE

With record earnings for a third consecutive year, Peoples Heritage Financial
Group is moving into the top tier of the region's and nation's banks. Our
performance numbers also reflect our ability to make profitable, sound
acquisitions.

RECORD EARNINGS - In 1996, Peoples Heritage achieved record annual
net earnings of $52.5 million, or $2.10 per share, even after merger-related
costs were expensed in the period. Net earnings were up 18% over 1995's record
net earnings of $44.5 million, or $1.80 per share.

RECORD DEPOSITS - In 1996, we increased our deposits to $4.2 billion from $3.2
billion at the end of 1995 -- an increase of 31%. Our strong increase was a
result of our


4
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                                        [ 5 PHOTOS ]

profitable acquisition strategy as well as our continued market share growth in
Maine.

STRONG MARGINS - Our diversified portfolio of consumer and commercial loans and
foundation of core deposits enabled us to maintain a strong 4.7+% net interest
margin for 1996, stable with 1995.

MORE LOANS - Net loans and leases increased 32% in 1996, from $2.7 billion to
$3.6 billion. Our results reflect the impact of our successful marketing
efforts, core growth, and growth from acquisitions.

INCREASED FEE INCOME - Fee income increased 20% in 1996. We attribute this
growth to a variety of factors including our rapidly growing Trust Services,
customer fees, strength in mortgage originations, and our mortgage servicing
income which includes $3.2 billion of mortgages we service for others.

INCREASED DIVIDEND - More than 30 cents of every net dollar earned in 1996 was
returned to shareholders as dividend. Following the fourth quarter of 1996, we
increased the quarterly dividend to 18 cents per share, up from 17 cents per
share the previous quarter, and from 16 cents per share for the same quarter a
year ago.

RETURN ON ASSETS - Our Return on Average Assets (ROA) reached an annual historic
high of 1.21%, up from 1.16% in 1995. Our ROA performance puts us on par with
some of America's best banks.

RETURN ON EQUITY - Our Return on Average Equity reached 14.41% in 1996, as
compared to 13.53% in 1995 -- another historic high.

STRONG ASSET QUALITY - Asset quality improved markedly in 1996. We reduced
nonperforming


                                                                               5
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                    ALONG THE ROAD IN          NEW HAMPSHIRE

                    In 1996, Bank of New Hampshire became a
                    part of Peoples Heritage Financial Group
                    and was combined with our previous New
                    Hampshire bank, The First National Bank
                    of Portsmouth. We also acquired five
                    Shawmut Bank of New Hampshire branches
                    in the past year with $160 million in
                    deposits. As a result, we now enjoy the
                    number three market position in New
                    Hampshire with 44 branches and $1.77
                    billion in assets

                         44 BRANCHES THROUGHOUT
                         NEW HAMPSHIRE

                         NO. 3 MARKET POSITION

                         $1.77 BILLION IN ASSETS

                    [ 2 PHOTOS ]
--------------------------------------------------------------------------------

assets to 1.01% of total assets, down from 1.40% in 1995, and down from 2.1% in
1994 -cutting nonperforming asset ratio in half in just two years.

RESERVE COVERAGE -- Peoples Heritage achieved nearly a 160% ratio of reserves to
nonperforming loans. Our more than adequate coverage reflects our prudent
management style.

STRATEGY

Our growth in New Hampshire and expansion into Massachusetts provides us with a
larger and more vigorous economy than Maine alone. Of course, we also
strengthened our ability to earn and reward shareholders. By continuing a
community banking approach in new market areas, we can continue building on our
success.

COMMUNITY BANKING - At the heart of everything we do, community banking is the
fundamental strategy behind our expansion.

NONPERFORMING ASSETS                                             COVERAGE RATIO

<TABLE>

<S>                                                              <C>
[BAR CHART FOR NONPERFORMING ASSETS]                             [BAR CHART FOR COVERAGE RATIO]

</TABLE>

6
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                                        [ 5 PHOTOS ]

With our newly acquired banks, we're expanding our community banking approach by
retaining the acquired banks' names, local management and customer contact staff
to continue to provide personal customer service. Local decision making will
also be maintained supported by our strategic business units and strong
performance expectations.

UNIQUE MARKET POSITION - With our lending expertise and systems, Peoples
Heritage is smartly positioned with the ability to serve the large segment of
commercial borrowers that big banks tend to ignore, and smaller banks can't
handle.

GROWTH AND PROFITABILITY - Peoples has demonstrated a history of intelligent,
profitable acquisitions. Our latest acquisitions are no exception -- in the
higher growth region of northern Massachusetts and in New Hampshire which boasts
New England's fastest growing economy.

OPERATIONAL EFFICIENCIES - Peoples' strong operations continued to improve in
1996. With our recent acquisitions, we achieved efficiencies by consolidating
"back room" functions including operations, accounting and finance, legal and
human resources.

BUILDING ON OUR STRENGTHS - With our expanded resources, we are able to share
successful products and ideas throughout our system. For example, we recently
took a successful checking product from Family Bank to Peoples, and took a
popular CD product from Peoples to Bank of New Hampshire.

EXPANDED ATM NETWORK - To make banking as convenient as possible for our
customers, we are


                                                                               7
<PAGE>   11

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                    ALONG THE ROAD IN          MASSACHUSETTS

                    Family Bank joined the Peoples family at
                    the end of 1996 with the acquisition of
                    its parent company, Family Bancorp.
                    Family Bank enjoys the top market
                    position in most of the local
                    communities it serves. This valuable
                    acquisition extends Peoples' presence
                    and community banking approach into
                    northeastern Massachusetts. Family Bank
                    adds 17 branches in northeastern
                    Massachusetts, five in southern New
                    Hampshire, and $1.01 billion in assets.

                         17 BRANCHES IN NORTHEASTERN
                         MASSACHUSETTS

                         5 BRANCHES IN SOUTHERN
                         NEW HAMPSHIRE

                         $1.01 BILLION IN ASSETS

                    [ 2 PHOTOS ]
--------------------------------------------------------------------------------

continuing to expand our ATM network with new machines in supermarkets, banking
centers and at freestanding locations throughout our market area.

GROWING PHONE BANK - Driven by strong demand, our telephone banking service grew
significantly in 1996. We now have 70 professionals and an automated response
unit responding to over 300,000 calls each month. So customers from all three
banks can check balances, originate a consumer loan, or determine recent account
activity. They can take advantage of our automated services or talk to a person
-- we're always there to help.

EXPANDED SUPERMARKET BANKING - Our customers really appreciate the ability to
bank where they shop. In 1996, we opened four new supermarket banking centers in
Maine. And with our experience and success, we're now laying the groundwork for
new supermarket

DIVIDEND BY YEAR                                                RETURN ON ASSETS

<TABLE>
<S>                                                             <C>
[BAR CHART FOR DIVIDEND BY YEAR]                                [BAR CHART FOR RETURN ON ASSETS]

</TABLE>

8
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                                        [ 5 PHOTOS ]

banking centers in New Hampshire and Massachusetts. It's all part of our
strategy to continue our customer-driven approach in new markets.

SUNDAY HOURS - Being a community bank means being there for our customers --
even on Sundays. We offer Sunday hours and expanded Saturday and weekday hours
at numerous branches throughout our market areas and at all supermarket banking
centers.

INCENTIVE COMPENSATION - Delivering superior customer service requires the
commitment and support of employees at every level. That's why all employees,
from tellers to top management, operate under incentive-based compensation.

COMMUNITY BANKING
SERVICES

At Peoples Heritage, community banking means more than personal service. Being a
true community bank means providing a range of banking services which encompass
all the business and consumer needs of the markets we serve.

MORTGAGE LENDING - Peoples is the 70th largest mortgage originator in the nation
-- up doubled digits from a year ago. We're the number one mortgage originator
in Maine, the second largest mortgage originator in New Hampshire, and we're
re-introducing mortgage lending at Family Bank. In addition, we service over
$3.2 billion of mortgages for others.

CONSUMER LENDING - Our successful consumer lending program includes home equity
loans, indirect auto loans, and manufactured housing loans.

COMMERCIAL LENDING - With the acquisitions of Bank of


                                                                               9
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New Hampshire and Family Bank, our commercial lending program is benefiting from
the more vigorous economies of New Hampshire and Massachusetts. In 1996, we also
assembled a team of experienced asset-based lending specialists to bring
asset-based lending services to all our markets.

CASH MANAGEMENT SERVICES - In 1996, the Cash Management Department at Peoples
Heritage Bank introduced a new on-line banking product to improve service and
attract and retain commercial customers.

PUBLIC FINANCE - Revitalized two years ago, our growing Public Finance
Department provides investment and loan products to northern New England's
cities, towns and other public bodies. The Department contributed $2.2 million
to our bottom line in 1996, while adding resources to service our new market
areas.

LEASING SERVICES - Our equipment leasing services expand our Public Finance
offerings and broaden the services we provide to our commercial customers. We're
now providing leasing throughout our three-state region.

INVESTMENT SERVICES - With the acquisition of Bank of New Hampshire, we added
the resources of their 100-year-old Trust department with $1.4 billion under
management and another $1 billion in corporate trust assets. This strengthens
our capabilities in Maine with a Trust department with $600 million under
management with a like amount of corporate trust assets. We also plan to bring
Trust services to Family Bank this year. In addition, we added Private Banking
to our range of services in Maine in 1996.

         AT PEOPLES HERITAGE, OUR ROAD TO SUCCESS RUNS RIGHT THROUGH THE
COMMUNITIES OF NORTHERN NEW ENGLAND. AFTER ALL, COMMUNITY BANKING IS AT THE
HEART OF WHAT MAKES US UNIQUE IN OUR MARKETS. BY STAYING CLOSE TO OUR CUSTOMERS
AND CLOSE TO OUR COMMUNITIES, WE ONCE AGAIN ACHIEVED RECORD ANNUAL EARNINGS AND
BUILT ON OUR SUCCESS.

         TO US, COMMUNITY BANKING MEANS UNDERSTANDING THE NEEDS OF OUR CUSTOMERS
IN ALL THE MARKETS WE SERVE -- AND OFFERING THE KINDS OF INNOVATIVE PRODUCTS AND
SERVICES THAT FIT THEIR LIVES AND MAKE BANKING EASIER AND MORE CONVENIENT. IT IS
OUR COMMUNITY BANKING PHILOSOPHY WHICH HAS GUIDED US THROUGH OUR HISTORY OF
SUCCESSFUL ACQUISITIONS. IT HAS ENABLED US TO GROW BOTH PRUDENTLY AND
PROFITABLY. IT HAS ALLOWED US TO DELIVER FOR OUR CUSTOMERS, AND IN TURN, OUR
SHAREHOLDERS.

         AS WE LOOK TO THE ROAD AHEAD, WE WILL CONTINUE TO SEEK BETTER WAYS TO
SERVE OUR CUSTOMERS, WE WILL EXPLORE ACQUISITIONS WHEN ADVANTAGEOUS, AND WE WILL
MAINTAIN OUR COMMITMENT TO ENHANCING SHAREHOLDER VALUE.

         WE LOOK FORWARD THE JOURNEY.

--------------------------------------------------------------------------------

TOTAL DEPOSITS                TOTAL ASSETS             SHAREHOLDER'S EQUITY

[ BAR CHART FOR               [ BAR CHART FOR          [ BAR CHART FOR
 TOTAL DEPOSITS]                TOTAL ASSETS]            SHAREHOLDER'S EQUITY]

10
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                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

SELECTED FIVE-YEAR CONSOLIDATED FINANCIAL AND OTHER DATA

<TABLE>
<CAPTION>
(Dollars in Thousands, Except Per Share Data)                              December 31,
---------------------------------------------------------------------------------------------------------------------
Financial Condition Data                         1996            1995            1994            1993            1992
---------------------------------------------------------------------------------------------------------------------
<S>                                        <C>             <C>             <C>             <C>             <C>
Total assets                               $5,398,398      $4,058,126      $3,737,906      $3,624,641      $3,523,094
Debt and equity securities, net (1)         1,045,069         766,648         719,194         717,467         557,787
Total loans and leases, net                 3,587,112       2,717,608       2,575,902       2,638,348       2,425,020
Goodwill and other intangibles                 71,649          22,792          20,713          22,758          22,310
Deposits                                    4,185,289       3,197,138       2,885,845       2,939,826       2,948,549
Borrowings                                    690,969         456,932         505,347         359,935         288,024
Shareholders' equity                          437,010         354,925         304,439         287,438         249,862
Nonperforming assets                           54,267          56,752          78,339         120,076         185,733
Allowance for loan and lease losses            67,488          60,975          63,675          67,385          71,223
Book value per share at end of period           15.48           14.16           12.26           11.61           10.73
Tangible book value per share at
    end of period                               12.95           13.25           11.42           10.69            9.77
---------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
Operations Data                                                        Year Ended December 31,
---------------------------------------------------------------------------------------------------------------------
                                                   1996           1995           1994            1993           1992
---------------------------------------------------------------------------------------------------------------------
<S>                                           <C>            <C>            <C>             <C>            <C>
Interest and dividend income                  $ 341,172      $ 305,849      $ 256,597       $ 243,452      $ 272,596
Interest expense                                150,599        134,895        108,002         112,305        150,458
                                              ---------      ---------      ---------       ---------      ---------
Net interest income                             190,573        170,954        148,595         131,147        122,138
Provision for loan losses                           900          4,230          3,374          14,047         32,025
                                              ---------      ---------      ---------       ---------      ---------
Net interest income after
    provision for loan losses                   189,673        166,724        145,221         117,100         90,113
                                              ---------      ---------      ---------       ---------      ---------
Net securities gains (losses)                       507            116           (254)          1,183          2,859
Net gains on sales of consumer loans                 --             --             33           2,576             --
Other noninterest income                         37,941         31,301         27,847          24,842         26,747
Noninterest expenses                            148,073        130,280        125,137         122,391        125,091
                                              ---------      ---------      ---------       ---------      ---------
Income (loss) before provision
    for income taxes                             80,048         67,861         47,710          23,310         (5,372)
Income tax expense                               27,568         23,375         13,662             799          1,510
Cumulative effect on years prior to 1992
    of a change in accounting principle              --             --             --              --          1,100
                                              ---------      ---------      ---------       ---------      ---------
    Net income (loss)                         $  52,480      $  44,486      $  34,048       $  22,511      $  (5,782)
                                              =========      =========      =========       =========      =========
Earnings (loss) per share                     $    2.10      $    1.80      $    1.37       $    0.95      $   (0.36)
Cash earnings per share (5)                   $    2.29      $    1.89      $    1.45       $    1.08      $   (0.20)
Dividends per share                           $     .65      $    0.46      $    0.23       $    0.01            $--
---------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
Other Data (2)                                                  At or For the Year Ended December 31,
---------------------------------------------------------------------------------------------------------------------
                                                      1996          1995          1994         1993           1992
---------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>           <C>            <C>          <C>            <C>
Net interest margin (3),(4)                           4.71%         4.79%         4.44%         4.11%         3.71%
Net interest rate spread (3),(4)                      4.12          4.20          4.01          3.76          3.41
Return on average assets                              1.21          1.16          0.94          0.64         (0.16)
Return on average equity (4)                         14.41         13.53         11.42          8.57         (2.69)
Tier I leverage capital ratio at end
    of period                                         7.96          8.33          7.96          7.63          7.00
Dividend payout ratio                                30.36         25.42         16.45          1.44            --
Price to book value at end of period                180.88        160.66         97.88        103.36         90.87
Nonperforming assets as a % of total
    assets at end of period                           1.01          1.40          2.10          3.31          5.29
Allowance for loan losses as a % of
    nonperforming loans at end of period            158.99        143.40        113.17         86.95         65.39
Allowance for loan losses as a % of
    total loans at end of period                      1.85          2.19          2.41          2.77          2.85
Full service banking offices at end of period          132           106            96            98           100
---------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) All securities were classified as available for sale at December 31, 1996,
and 1995. (2) Ratios are based on average daily balances during the respective
periods. (3) Fully-taxable equivalent basis. (4) Excludes effect of unrealized
gains or losses on securities available for sale. (5) Earnings before the
amortization of goodwill and core deposit premiums.


                                                                              11
<PAGE>   15

Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

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

GENERAL

Peoples Heritage Financial Group, Inc. (the "Company") is a Maine-chartered,
multi-bank holding company which conducts business from its headquarters in
Portland, Maine and 131 offices located throughout Maine, New Hampshire and
northern Massachusetts. Based on $5.4 billion of total assets at December 31,
1996, the Company is the largest independent bank holding company headquartered
in northern New England and the fifth largest independent bank holding company
headquartered in New England.

    The Company offers a broad range of commercial and consumer banking services
and products and trust and investment advisory services through three
wholly-owned banking subsidiaries: Peoples Heritage Bank ("PHB"), Bank of New
Hampshire ("BNH") and Family Bank, FSB ("Family"). PHB is a Maine-chartered
savings bank which operates 66 offices throughout Maine and, through
subsidiaries, engages in mortgage banking, financial planning and equipment
leasing activities. At December 31, 1996, PHB had consolidated assets of $2.6
billion and consolidated shareholder's equity of $175.3 million. BNH is a New
Hampshire-chartered commercial bank which operates 44 offices throughout New
Hampshire. At December 31, 1996, BNH had consolidated assets of $1.8 billion and
consolidated shareholder's equity of $135.6 million. Family is a
federally-chartered savings bank which operates 22 offices in northern
Massachusetts and southern New Hampshire. At December 31, 1996, Family had
consolidated assets of $1.0 billion and consolidated shareholder's equity of
$107.1 million. Each of PHB, BNH and Family is a member of the Bank Insurance
Fund ("BIF") administered by the Federal Deposit Insurance Corporation ("FDIC").

Business Strategy.

The principal business of the Company consists of attracting deposits from the
general public through its offices and using such deposits and other sources of
funds to originate residential mortgage loans, commercial business loans and
leases, commercial real estate loans and a variety of consumer loans. The
Company also invests in mortgage-backed securities and securities issued by the
United States Government and agencies thereof. In addition, the Company engages
in the sale of other financial products (annuities and mutual funds), provides
trust services, and services residential mortgage loans for investors.

   The Company's goal is to sustain profitable, controlled growth by focusing on
increased loan and deposit market share in Maine, New Hampshire and northern
Massachusetts, developing new financial products, services and delivery
channels, closely managing yields on earning assets and rates on
interest-bearing liabilities, increasing non-interest income through, among
other things, expanded trust and investment advisory services and mortgage
servicing operations and controlling growth of noninterest expenses. It is also
part of the business strategy of the Company to supplement internal growth with
targeted acquisitions of other banking or thrift institutions in New England.
During the period covered by this discussion, the Company engaged in numerous
merger and acquisition related activities. For further information, see Note 2
to the Consolidated Financial Statements and "Overview" below.

OVERVIEW

The year 1996 was highlighted by several acquisitions by the Company. On
December 6, 1996 the Company completed the acquisition of Family Bancorp, the
holding company for Family, through the exchange of 1.26 shares of the Company's
Common Stock for each share of Family Bancorp Common Stock. There were 5,480,335
shares of the Company's Common Stock issued in connection with the acquisition
of Family Bancorp, including 2,500,000 shares of treasury stock. This
transaction was accounted for as a purchase. Accordingly, the impact of the
absorption of Family's operations is reflected in the Company's consolidated
financial statements from the date of acquisition.

    On April 2, 1996, the Company completed the merger with Bank of New
Hampshire Corporation ("BNHC"), the holding company for BNH, whereby each share
of BNHC was converted into two shares of Common Stock of the Company. Because
the acquisition was accounted for under the pooling-of-interests method of
accounting, the consolidated financial statements of the Company for periods
prior to the acquisition have been restated to include BNHC. At December 31,
1995, BNHC had total consolidated assets of $977.8 million and total
consolidated shareholders' equity of $84.5 million.

    On February 16, 1996, the Company acquired five branch offices and
approximately $160 million of related deposits from Fleet Bank NH (the "Branch
Acquisition"). The Company also acquired approximately $216.4 million of loans
in connection with this transaction, which consisted primarily of $178.6 million
of single-family residential loans.

    On July 1, 1995, the Company acquired Bankcore, Inc. ("Bankcore"), the New
Hampshire-based holding company for North Conway Bank. At the time of
acquisition, Bankcore had $132.8 million in total assets and shareholders'
equity of $17.8 million. The Bankcore acquisition was treated as a purchase for
accounting purposes and, accordingly, the Company's financial statements reflect
the acquisition from the date of acquisition.

    On June 15, 1995, the Company purchased all the branches and $46.1 million
in deposits, as well as $17.1 million in loans, of Fleet Bank of Maine located
in Aroostook County, Maine. Five of the seven branches purchased were merged
with and into existing branches of PHB.

    During 1994, the Company acquired Mid-Maine Savings Bank, F.S.B., which was
accounted for under the pooling-of-interests method. Accordingly, the
consolidated financial statements of the Company have been restated to reflect
the acquisition for all periods presented.

Economic Conditions in Northern New England.

The Company believes that Maine, New Hampshire, northeastern Massachusetts and
New England in general have witnessed slow but steady economic growth since
1992. Although economic activity is just beginning to reach levels experienced
in the mid-to-late 1980s, the northern New England economy appears stable at
this time. The economies and real estate markets in the Company's primary market
areas will continue to be significant determinants of the quality of the
Company's assets in future periods and, thus, its results of operations.


12
<PAGE>   16

                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

REVIEW OF FINANCIAL STATEMENTS

The discussion and analysis which follows focuses on the factors affecting the
Company's financial condition at December 31, 1996 and 1995 and financial
results of operations during 1996, 1995 and 1994. The consolidated financial
statements and related notes beginning on page 30 of this report should be read
in conjunction with this review. Certain amounts in years prior to 1996 have
been reclassified to conform to the 1996 presentation.

RESULTS OF OPERATIONS

Overview.

The Company reported net income of $52.5 million or $2.10 per share in 1996, as
compared to net income of $44.5 million or $1.80 per share in 1995 and $34.0
million or $1.37 per share in 1994. Return on average assets amounted to 1.21%
in 1996, as compared to 1.16% and .94% during 1995 and 1994, respectively, and
return on average equity amounted to 14.41% in 1996, as compared to 13.53% and
11.42% during 1995 and 1994, respectively. The improved results were
attributable to substantial increases in net interest income, which on a
fully-taxable equivalent basis amounted to $191.4 million, $172.0 million and
$149.3 million for the years ended 1996, 1995 and 1994, respectively. The
increase in net interest income in 1996 was offset in part by non-recurring
expenses of $1.9 million incurred in connection with the recapitalization of the
Savings Association Insurance Fund ("SAIF") and $5.1 million in merger-related
expenses. The Company also experienced increases in noninterest income,
particularly in customer services income and mortgage banking services income
during 1996, 1995 and 1994.

    The Company's results of operations are affected not only by its net
interest income, but also by the level of its other noninterest income including
gains and losses on the sales of loans and securities, noninterest expenses,
provision for loan losses resulting from the Company's assessment of the
adequacy of the allowance for loan losses, and income tax expense. Each of these
components of the Company's operating results is discussed below.

Net Interest Income.

The following table sets forth the information related to changes in net
interest income. For purposes of the table and the following discussion, (i)
income from interest-earning assets and net interest income is presented on a
fully-taxable equivalent basis primarily by adjusting income and yields earned
on tax-exempt interest received on loans to qualifying borrowers and on certain
of the Company's equity securities to make them equivalent to income and yields
earned on fully-taxable investments, assuming a federal income tax rate of 35%,
and (ii) nonaccrual loans have been included in the appropriate average balance
loan category, but unpaid interest on nonaccrual loans has not been included for
purposes of determining interest income.


                                       13
<PAGE>   17

Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------------
                                                                     Year Ended December 31,
                                                      1996                                             1995
--------------------------------------------------------------------------------------------------------------------------------
                                    AVERAGE                          YIELD/           AVERAGE                        YIELD/
(Dollars in Thousands)              BALANCE         INTEREST          RATE            BALANCE        INTEREST         RATE
--------------------------------------------------------------------------------------------------------------------------------
<S>                              <C>             <C>              <C>              <C>            <C>            <C>
Loans and leases: (1)
   Residential real estate
     mortgages                   $   1,110,741   $      87,357             7.86%   $     848,773  $      69,957           8.24%
   Commercial real estate
     mortgages                         829,011          80,825             9.75          762,275         75,657           9.93
   Commercial business loans
     and leases                        425,873          40,880             9.60          371,863         37,174          10.00
   Consumer loans and leases           858,684          80,524             9.38          749,407         71,696           9.57
                                 -------------   -------------                     -------------  -------------
     Total loans and leases          3,224,309         289,586             8.98        2,732,318        254,484           9.31
                                 -------------   -------------                     -------------  -------------
Securities available for
     sale (2)                          793,847          50,102             6.31          771,462         47,392           6.14
Federal funds sold                      43,716           2,350             5.38           85,191          5,066           5.95
                                 -------------   -------------                     -------------  -------------
     Total earning assets            4,061,872         342,038             8.42        3,588,971        306,942           8.55
                                 -------------   -------------                     -------------  -------------
Nonearning assets (2)                  289,781                                           256,797
                                 -------------                                     -------------
     Total assets                $   4,351,653                                     $   3,845,768
                                 =============                                     =============
Interest-bearing deposits
   Regular savings               $     603,329          16,433             2.72    $     588,581         16,753           2.85
   NOW accounts                        364,670           4,593             1.26          328,238          4,697           1.43
   Money market access accounts        505,426          18,190             3.60          414,025         15,507           3.75
   Certificates of deposit           1,462,097          81,227             5.56        1,299,735         71,252           5.48
                                 -------------   -------------                     -------------  -------------
     Total interest-bearing
       deposits                      2,935,522         120,443             4.10        2,630,579        108,209           4.11
Borrowed funds                         568,406          30,156             5.31          471,456         26,686           5.66
                                 -------------   -------------                     -------------  -------------
   Total interest-bearing
     liabilities                     3,503,928         150,599             4.30        3,102,035        134,895           4.35
                                 -------------   -------------                     -------------  -------------
Demand accounts                        448,154                                           368,832
Other liabilities                       35,318                                            46,197
Shareholders' equity (2)               364,253                                           328,704
                                 -------------                                     -------------
   Total liabilities and
     shareholders' equity        $   4,351,653                                     $   3,845,768
                                 =============                                     =============
Net earning assets               $     557,944                                     $     486,936
                                 =============                                     =============
Net interest income (fully-
   taxable equivalent)                                 191,439                                          172,047
Less: fully-taxable equivalent
   adjustments                                            (866)                                          (1,093)
                                                 -------------                                    -------------
Net interest income                              $     190,573                                    $     170,954
                                                 =============                                    =============
Net interest rate spread
   (fully-taxable equivalent)                                              4.12                                           4.20%
Net interest margin
   (fully-taxable equivalent)                                              4.71                                           4.79%
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
----------------------------------------------------------------------------
                                            Year Ended December 31,
                                                     1994
----------------------------------------------------------------------------
                                    AVERAGE                        YIELD/
(Dollars in Thousands)              BALANCE        INTEREST         RATE
----------------------------------------------------------------------------
<S>                              <C>            <C>            <C>
Loans and leases: (1)
   Residential real estate
     mortgages                   $     808,715  $      62,147           7.68%
   Commercial real estate
     mortgages                         727,671         63,402           8.71
   Commercial business loans
     and leases                        315,826         28,774           9.11
   Consumer loans and leases           677,511         61,264           9.04
                                 -------------  -------------
     Total loans and leases          2,529,723        215,587           8.52
                                 -------------  -------------
Securities available for
     sale (2)                          749,507         38,434           5.13
Federal funds sold                      81,376          3,295           4.05
                                 -------------  -------------
     Total earning assets            3,360,606        257,316           7.66
                                 -------------  -------------
Nonearning assets (2)                  269,352
                                 -------------
     Total assets                $   3,629,958
                                 =============
Interest-bearing deposits
   Regular savings               $     596,254         16,313           2.74
   NOW accounts                        307,021          5,014           1.63
   Money market access accounts        367,820          9,770           2.66
   Certificates of deposit           1,275,805         56,823           4.45
                                 -------------  -------------
     Total interest-bearing
       deposits                      2,546,900         87,920           3.45
Borrowed funds                         414,956         20,082           4.84
                                 -------------  -------------
   Total interest-bearing
     liabilities                     2,961,856        108,002           3.65
                                 -------------  -------------
Demand accounts                        325,615
Other liabilities                       44,357
Shareholders' equity (2)               298,130
                                 -------------
   Total liabilities and
     shareholders' equity        $   3,629,958
                                 =============
Net earning assets               $     398,750
                                 =============
Net interest income (fully-
   taxable equivalent)                                149,314
Less: fully-taxable equivalent
   adjustments                                           (719)
                                                -------------
Net interest income                             $     148,595
                                                =============
Net interest rate spread
   (fully-taxable equivalent)                                           4.01
Net interest margin
   (fully-taxable equivalent)                                           4.44
----------------------------------------------------------------------------
</TABLE>

(1) Loans and leases include portfolio loans and leases, loans held for sale and
nonperforming loans.

(2) Excludes effect of unrealized gains or losses on securities available for
sale.


14
<PAGE>   18

                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

The following table presents certain information on a fully-taxable equivalent
basis regarding changes in interest income and interest expense of the Company
for the periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided with respect to changes
attributable to (1) changes in rate (change in rate multiplied by old volume),
(2) changes in volume (change in volume multiplied by old rate) and (3) changes
in rate/volume (change in rate multiplied by change in volume).

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------------
                                             Year Ended December 31, 1996 vs 1995       Year Ended December 31, 1995 vs 1994
(Dollars in Thousands)                            Increase (Decrease) Due to                 Increase (Decrease) Due to
-------------------------------------------------------------------------------------------------------------------------------
                                                                  Rate/                                       Rate/
                                            Rate      Volume     Volume     Total       Rate      Volume     Volume      Total
-------------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>
Interest-earning assets:
  Loans and leases: (1)
    Residential real estate mortgages     $ (3,225)  $ 21,586   $   (961)  $ 17,400   $  4,529   $  3,076   $    205   $  7,810
    Commercial real estate mortgages        (1,372)     6,627        (87)     5,168      8,878      3,014        363     12,255
    Commercial business loans and leases    (1,487)     5,401       (208)     3,706      2,811      5,105        484      8,400
    Consumer loans and leases               (1,424)    10,458       (206)     8,828      3,591      6,499        342     10,432
                                          --------   --------   --------   --------   --------   --------   --------   --------
      Total loans and leases                (7,508)    44,072     (1,462)    35,102     19,809     17,694      1,394     38,897
                                          --------   --------   --------   --------   --------   --------   --------   --------
  Securities available for sale              1,311      1,374         25      2,710      7,570      1,126        262      8,958
  Federal funds sold                          (486)    (2,468)       238     (2,716)     1,546        155         70      1,771
                                          --------   --------   --------   --------   --------   --------   --------   --------
    Total                                   (6,683)    42,978     (1,199)    35,096     28,925     18,975      1,726     49,626
                                          --------   --------   --------   --------   --------   --------   --------   --------
Interest-bearing liabilities:
  Deposits:
    Regular savings                           (765)       420         25       (320)       656       (210)        (6)       440
    NOW accounts                              (558)       521        (67)      (104)      (614)       346        (49)      (317)
    Money market access accounts              (621)     3,428       (124)     2,683      4,009      1,229        499      5,737
    Certificates of deposit                  1,040      8,897         38      9,975     13,141      1,065        223     14,429
                                          --------   --------   --------   --------   --------   --------   --------   --------
      Total deposits                          (904)    13,266       (128)    12,234     17,192      2,430        667     20,289
  Borrowed funds                            (1,650)     5,487       (367)     3,470      3,403      2,735        466      6,604
                                          --------   --------   --------   --------   --------   --------   --------   --------
    Total                                   (2,554)    18,753       (495)    15,704     20,595      5,165      1,133     26,893
                                          --------   --------   --------   --------   --------   --------   --------   --------
Net interest income
  (fully taxable equivalent)              $ (4,129)  $ 24,225   $   (704)  $ 19,392   $  8,330   $ 13,810   $    593   $ 22,733
                                          ========   ========   ========   ========   ========   ========   ========   ========
-------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Loans and leases include portfolio loans and loans held for sale and
nonperforming loans.

Net interest income increased by $19.4 million or 11.3% during 1996. This
increase was primarily attributable to significant increases in the volume of
interest-earning assets, primarily loans and leases, which contributed to a
$71.0 million or 14.6% increase in net earning assets during 1996. The increase
in volume of interest-earning assets was offset in part by a decrease in the
weighted average yield on all categories of interest-earning assets. The
Company's net interest margin decreased slightly from 4.79% in 1995 to 4.71% for
1996, and the net interest rate spread decreased to 4.12% in 1996 from 4.20% in
1995.

    Interest and dividend income increased $35.1 million or 11.4% during 1996,
primarily due to increased interest on loans and leases. The average outstanding
balance of loans and leases increased $492.0 million or 18.0% from 1995 to 1996,
primarily as a result of the acquisition of $216.4 million of loans in
connection with the Branch acquisition.

    The increase in volume of loans and leases was offset in part by a decrease
in the weighted average yield on loans and leases from 9.31% in 1995 to 8.98% in
1996. This decrease was due to growth in the percentage of lower-yielding
residential mortgage loans relative to other loans, as well as increased
competition for both consumer and commercial loans. At December 31, 1996, the
percentage of the Company's loans and leases which had adjustable or floating
interest rates amounted to 54.5%.

    Interest expense increased $15.7 million or 11.6% during 1996. Interest
expense on interest-bearing deposits increased $12.2 million or 11.3% while
interest expense on borrowed funds, primarily from the Federal Home Loan Bank of
Boston, increased $3.5 million or 13.0%. The increase in interest expense was
primarily attributable to a $401.9 million or 13.0% increase in the volume of
interest-bearing liabilities as rates paid on deposits remained relatively
stable. The majority of the increase in volume was in certificates of deposit.
The $160.9 million of deposits acquired in connection with the Branch
Acquisition in February 1996 significantly contributed to the increase in the
volume of deposits, whereas the $774.6 million of deposits acquired in
connection with the acquisition of Family Bank in December 1996 contributed only
slightly to the increase in volume because such deposits were outstanding only
since the date of acquisition.


                                                                              15
<PAGE>   19

Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

    Net interest income increased by $22.7 million or 15.2% during 1995. This
increase was primarily attributable to changes in the volume of interest-earning
assets and interest-bearing liabilities, which resulted from an $88.2 million or
22.1% increase in net earning assets from 1994 to 1995 and an increase in the
Company's net interest margin from 4.44% to 4.79% during the same respective
periods, and to a lesser extent to changes in the yields earned on
interest-earning assets and the rates paid on interest-bearing liabilities,
which resulted in an increase in the Company's interest rate spread from 4.01%
to 4.20% during 1994 and 1995, respectively.

    Interest and dividend income increased by $49.6 million or 19.3% during 1995
primarily as a result of a $38.9 million or 18.0% increase in interest on loans
and leases available for sale and held for investment (collectively "loans and
leases"). The increase in interest on loans and leases was attributable to both
an increase in the weighted average yield on loans and leases from 8.52% during
1994 to 9.31% during 1995, which reflected increases in all loan categories, and
a $202.6 million or 8.0% increase in the average balance of loans and leases
from 1994 to 1995, which also reflected increases in all loan categories. At
December 31, 1995, the percentage of the Company's loans and leases which had
adjustable or floating rates amounted to 45.3%.

    Interest and dividend income also increased in 1995 as a result of a $9.0
million or 23.3% increase in interest income on securities available for sale
which was primarily attributable to an increase in the weighted average yield
earned on securities from 5.13% to 6.14% during 1994 and 1995, respectively.

    Interest expense increased by $26.9 million or 24.9% during 1995 as a result
of a $20.3 million or 23.1% increase in interest expense on interest-bearing
deposits and a $6.6 million or 32.9% increase in interest expense on borrowed
funds, which consist primarily of advances from the Federal Home Loan Bank of
Boston and, to a lesser extent, securities sold under agreements to repurchase
and federal funds purchased. These increases were primarily attributable to an
increase in the weighted average rate paid on interest-bearing liabilities,
which increased from 3.65% to 4.35% during 1994 to 1995, respectively. Interest
expense also increased during 1995 as a result of a $140.2 million or 4.7%
increase in the average balance of interest-bearing liabilities, which was
attributable to increases in both interest-bearing deposits, particularly money
market access accounts and borrowings.

Provision for Loan Losses.

The Company incurred a $900 thousand provision for loan losses in 1996
reflecting a decrease of $3.3 million from 1995. In 1995, the provision for
loans losses increased $856 thousand from $3.4 million in 1994 to $4.2 million
in 1995. The allowance for loan losses as a percentage of nonperforming loans
increased to 158.99% at December 31, 1996 compared to 143.40% at December 31,
1995. Provisions for loan losses are attributable to management's ongoing
evaluation of the adequacy of the allowance for loan and lease losses, which
incudes, among other procedures, consideration of the character and size of the
loan portfolio, monitoring trends in nonperforming loans, delinquent loans and
net charge-offs, as well as new loan originations and other asset quality
factors.

    Although management utilizes its best judgment in providing for possible
losses, there can be no assurance that the Company will not have to change its
provisions for loan losses in subsequent periods to a higher level from that
recorded during 1996. Changing economic and business conditions in northern New
England, fluctuations in local markets for real estate, future changes in
nonperforming asset trends, large upward movements in market-based interest
rates or other reasons could affect the Company's future provisions for loan
losses.

    In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the adequacy of the Company's allowance
for loan and lease losses. Such agencies may require the Company to recognize
changes to the allowance for loan and lease losses based on their judgment about
information available to them at the time of examination.

Noninterest Income.

Noninterest income was $38.5 million, $31.4 million and $27.6 million for the
years ended December 31, 1996, 1995 and 1994, respectively. The $7.1 million or
22.6% increase in noninterest income during 1996 was primarily attributable to a
$3.4 million or 28.9% increase in customer services income, a $2.1 million or
19.3% increase in mortgage banking services income, and a $1.4 million or 23.6%
increase in trust and investment advisory services income. The $3.8 million or
13.7% increase in noninterest income during 1995 was primarily attributable to a
$2.4 million or 28.5% increase in mortgage banking services income and a $1.4
million or 13.6% increase in customer services income.

The following sets forth information relating to the Company's noninterest
income.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                  Year Ended December 31,
--------------------------------------------------------------------------------
(In Thousands)                                   1996        1995        1994
--------------------------------------------------------------------------------
<S>                                            <C>         <C>         <C>
Customer services                              $ 15,353    $ 11,908    $ 10,481
Mortgage banking services                        12,940      10,849       8,446
Trust and investment
  advisory services                               7,233       5,850       5,471
Net securities gains (losses)                       507         116        (254)
Other noninterest income                          2,415       2,694       3,482
                                               --------    --------    --------
                                               $ 38,448    $ 31,417    $ 27,626
                                               ========    ========    ========
--------------------------------------------------------------------------------
</TABLE>

Mortgage banking services income is comprised of residential mortgage sales
income and residential mortgage servicing income. The increase in mortgage
banking services income in both 1996 and 1995 was primarily attributable to an
increase in residential mortgage sales income.


16
<PAGE>   20

                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

The following table sets forth certain information relating to the Company's
mortgage banking activities.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------
                                              At or for the Year Ended December 31,
-----------------------------------------------------------------------------------
(In Thousands)                                      1996        1995        1994
-----------------------------------------------------------------------------------
<S>                                              <C>         <C>         <C>
Residential mortgages
   serviced for investors                        $3,227,659  $2,595,049  $2,089,972
                                                 ==========  ==========  ==========
Residential mortgage
   sales income                                  $    7,108  $    4,224  $    1,915
Residential mortgage
   servicing income                                   5,832       6,625       6,531
Mortgage banking
   services income                               $   12,940  $   10,849  $    8,446
                                                 ==========  ==========  ==========
-----------------------------------------------------------------------------------
</TABLE>

The Company's portfolio of residential mortgages serviced for investors
increased by $632.6 million or 24.4% from December 31, 1995 to December 31,
1996. In conjunction with the acquisition of Family Bank on December 6, 1996,
the Company added $322.6 million to its portfolio of residential mortgages
serviced for investors. In addition, the Company's portfolio of mortgages
serviced for others continued to increase due to origination and sale of
residential mortgages to the secondary market while retaining the rights to
service these loans for the investors purchasing them. In addition, the
outstanding amount of residential mortgages serviced for investors is impacted,
from time to time, by the purchase and sale of mortgage servicing rights for
portfolios of residential mortgage loans.

    Residential mortgage sales income increased by $2.9 million and $2.3
million, or 68.3% and 120.6%, in 1996 and 1995, respectively. Included in
residential mortgage sales income in 1996 and 1995 are $1.1 million and $642
thousand of gains on the sale of residential mortgage servicing rights,
respectively. The mortgage sales income in 1996 was attributable to a
significant increase in the volume of loans originated from correspondent
lenders, the vast majority of which were sold in the secondary mortgage market.
Residential mortgage originations from correspondent lenders increased to $844.5
million in 1996 from $378.5 million in 1995, a 123.1% increase.

    Residential mortgage servicing income decreased by $793 thousand in 1996 and
increased by $94 thousand in 1995. During 1996, the Company reclassified the
amortization expense of constant maturity treasury floors ("CMT") to residential
mortgage servicing income from other noninterest expenses, which resulted in a
$684 thousand decrease in residential mortgage servicing income in 1996 as
compared with 1995. Excluding the CMT floor amortization expense in 1996 as an
offset to mortgage servicing income, mortgage servicing income would have been
$6.5 million, or $109 thousand less than 1995. Residential mortgage servicing
income has lagged increases in the portfolio of mortgages serviced for others as
a result of the impact of the Company's adoption of Statement of Financial
Accounting Standards ("SFAS") No. 122 in 1995, which effectively accelerates
mortgage servicing income into the current period as a component of capitalized
mortgage servicing rights. The mortgage servicing rights that have been created
as a result of the adoption of SFAS No. 122 are amortized and recorded as an
offset to mortgage servicing income. For additional discussion of CMT floors,
see "Interest Rate Risk and Asset Liability Management" below.

    The generation of mortgage sales income and the recognition of net gains on
the sales of securities are dependent on market and economic conditions and,
accordingly, there can be no assurance that the income and net gains reported in
prior periods can be achieved in the future or that there will not be
significant inter-period variations in the results of such activities.

    Customer services income increased by $3.4 million or 28.9% during 1996 and
by $1.4 million or 13.6% during 1995. The increase in customer services income
reflects the Company's focus on increasing the number and volume of transaction
accounts, the increased use of and fees generated by ATM machines, and the
impact of purchase acquisitions.

    Trust and investment advisory services income increased $1.4 million or
23.6% in 1996 to $7.2 million. The increase primarily reflects the growth of the
trust department at PHB, which was started during the first quarter of 1995, as
well as increased fee based income from the sale of mutual fund and annuity
products.

    Other noninterest income is primarily attributable to loan related services
income, which amounted to $2.1 million, $1.9 million and $1.8 million during
1996, 1995 and 1994, respectively.

Noninterest Expenses.

Total noninterest expenses increased $17.8 million or 13.7% during 1996 and $5.1
million or 4.1% in 1995. Excluding merger expenses in all periods and the
one-time assessment of all SAIF-insured deposits to recapitalize the SAIF in
1996, total noninterest expenses increased $15.8 million or 12.6% during 1996
and $744 thousand or 0.6% in 1995. The increase in noninterest expenses in 1996
was attributable to the expansion of the core banking franchise internally and
through acquisitions, asset growth, new product development, enhancements to
alternative delivery systems, increased market share in existing markets and
growth in noninterest income revenue. As the Company made investments in new
systems, products and employees during the past few years to support the current
business strategy, it has been able to significantly reduce collection and
carrying costs associated with nonperforming assets and has benefited from
substantially lower deposit insurance assessment related expenses.


                                                                              17
<PAGE>   21

Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

The following table sets forth information relating to the Company's noninterest
expenses during the periods indicated.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                     Year Ended December 31,
--------------------------------------------------------------------------------
(In Thousands)                                    1996        1995        1994
--------------------------------------------------------------------------------
<S>                                             <C>         <C>         <C>
Salaries and employee benefits                  $ 73,303    $ 67,472    $ 61,799
Data processing                                   12,528       8,924       7,306
Occupancy                                         12,320      10,574      10,454
Equipment                                          8,479       6,844       6,233
Advertising and marketing                          4,327       4,642       4,642
Deposit and other assessments                      3,050       4,497       7,899
Collection and carrying costs of
   nonperforming assets                            1,573       2,595       6,033
Merger expenses                                    5,105       4,958         559
Other noninterest expenses:
   Amortization of goodwill                        2,215       1,925       1,801
   Amortization of deposit premium                 2,659          --          --
   Other                                          22,514      17,849      18,411
                                                --------    --------    --------
    Total other noninterest expenses              27,388      19,774      20,212
                                                --------    --------    --------
Total noninterest expenses                      $148,073    $130,280    $125,137
                                                ========    ========    ========
--------------------------------------------------------------------------------
</TABLE>

Salaries and employee benefits increased by $5.8 million or 8.6% from 1995 to
1996 and by $5.7 million or 9.2% from 1994 to 1995. These increases reflect
staff additions in connection with the expansion of the retail franchise,
expanded telephone banking services, increased mortgage banking activities and
trust services, and additional staff related to the purchase acquisitions, as
well as normal salary and wage increases.

    Data processing expenses increased by $3.6 million or 40.4% during 1996 and
by $1.6 million or 22.1% during 1995. Investment in expanded operational
capacities to support new product offerings and improve customer services,
increased transaction volumes related to mortgage banking operations, increased
automated deposit and check processing volumes, and the increase in
transactional processing associated with the purchase acquisitions were among
the primary factors behind the increase in data processing expenses in 1996.
Data processing expenses were also higher in 1996 as a result of BNH which, in
1995, processed checks in-house as opposed to outsourcing check processing in
1996. Consequently, the cost to outsource check processing is included in data
processing in 1996, with no equivalent charge in 1995. Effective July 1, 1996,
the computer systems and other back office functions of BNH were merged with
those of the Bank. Family Bank computer systems and other back office functions
were merged effective as of the acquisition date on December 6, 1996.

    Occupancy expenses increased by $1.7 million or 16.5% in 1996 and by $120
thousand or 1.1% in 1995. The increase in occupancy expense in 1996 was
primarily attributable to the expansion of the Company's retail delivery system,
which resulted in higher rent, depreciation, utilities and maintenance expenses.

    Deposit and other assessment expenses decreased by $1.5 million or 32.2%
during 1996 and by $3.4 million or 43.1% in 1995. These expenses consist
primarily of deposit insurance premiums paid by the Company's subsidiary banks
to either the Bank Insurance Fund ("BIF") or the SAIF administered by the FDIC.
The BIF premium, which had been set at $.23 per $100 deposits since 1991, was
lowered to $.04 per $100 of deposits in August 1995, and as a result of the BIF
becoming fully capitalized, the FDIC voted in November 1995 to reduce the
premium to zero as of January 1, 1996 with only an administrative fee being
assessed. Consequently, the Company incurred only a minimal expense for 1996
thereby accounting for approximately a $3.3 million decrease in premiums in
1996. This was offset by a one-time charge of $1.85 million to recapitalize the
SAIF, which was assessed as a result of legislation enacted by Congress in
September 1996. At December 31, 1996, the Company had approximately 91.1% of its
deposits insured by the BIF and 8.9% by the SAIF. Due to an overall reduction in
assessment rates, the Company expects a net decrease in deposit insurance
premium expenses for 1997.

    The Company continued to benefit in 1996 from lower collection and carrying
costs associated with the reduction of nonperforming assets. Collection and
carrying costs of nonperforming assets decreased $1.0 million or 39.4% during
1996 and by $3.4 million or 57.0% during 1995. See "Financial Condition -
Nonperforming Assets" below.

    Other categories of noninterest expense include equipment, which increased
$1.6 million in 1996, and advertising and marketing, which decreased $315
thousand in 1996.

    Merger expenses of $5.1 million in 1996 and $5.0 million in 1995 are
primarily related to the acquisition of BNH by the Company. Of the $5.0 million
of merger expenses in 1995, $1.3 million was related to the acquisition of
Bankcore and the remainder related to the acquisition of BNH. Merger expenses
included employee severance costs, professional fees, branch consolidation costs
and operational consolidation costs.

    Other noninterest expenses include amortization of goodwill and deposit
premiums as well as other administrative expenses. The increases in other
noninterest expenses in 1996 were primarily attributable to recent acquisitions
by the Company. Prior to 1996, deposit premium expense was included in interest
on deposits.


18
<PAGE>   22

                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

Income Tax Expense.

The Company recognized $27.6 million, $23.4 million and $13.7 million in income
tax expense for the years ended December 31, 1996, 1995 and 1994, respectively.
The effective tax rate was 34.4% for 1996, 34.5% for 1995 and 28.6% for 1994. As
a result of the acquisition of MMSB by the Company in mid 1994, the Company
recorded a one-time $1.7 million tax benefit from the reversal of the valuation
allowance for net deferred tax assets. This one-time benefit is reflected in the
Company's income tax expense for 1994. For additional information relating to
income taxes, see Note 10 to the Consolidated Financial Statements.

FINANCIAL CONDITION

General.

The Company's total consolidated assets increased by $1.3 billion or 33.0% from
$4.1 billion at December 31, 1995 to $5.4 billion at December 31, 1996. This
increase reflected internal growth, as well as the Company's acquisitions as
discussed above. Of the $1.3 billion increase, approximately $1.0 billion was
due to the acquisition of Family Bank and $216 million was due to the Branch
Acquisition.

    Set forth below is a discussion of the material changes in the Company's
financial condition from December 31, 1995 to December 31, 1996.

BALANCE SHEET REVIEW

Securities Available for Sale.

Securities available for sale, which include U.S. Government securities,
asset-backed and mortgage-backed securities, collateralized mortgage
obligations, and other debt and equity securities, increased by $278.4 million
or 36.3%. Of the increase, Family Bank contributed $391.8 million, which was
offset by sales activity to fund loan growth. The overall increase in securities
available for sale was primarily in mortgage-backed securities, which is
consistent with the Company's investment strategy.

    The changes in the securities portfolio reflect the Company's efforts to
meet asset and liability objectives and otherwise manage its liquidity and
funding needs within the parameters of current accounting policies. For
additional information see "Risk Management" below and Notes 1 and 3 to the
Consolidated Financial Statements.

The following table sets forth the carrying value of the Company's securities
available for sale and securities held to maturity at the dates indicated.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                         December 31,
--------------------------------------------------------------------------------
(In Thousands)                                   1996        1995        1994
--------------------------------------------------------------------------------
<S>                                           <C>         <C>         <C>
Securities available for sale:
   Bonds and other debt securities:
     U.S. Government and federal agencies     $  432,230  $  526,576  $  219,220
     Tax-exempt bonds and notes                   17,828      10,837      11,085
     Other bonds and notes                         7,819       5,694       2,706
     Mortgage-backed securities                  443,995     195,823     172,466
     Collateralized mortgage obligations         102,817          --          --
                                              ----------  ----------  ----------
      Total debt securities                    1,004,689     738,930     405,477
                                              ----------  ----------  ----------
   Equities:
     FHLB stock                                   37,948      23,793      23,236
     Other equity securities                       2,432       3,925       3,904
                                              ----------  ----------  ----------
      Total equity securities                     40,380      27,718      27,140
                                              ----------  ----------  ----------
      Total securities available for sale     $1,045,069  $  766,648  $  432,617
                                              ==========  ==========  ==========
Securities held to maturity:
   Bonds and other debt securities:
     U.S. Government and federal agencies     $       --  $       --  $  285,392
     Tax-exempt bonds and notes                       --          --         908
     Other bonds and notes                            --          --         277
                                              ----------  ----------  ----------
      Total debt securities                           --          --     286,577
                                              ----------  ----------  ----------
   Equities:
     Other equity securities                          --          --          --
                                              ----------  ----------  ----------
      Total equity securities                         --          --          --
                                              ----------  ----------  ----------
      Total investment securities held
      to maturity                             $       --  $       --  $  286,577
                                              ==========  ==========  ==========
--------------------------------------------------------------------------------
</TABLE>


                                                                              19
<PAGE>   23

                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

The following table sets forth the scheduled maturities and weighted average
yields of the Company's debt securities available for sale at December 31, 1996,
based on amortized cost.

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------------
                                                                Amortized Cost Maturing in
---------------------------------------------------------------------------------------------------------------------------------
                                                 More Than One to    More Than Five to
(Dollars in Thousands)      One Year or Less        Five Years           Ten Years        More Than Ten Years           Total
---------------------------------------------------------------------------------------------------------------------------------
                            Amount     Yield     Amount     Yield     Amount     Yield     Amount     Yield      Amount      Yield
<S>                        <C>         <C>      <C>         <C>      <C>         <C>      <C>         <C>      <C>           <C>
U.S. government and
   federal agencies        $213,287    5.78%    $204,089    5.91%    $  8,383    7.18%    $  6,608    7.12%    $  432,367    5.89%
Tax-exempt bonds and
   notes                     13,624    3.78        3,825    4.65           --      --          340    6.33         17,789    4.02
Other bonds and notes         3,290    5.62        4,481    6.11           87    7.14           --      --          7,858    5.92
Mortgage-backed
   securities                   129    7.50       13,011    6.11       31,754    7.01      399,719    7.04        444,613    7.01
Collateralized mortgage
   obligations                  225    8.16        3,154    7.33        9,081    7.05       90,777    7.05        103,237    7.06
                           --------             --------             --------             --------             ----------
     Total                 $230,555    5.66     $228,560    5.92     $ 49,305    7.05     $497,444    7.04     $1,005,864    6.47
                           ========             ========             ========             ========             ==========
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Loans Held for Sale.

Loans held for sale increased by $32.3 million or 45.5%. This increase was due
to an increased volume of residential mortgages originated for sale in the
secondary market at the end of 1996 as compared with the end of 1995, and an
increase in the volume of loans originated through the correspondent lenders.
For additional information, see Note 1 to the Consolidated Financial Statements
and "Financial Condition-Loans and Leases" below.

Loans and Leases.

Total loans and leases increased by $876.0 million or 31.5%. Family Bank and the
Branch Acquisitions accounted for $692.0 million of this increase. In addition,
significant internal growth was realized in the consumer loan portfolio.


20
<PAGE>   24

Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

The following table sets forth information concerning the Company's loan
portfolio by type of loan at the dates indicated.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                                            December 31,
-----------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)              1996                 1995                1994               1993                1992
-----------------------------------------------------------------------------------------------------------------------------------
                                         % OF                 % of                 % of                % of                  % of
                             AMOUNT     LOANS     Amount     Loans     Amount     Loans     Amount    Loans      Amount     Loans
                           ----------  ------   ----------  ------   ----------  ------   ----------  ------   ----------  ------
<S>                        <C>         <C>      <C>         <C>      <C>         <C>      <C>         <C>      <C>         <C>
Residential real
  estate loans:
    Adjustable rate        $  617,323   16.89%  $  402,695   14.49%  $  418,653   15.86%  $  382,485   15.70%  $  303,437   12.16%
    Fixed rate                559,551   15.31      395.381   14.23      384,845   14.58      336,391   13.81      391,160   15.67
                           ----------  ------   ----------  ------   ----------  ------   ----------  ------   ----------  ------
      Total                 1,176,874   32.20      798,076   28.72      803,498   30.44      718,876   29.51      694,597   27.83
                           ----------  ------   ----------  ------   ----------  ------   ----------  ------   ----------  ------
Commercial real
  estate loans:
    Permanent first
      mortgage loans          901,105   24.66      753,857   27.13      745,356   28.24      731,074   30.01      793,019   31.77
    Construction and
      development              61,270    1.68       43,829    1.58       25,216    0.96       21,260    0.87       27,235    1.09
                           ----------  ------   ----------  ------   ----------  ------   ----------  ------   ----------  ------
      Total                   962,375   26.34      797,686   28.71      770,572   29.20      752,334   30.88      820,254   32.86
                           ----------  ------   ----------  ------   ----------  ------   ----------  ------   ----------  ------
Commercial loans
   and leases:
    Business Loans            463,011   12.67      397,652   14.31      315,200   11.94      292,645   12.01      314,550   12.60
    Leases                     14,391    0.39       10,940    0.39        9,208    0.35       10,949    0.45       18,467    0.74
                           ----------  ------   ----------  ------   ----------  ------   ----------  ------   ----------  ------
      Total                   477,402   13.06      408,592   14.70      324,408   12.29      303,594   12.46      333,017   13.34
                           ----------  ------   ----------  ------   ----------  ------   ----------  ------   ----------  ------
Consumer loans
   and leases:
    Home equity               362,105    9.91      283,008   10.19      247,751    9.39      222,262    9.13      220,674    8.84
    Mobile home               206,061    5.64      214,761    7.73      222,600    8.43      210,682    8.65      189,732    7.60
    Automobile                192,295    5.26      127,969    4.61      125,887    4.77       95,449    3.92       77,942    3.12
    Education Loans           106,900    2.93       38,685    1.39       43,599    1.65       17,133    0.71        9,322    0.37
    Boat and recreational
      vehicle                  31,969    0.87       22,716    0.82       20,680    0.78       24,992    1.03       28,767    1.15
    Other                     138,619    3.79       87,090    3.13       80,582    3.05       90,411    3.71      121,938    4.89
                                                ----------  ------   ----------  -------  ----------  ------   ----------  ------
      Total                 1,037,949   28.40      774,229   27.87      741,099   28.07      660,929   27.15      648,375   25.97
                           ----------  ------   ----------  ------   ----------  ------   ----------  ------   ----------  ------
        Total loans
          receivable        3,654,600  100.00%   2,778,583  100.00%   2,639,577  100.00%   2,435,733  100.00%   2,496,243  100.00%
                           ----------  ------   ----------  ------   ----------  ------   ----------  ------   ----------  ------
Allowance for loan and
   lease losses                67,488               60,975               63,675               67,385              71,223
        Net loans
          receivable       $3,587,112           $2,717,608           $2,575,902           $2,368,348          $2,425,020
                           ==========           ==========           ==========           ==========          ==========
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                                                              21
<PAGE>   25

                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

The following table sets forth loans held for sale and total loans and leases
originated, purchased, sold and repaid during 1996 and 1995.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                        Year Ended December 31,
--------------------------------------------------------------------------------
(In Thousands)                                            1996           1995
--------------------------------------------------------------------------------
<S>                                                    <C>            <C>
Originations and purchases:
   Residential real estate mortgages                   $1,297,723     $  721,400
   Commercial real estate mortgages                       174,021        146,300
   Commercial business loans and
    leases                                                522,047        453,900
   Consumer loans and leases                              491,261        290,600
                                                       ----------     ----------
   Total originations and purchases                     2,485,052      1,612,200
                                                       ----------     ----------
   Loans acquired through purchases
    and acquisitions                                      691,966         94,452
                                                       ----------     ----------
   Total loan originations, purchases
    and acquisitions                                    3,177,018      1,706,652
                                                       ----------     ----------
Sales and principal reductions:
   Sales                                                1,057,261        552,774
   Principal reductions                                 1,211,449        954,985
                                                       ----------     ----------
   Total sales and principal reductions                 2,268,710      1,507,759
                                                       ----------     ----------
Net increase in loans held for sale
   and loans and leases                                $  908,308     $  198,893
                                                       ==========     ==========
--------------------------------------------------------------------------------
</TABLE>

Residential real estate mortgage loan originations increased to $1.3 billion in
1996, a 79.9% increase over 1995 originations. Residential real estate loans
consist of loans secured by single-family (one-to-four units) residences and
consist primarily of conventional loans. The Company's strategy generally is to
originate fixed-rate residential loans for sale to investors in the secondary
market. The Company generally retains adjustable-rate loans in its portfolio but
will, from time to time, also retain 15 year fixed-rate mortgages. Residential
real estate mortgage originations from correspondent lenders increased to $844.5
million from $378.5 million in 1995, a 123.1% increase.

    Commercial real estate loans consist of loans secured by income-producing
commercial real estate (including office buildings and industrial buildings),
service industry real estate (including hotels and health care facilities),
multi-family (over four units) residential real estate and retail trade real
estate (including restaurants, automotive-related properties and food stores),
as well as loans for the acquisition, development and construction of such
commercial real estate.

    Commercial real estate mortgage originations increased by $27.7 million or
19.0% in 1996 as compared with 1995. The Company's business plan is to continue
to lend within its geographic markets to sound commercial businesses which
collateralize their borrowings with commercial real estate properties as well as
ongoing refinances of existing commercial real estate mortgages in the Company's
loan portfolio. The Company continues to de-emphasize commercial real estate
loans and to reduce its relative exposure to such loans in favor of other types
of loans.

    Commercial business loans consist primarily of loans secured by various
equipment, machinery and other corporate assets, as well as loans to provide
working capital to businesses in the form of lines of credit, which may be
secured by inventory, accounts receivable or other assets or unsecured. The
Company also originates commercial business leases. Commercial business loans
and leases increased by $68.1 million or 15.0% in 1996 as compared with 1995.
The Company continues to focus on lending to sound, small and medium sized
business customers within its geographical markets.

    Consumer loans consist of a wide variety of loans which have been emphasized
by the Company in recent years in order to provide a full range of financial
services to its customers and because such loans generally have shorter terms
and higher interest rates than mortgage loans. Consumer loans are originated
directly by the Company, or in the case of mobile home loans, automobile loans,
boat loans and certain other loans, indirectly through various dealers in
products financed by the Company. Consumer loan originations increased by 69.1%
to $491.3 million during 1996. The increase was primarily a result of growth in
home equity loans, indirect automobile loans and educational loans, which are
included in other consumer loans. Increased consumer loan originations is
consistent with the Company's strategy to increase the percentage of consumer
loans in its loan portfolio.


22
<PAGE>   26

                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

    The following table sets forth scheduled contractual amortization of loans
in the Company's portfolio at December 31, 1996, as well as the dollar amount of
loans which are scheduled to mature after one year which have fixed or
adjustable interest rates. Demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdraft loans are reported as due in
one year or less.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
                                                                          Commercial
                                          Residential     Commercial       Business        Consumer
                                          Real Estate     Real Estate     Loans and       Loans and
(In Thousands)                               Loans          Loans           Leases          Leases         Total (1)
--------------------------------------------------------------------------------------------------------------------
<S>                                       <C>             <C>             <C>             <C>             <C>
Amounts due:
   Within one year                        $   52,226      $  152,261      $  191,234      $  548,335      $  944,056
   After one year through five years         151,441         394,581         185,414         296,597       1,028,033
   Beyond five years                         973,207         415,533         100,754         193,017       1,682,511
                                          ----------      ----------      ----------      ----------      ----------
    Total                                 $1,176,874      $  962,375      $  477,402      $1,037,949      $3,654,600
                                          ==========      ==========      ==========      ==========      ==========
Interest rate terms on
  amounts due after one year:
    Fixed                                 $  547,773      $  313,909      $  115,629      $  417,944      $1,395,255
    Adjustable                               576,875         496,205         170,539          71,670       1,315,289
--------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Scheduled contractual amortization does not reflect the actual maturities of
    loans and leases because of prepayments and, in the case of conventional
    mortgage loans, due-on-sale clauses, which give the lender the right to
    require repayment of a mortgage loan in connection with a transfer of the
    related property.

Substantially all of the mortgage loans in the Company's loan portfolio are
secured by properties located in Maine, New Hampshire and northern
Massachusetts. Moreover, substantially all of the Company's non-mortgage loan
portfolio consists of loans made to residents of and businesses located in these
areas.

Nonperforming assets.

Nonperforming assets decreased $2.5 million or 4.4% from $56.8 million at
December 31, 1995 to $54.3 million at December 31, 1996. The decrease reflects a
decline in nonperforming loans and other nonperforming assets in recent years.
Nonperforming assets as a percentage of total assets decreased from 2.10% at
December 31, 1994 to 1.01% at December 31, 1996.

    The Company continues to focus on asset quality issues and to allocate
significant resources to the key asset quality control functions of credit
policy and administration and loan review. The collection, workout and asset
management functions continue to focus on the further reduction of nonperforming
asset levels. Despite the ongoing focus on asset quality and reductions of
nonperforming asset levels, there can be no assurance that adverse changes in
the real estate markets and economic conditions in the Company's primary market
areas will not result in higher nonperforming asset levels in the future and
negatively impact the Company's operations through higher provisions for loan
losses, net loan chargeoffs, decreased accrual of interest income and increased
noninterest expenses as a result of the allocation of resources to the
collection and workout of nonperforming assets.


                                                                              23
<PAGE>   27

Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------
The following table sets forth information regarding nonperforming loans and
leases and other nonperforming assets held by the Company at the dates
indicated.
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
                                                                              December 31,
-------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)                         1996             1995             1994             1993             1992
-------------------------------------------------------------------------------------------------------------------------
<S>                                          <C>              <C>              <C>              <C>              <C>
Residential real estate loans
   Nonaccrual loans                          $  3,867         $  5,713         $  3,317         $  4,806         $  8,555
   Accruing loans 90 days overdue               5,560            3,728            4,473            4,479            4,316
   Troubled debt restructurings                    --               --               --              111            1,097
                                             --------         --------         --------         --------         --------
     Total                                      9,427            9,441            7,790            9,396           13,968
                                             --------         --------         --------         --------         --------
Commercial real estate loans:
   Nonaccrual loans                            15,270           17,029           26,978           30,780           43,731
   Accruing loans 90 days overdue                  --               --            1,020              454            1,704
   Troubled debt restructurings                 1,581            3,186            6,284           15,275           18,155
                                             --------         --------         --------         --------         --------
     Total                                     16,851           20,215           34,282           46,509           63,590
                                             --------         --------         --------         --------         --------
Commercial business loans and leases:
   Nonaccrual loans                             8,016            6,735            6,871           14,399           24,252
   Accruing loans 90 days overdue                  --               25               30              336            1,163
   Troubled debt restructurings                   579            1,859            2,684            2,547            1,649
                                             --------         --------         --------         --------         --------
     Total                                      8,595            8,619            9,585           17,282           27,064
                                             --------         --------         --------         --------         --------
Consumer loans:
   Nonaccrual loans                             5,097            3,586            3,775            3,386            3,038
   Accruing loans 90 days overdue               2,478              659              831              897            1,268
   Troubled debt restructurings                    --               --               --               26               --
                                             --------         --------         --------         --------         --------
     Total                                      7,575            4,245            4,606            4,309            4,306
                                             --------         --------         --------         --------         --------
Total nonperforming loans:
   Nonaccrual loans                            32,250           33,063           40,941           53,371           79,576
   Accruing loans 90 days overdue               8,038            4,412            6,354            6,166            8,451
   Troubled debt restructurings                 2,160            5,045            8,968           17,959           20,901
                                             --------         --------         --------         --------         --------
     Total                                     42,448           42,520           56,263           77,496          108,928
                                             --------         --------         --------         --------         --------
Other nonperforming assets:
   Other real estate owned, net of
     related reserves                          10,000           12,679           16,682           28,867           37,657
   In-substance foreclosures, net of
     related reserves                              --               --            3,391           11,752           36,582
   Repossessions, net of related
     reserves                                   1,818            1,553            2,003            1,961            2,566
                                             --------         --------         --------         --------         --------
      Total                                    11,818           14,232           22,076           42,580           76,805
                                             --------         --------         --------         --------         --------
Total nonperforming assets                   $ 54,267         $ 56,752         $ 78,339         $120,076         $185,733
                                             ========         ========         ========         ========         ========
Total nonperforming loans as a
   percentage of total loans                     1.16%            1.53%            2.13%            3.18%            4.36%
Total nonperforming assets as a
   percentage of total assets                    1.01             1.40             2.10             3.31             5.29
Total nonperforming assets as a
   percentage of total loans and
   total other nonperforming assets              1.48             2.03             2.94             4.85             7.22
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

It is the policy of the Company to generally place all commercial real estate
loans and commercial business loans and leases which are 90 days or more past
due, unless secured by sufficient cash or other assets immediately convertible
to cash, on nonaccrual status. All such loans 90 days or more past due, whether
on nonaccrual status or not, are considered as nonperforming loans. Residential
real estate loans and consumer loans and leases are placed on nonaccrual status
generally at 90 days or more past due or when in management's judgment the
collectibility of interest and/or principal is doubtful.

    It is also the policy of the Company to place on nonaccrual and therefore
nonperforming status loans currently less than 90 days past due or performing in
accordance with their terms but which in management's judgment are likely to
present future principal and/or interest repayment problems and which thus
ultimately would be classified as nonperforming. At December 31, 1996, $10.8
million of commercial real estate and commercial business loans and leases, or
42.5% of total nonperforming loans, were on nonaccrual status and thus disclosed
as nonperforming loans even though they were less than 90 days past due.


24
<PAGE>   28

                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

    Real estate acquired by the Company as a result of foreclosure or by
deed-in-lieu of foreclosure generally is classified as other real estate owned
until it is sold. When property is acquired as other real estate owned, it is
recorded at the lower of carrying or fair value at the date of acquisition or
classification and any writedown resulting therefrom is charged to the allowance
for loan and lease losses. All costs incurred from that date in maintaining the
property and subsequent reductions in value are expensed and are included in
collection and carrying costs of nonperforming assets (a component of
noninterest expenses). For further information, see Note 9 to the Consolidated
Financial Statements.

Potential Nonperforming Assets.

The total of commercial real estate and commercial business loans and leases
which are internally graded substandard or lower, according to the Company's
internal loan grading system, but which are still in a performing status (the
population from which future nonperforming loans would most likely arise), has
continued to decrease since the middle of 1992. At December 31, 1996 and 1995,
the Company had classified a total of $79.6 million and $89.7 million,
respectively, of commercial real estate and commercial business loans and leases
as substandard or lower on its risk rating system. Included in this amount at
December 31, 1996 was the Company's $25.4 million of nonperforming commercial
real estate loans and commercial business loans and leases. In the opinion of
management, the remaining $54.2 million of commercial real estate loans and
commercial business loans and leases classified as substandard at December 31,
1996 evidence one or more weaknesses or potential weaknesses and, depending on
the regional economy and other factors, may become nonperforming assets in
future periods. These loans are net of charge-offs, but not general reserves
which have been established based on the Company's internal rating of such loans
and evaluation of the adequacy of its allowance for loan and lease losses.

Allowance for Loan and Lease Losses.

The allowance for loan and lease losses is maintained at a level determined to
be adequate by management to absorb future chargeoffs of loans and leases deemed
noncollectible. This allowance is increased by provisions charged to operating
expense and by recoveries on loans previously charged off. Arriving at an
appropriate level of allowance for loan and lease losses necessarily involves a
high degree of judgment, as discussed above under the "Results of Operations
Provision for Loan Losses."

    The allowance for loan and lease losses is available for offsetting credit
losses in connection with any loan but is internally allocated to various loan
categories as part of the Company's process for evaluating the adequacy of the
allowance for loan and lease losses. The following sets forth information
concerning the activity in the Company's allowance for loan and lease losses
during the periods indicated.

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                                                         Year Ended December 31,
---------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)                         1996             1995              1994             1993              1992
---------------------------------------------------------------------------------------------------------------------------
<S>                                          <C>              <C>              <C>              <C>              <C>
Average loans and leases outstanding         $3,224,309       $2,732,316       $2,529,723       $2,473,666       $2,647,479
                                             ==========       ==========       ==========       ==========       ==========
Allowance at the beginning of period         $   60,975       $   63,675       $   67,385       $   71,223       $   88,067
Additions due to acquisitions                    11,365            2,314               --               --               --
Charge-offs:
   Residential real estate mortgages              2,812            4,139            4,646            6,607           13,565
   Commercial real estate mortgages               8,769            8,964            6,207            8,482           19,053
   Commercial business loans and leases           2,994            2,234            4,124            9,622           18,825
   Consumer loans and leases                      3,598            2,631            2,225            3,861            5,771
                                             ----------       ----------       ----------       ----------       ----------
     Total loans charged off                     18,173           17,968           17,202           28,572           57,214
                                             ----------       ----------       ----------       ----------       ----------
Recoveries:
   Residential real estate mortgages                507              620              904              642              627
   Commercial real estate mortgages               9,541            5,185            4,917            6,293            2,582
   Commercial business loans and leases           1,536            2,181            3,440            2,035            2,997
   Consumer loans and leases                        837              738              857            1,717            2,139
                                             ----------       ----------       ----------       ----------       ----------
     Total loans recovered                       12,421            8,724           10,118           10,687            8,345
                                             ----------       ----------       ----------       ----------       ----------
Net charge-offs                                   5,752            9,244            7,084           17,885           48,869
Additions charged to operating expenses             900            4,230            3,374           14,047           32,025
                                             ----------       ----------       ----------       ----------       ----------
Allowance at the end of the period           $   67,488       $   60,975       $   63,675       $   67,385       $   71,223
                                             ==========       ==========       ==========       ==========       ==========
Ratio of net charge-offs to average
   loans and leases outstanding                    0.18%            0.34%            0.28%            0.72%            1.85%
Ratio of allowance to total loans
   and leases at end of period                     1.85%            2.19%            2.41%            2.77%            2.85%
Ratio of allowance to nonperforming
   loans at end of period                        158.99%          143.40%          113.17%           86.95%           65.39%
---------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                                                              25
<PAGE>   29

Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

The following table sets forth information concerning the allocation of the
Company's allowance for loan and lease losses by loan categories at the dates
indicated.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
                                                                   December 31,
----------------------------------------------------------------------------------------------------------------------------------
                            1996                 1995                1994                1993                   1992
----------------------------------------------------------------------------------------------------------------------------------
                              ALLOWANCE TO         Allowance to        Allowance to        Allowance to            Allowance to
                               PERCENT OF           Percent of          Percent of          Percent of              Percent of
                              TOTAL LOANS          Total Loans         Total Loans         Total Loans             Total Loans
(Dollars in Thousands) AMOUNT BY CATEGORY  Amount  by Category  Amount by Category  Amount  by Category   Amount   by Category
----------------------------------------------------------------------------------------------------------------------------------
<S>                   <C>          <C>     <C>          <C>     <C>          <C>     <C>          <C>     <C>          <C>
Residential real
   estate loans       $ 7,723      0.66%   $10,118      1.27%   $ 8,567      1.07%   $ 9,864      1.37%   $13,647      1.96%
Commercial real
   estate loans        35,478      3.69     31,673      3.97     35,505      4.61     38,177      5.07     40,899      4.99
Commercial business
   loans and leases    13,449      2.82      9,491      2.32      9,274      2.86      8,734      2.88     12,162      3.65
Consumer loans and
   leases              10,838      1.04      9,693      1.25     10,329      1.39     10,610      1.61      4,515      0.70
                      -------              -------              -------              -------              -------
                      $67,488      1.85    $60,975      2.19    $63,675      2.41    $67,385      2.77    $71,223      2.85
                      =======              =======              =======              =======              =======
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Deposits.

The following table presents the changes in the balances of deposits outstanding
at December 31, 1996, 1995 and 1994:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                                                      1996-1995                   1995-1994
                                                                        Change                     Change
(Dollars in Thousands)            1996         1995         1994        Amount          Percent     Amount          Percent
---------------------------------------------------------------------------------------------------------------------------
<S>                            <C>          <C>          <C>          <C>                <C>     <C>                 <C>
Demand deposits                $  604,980   $  434,091   $  362,790   $  170,889         39.4%   $   71,301          19.7%
NOW accounts                      497,930      351,481      333,192      146,449         41.7        18,289           5.5
Money market access accounts      525,518      490,575      327,424       34,943          7.1       163,151          49.8
Regular savings                   760,340      557,896      650,302      202,444         36.3       (92,406)        (14.2)
Certificates of deposit         1,796,521    1,363,095    1,212,137      433,426         31.8       150,958          12.5
                               ----------   ----------   ----------   ----------                 ----------
   Total deposits              $4,185,289   $3,197,138   $2,885,845   $  988,151         30.9%   $  311,293          10.8%
                               ==========   ==========   ==========   ==========                 ==========
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

The increase of $988.2 million in deposits in 1996 was principally due to $774.6
million of deposits acquired in connection with the acquisition of Family Bank
in December 1996 and $160.9 million of deposits acquired in connection with the
Branch Acquisition in February 1996.

Certificates of deposit of $100,000 or more are scheduled to mature as follows
at December 31, 1996:

<TABLE>
--------------------------------------------------------------------------------
(In Thousands)
<S>                                                      <C>           <C>
3 months or less                                         $ 77,403          33.3%
Over 3 to 6 months                                         50,566          21.7
Over 6 to 12 months                                        36,839          15.8
More than 12 months                                        68,072          29.2
                                                         --------      --------
                                                         $232,880         100.0%
                                                         ========      ========
--------------------------------------------------------------------------------
</TABLE>

Other Interest-Bearing Liabilities.

Other interest-bearing liabilities consist of borrowings from the Federal Home
Loan Bank ("FHLB"), securities sold under repurchase agreements, Federal Funds
purchased, debentures and treasury tax and loan borrowings from the Federal
Reserve Bank. Total interest-bearing liabilities increased 51.2% to $691.0
million at December 31, 1996. The majority of the increase was in borrowings
from the Federal Home Loan Bank of Boston. The acquisition of Family Bank added
$69.6 million in borrowings in December 1996.

The following table sets forth certain information concerning the Company
borrowings at the dates indicated.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                        December 31,
--------------------------------------------------------------------------------
(In Thousands)                              1996           1995           1994
--------------------------------------------------------------------------------
<S>                                       <C>            <C>            <C>
FHLB advances                             $470,080       $252,446       $362,450
Repurchase agreements                      197,005        180,957        127,519
Federal funds purchased                         --          1,500          4,404
Other                                       23,884         22,029         10,974
                                          --------       --------       --------
   Total                                  $690,969       $456,932       $505,347
                                          ========       ========       ========
--------------------------------------------------------------------------------
</TABLE>

FHLB advances remain the largest nondeposit related interest-bearing funding
source for the Company in 1996. These borrowings are secured by qualified
residential loans, certain investment securities and certain other assets
available to be pledged. The increase in FHLB borrowings was used to partially
fund the Branch Acquisition and to support loan growth. For additional
information regarding FHLB advances, see Note 12 to the Consolidated Financial
Statements. At December 31, 1996, the Company estimates its addi-


                                       26
<PAGE>   30

                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

tional available borrowing capacity from the FHLB to be approximately $641.9
million.

    The increase in securities sold under repurchase agreements of $16.0 million
was primarily attributable to the acquisition of Family Bank in December 1996,
which had securities sold under repurchase agreements of $11.2 million at
December 31, 1996. For additional information regarding securities sold under
repurchase agreements, see Note 11 to the Consolidated Financial Statements.

Capital Resources.

Consistent with its long-term goal of operating a safe, sound and profitable
organization, the Company strives to maintain a strong capital base. The
Company's shareholders' equity totaled $437.0 million or 8.1% of total assets at
December 31, 1996, as compared to $354.9 million or 8.7% of total assets at
December 31, 1995. The $82.1 million or 23.1% increase in shareholders' equity
from December 31, 1995 to December 31, 1996 was the result of $52.5 million in
net income, $47.9 million in new stock issuance related to the purchase of
Family Bank and $2.3 million of treasury stock sales related to various employee
benefit plans of the Company, the effects of which were offset in part by cash
dividends of $15.9 million and a $4.7 million reduction in net unrealized gain
(net of tax effect) in the market value of securities available for sale.

    During 1996 the Company completed an issuer tender offer in anticipation of
the Family Bank purchase and acquired 2,500,000 shares of its common stock.
These shares were reissued in connection with the acquisition of Family Bank in
December 1996.

    In anticipation of the Bankcore acquisition, the Company repurchased 751,600
shares of its common stock for a total cost of $9.6 million during 1994 and
1995. All shares repurchased were reissued in connection with the Bankcore
acquisition in July 1995.

    On January 24, 1997, the Company established a statutory business trust
which issued $100 million in capital securities on January 31, 1997. The
proceeds were invested in Company issued junior subordinated debentures due
2027. See Note 19 to the Consolidated Financial Statements for more information.

    For additional discussion on capital resources, see Note 13 to the
Consolidated Financial Statements and "Regulatory Capital Requirements" under
"Regulatory Environment" below.

RISK MANAGEMENT

The Company's success is largely dependent upon its ability to strategically
manage financial and nonfinancial risks. Prominent nonfinancial challenges
facing the Company and addressed through the Company's strategic planning
process include competition from bank and nonbank financial service companies,
changing regulatory and political environments, rapid advances in
technology-based information systems and demographic and economic changes. The
significant financial risks actively managed by the Company include:a) credit
risk; b) interest rate risk, including asset and liability management; c)
liquidity risk; and d) off-balance sheet risks and commitments.

Credit Risk Management.

The Company's net loan portfolio accounted for 66.4% of the assets of the
Company at December 31, 1996 and represents its primary source of credit risk.
The Company has dedicated and will continue to dedicate a substantial amount of
time and resources to the management of credit risk within its loan portfolio.
The Company has established systems of checks and balances to manage the
origination, control and collection of loan assets.

    For additional information relating to credit risk, see "Results of
Operations - Provision for Loan Losses," "Financial Condition - Nonperforming
Assets" and Notes 4 and 5 to the Consolidated Financial Statements.

Interest Rate Risk and Asset/Liability Management.

The Company's interest rate risk and asset and liability management are the
responsibility of a Liquidity and Funds Management Committee which reports to
the Board of Directors and is comprised of members of the Company's senior
management. The Committee is actively involved in formulating the economic
projections used by the Company in its planning and budgeting process and
establishes policies which monitor and coordinate the Company's sources, uses
and pricing of funds.

    Interest rate risk can be defined as the exposure of the Company's net
income or financial position to adverse movements in interest rates. In addition
to directly impacting net interest income, changes in the level of interest
rates also can affect (i) the amount of loans originated and sold by an
institution, (ii) the ability of borrowers to repay adjustable rate loans, (iii)
the average maturity of mortgage loans, which tends to increase when current
mortgage loan rates are substantially higher than rates on existing mortgage
loans and, conversely, decrease when rates on existing mortgage loans are
substantially lower than current mortgage loan rates (due to refinancings of
loans at lower rates), (iv) the value of an institution's interest-earning
assets and the resultant ability to realize gains on the sale of such assets and
(v) the carrying value of investment securities classified as available for sale
and resultant adjustments to shareholders' equity.

    The Company seeks to reduce the volatility of its net interest income by
managing the relationship of interest-rate sensitive assets to interest-rate
sensitive liabilities. To accomplish this, the Company has undertaken various
steps to increase the percentage of floating rate assets and to reduce the
average maturity of such assets. A principal focus in recent years has been on
the origination of adjustable-rate residential real estate loans and consumer
loans, which generally have shorter maturities than fixed-rate residential real
estate loans. The Company also originates adjustable-rate and fixed-rate
commercial real estate loans and commercial business loans and leases, which
collectively also generally mature or reprice more quickly than fixed-rate
residential real estate loans.

    Net interest income sensitivity to movements in interest rates is measured
through use of a simulation model which analyzes resulting net income under
various interest rate scenarios. Projected net interest income is modeled based
on both an immediate rise or fall in interest rates ("rate shock") as well as
gradual movements in interest rates over a twelve month period. The model is
based on the actual maturity and repricing characteristics of interest-rate
sensitive assets and liabilities and factors in projections for anticipated
activity levels by major product lines of the Company. The simulation model
incorporates assumptions regarding the impact of changing interest rates on the
prepayment rate of certain assets and liabilities. The model also takes into
account the Company's ability to exert greater control over the setting of
interest rates on certain deposit products than it has over variable and
adjustable-rate loans which are tied to published indices, such as designated
prime lending rates and the rate on U.S. Treasury Bills.


                                                                              27
<PAGE>   31

Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

    Based on the information and assumptions in effect at December 31, 1996,
management of the Company believes that a 200 basis point gradual change in
interest rates over a twelve month period, up or down, would not significantly
affect the Company's annualized net interest income.

    As a result of the Company's business strategy to increase noninterest
income related to mortgage banking services, the Company has increased its
portfolio of residential mortgages serviced for investors. As a result of that
strategy, as well as the adoption of SFAS No. 122, the level of mortgage
servicing rights has increased significantly in recent periods.

    In order to mitigate the prepayment risk associated with mortgage servicing
rights and protect economic value, in 1995 the Company began purchasing constant
maturity treasury floors ("CMTs"). The value of the CMTs is related to movements
in market interest rates to which they are indexed and the remaining term of the
CMT. A CMT's value is inversely related to movements in market interest rates.
As interest rates decline, the value of a CMT increases. Market interest rate
movements also influence the behavior of borrowers, which impacts the value of
mortgage servicing rights as a result of an increase or decrease in mortgage
loan prepayment speeds. The value of mortgage servicing rights generally
increases as market interest rates increase and declines as market interest
rates decrease. Although not accorded hedge accounting treatment due to the
uncertainty of strict correlation, in the event that interest rates fall any
resulting increase in the value of the CMT is intended to offset, in part, the
prospective impairment to the value of the Company's mortgage servicing rights.
At December 31, 1996, the Company's CMTs had an amortized cost of $279 thousand,
which approximates market value, and were included in other assets on the
Company's balance sheet.

Liquidity Risk Management.

The Company seeks to maintain various sources of funds and prudent levels of
liquid assets in order to satisfy its varied liquidity demands. Many factors
affect the Company's ability to meet its liquidity needs, including its mix of
assets and liabilities, reputation and credit standing in the marketplace,
interest rates and general economic conditions. The Company's actual inflow and
outflow of funds is detailed in the Consolidated Statements of Cash Flows.

    Each of the Company's banking subsidiaries monitors its liquidity in
accordance with guidelines established by the Company and applicable regulatory
requirements. The primary sources of funds of the Company's banking subsidiaries
are deposits, borrowings from the FHLB of Boston and other sources, cash flows
from operations, prepayments and maturities of outstanding loans, leases,
investments and mortgage-backed securities and the sale of mortgage loans.
During 1996 and 1995, the Company's banking subsidiaries used their sources of
funds primarily to meet ongoing commitments to pay maturing savings certificates
and savings withdrawals, fund loan and lease commitments and maintain a
substantial securities portfolio.

    Management believes that the Company's banking subsidiaries currently have
adequate liquidity available to respond to both expected and unexpected
liquidity demands, according to the measurement system established during 1991
and set forth in the Company's contingency liquidity plan. This system measures
the net amount of marketable assets, after deducting pledged assets, plus lines
of credit, primarily with the FHLB, which are available to fund liquidity
requirements. It then measures the adequacy of that amount against the amount of
sensitive or volatile liabilities, which include core deposit balances in excess
of $100,000, term deposits with short maturities and credit commitments
outstanding. This evaluation is conducted at each banking subsidiary and
consolidated for the Company on a monthly basis. It allows the Company to manage
its liquidity position and funding sources in order to ensure that is has
continuing ability to meet its ongoing commitments to pay maturing savings
certificates and savings withdrawals, fund loan and lease commitments, meet
contractual maturities on borrowings and maintain a significant portfolio of
investment securities.

    The Company's liquidity management policies currently include requirements
that the Company maintain a minimum liquidity ratio of no less than 15% with a
target of 20%. The Company's consolidated liquidity position generally has
exceeded these amounts, as net cash, short-term and marketable assets amounted
to 26.8% of net deposits and short-term liabilities at December 31, 1996, as
compared to 26.5% at December 31, 1995.

    A secondary source of liquidity, not included in the liquidity ratio
calculation, is represented by asset-based liquidity. Asset-based liquidity
consists primarily of single-family residential real estate loans which qualify
for sale in the secondary market.

    The liquidity needs of the Company on a parent-only basis consist primarily
of dividends to shareholders and expenses for general corporate purposes. The
primary source of parent-only company cash flow is dividends received from
subsidiary banks. For additional information, see Notes 13 and 18 to the
Consolidated Financial Statements.

Off-Balance Sheet Risks and Commitments.

Set forth below is a discussion of various off-balance sheet risks and
commitments of the Company.

Commitments to extend credit.

At December 31, 1996 and 1995, the total approved loan commitments outstanding,
commitments under unused lines of credit and the unadvanced portion of
construction loans amounted to $828.8 million and $716.2 million, respectively.

Derivatives.

The Company has only limited involvement with off-balance sheet derivative
financial instruments and does not use them for trading purposes.

    The Company has explored and utilized in the past certain financial
techniques, such as interest rate exchange agreements, to assist in the
management of interest rate risk. The Company believes that such techniques have
benefits under certain market and economic conditions. At December 31, 1996, the
Company did not have any interest rate exchange agreements in place.

    The Company makes use of forward commitments to sell loans as part of its
mortgage banking business. Forward commitments are used in the normal course of
business to reduce the Company's exposure to fluctuations in interest rates.

    For additional information, see Note 14 to the Consolidated Financial
Statements.


28
<PAGE>   32

                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

Counterparty risk.

The Company does business with a variety of financial institutions and other
companies in the normal course of business. The Company is subject to potential
financial loss if the counterparty is unable to complete an agreed upon
transaction. The Company controls counterparty risk through financial analysis,
dollar limits and other monitoring procedures.

REGULATORY ENVIRONMENT

Regulatory Capital Requirements.

Banks and bank holding companies are subject to a broad scope of laws and
regulations. The Company believes that it is in material compliance with all
applicable federal and state laws and regulations.

    Under Federal Reserve Board ("FRB") guidelines, bank holding companies such
as the Company are required to maintain capital based on "risk-adjusted" assets.
Under risk-based capital guidelines, categories of assets with potentially
higher credit risk require more capital than assets with lower risk. In addition
to balance sheet assets, bank holding companies are required to maintain
capital, on a risk-adjusted basis, to support certain off-balance sheet
activities such as loan commitments. The FRB guidelines classify capital into
two tiers, Tier I and Total. Tier I risk-based capital consists of common
shareholders' equity, noncumulative perpetual preferred stock, cumulative
perpetual preferred stock and capital securities of trust subsidiaries, subject
in each case to specified limitations, and minority interests, less goodwill and
certain other intangible assets. Total risk-based capital consists of Tier I
capital plus a portion of the general allowance for loan losses, hybrid capital
instruments, term subordinated debt and intermediate preferred stock.

    In addition to risk-based capital requirements, the FRB requires bank
holding companies to maintain a minimum leverage capital ratio of Tier I capital
to total assets. Total assets for this purpose do not include goodwill and any
other intangible assets and investments that the FRB determines should be
deducted from Tier I capital. For more information, see Note 13 to the
Consolidated Financial Statements.

Impact of Inflation and Changing Prices.

The Consolidated Financial Statements and related Notes thereto presented
elsewhere herein have been prepared in accordance with generally accepted
accounting principles which require the measurement of financial position and
operating results in terms of historical dollars without considering changes in
the relative purchasing power of money over time due to inflation.

    Unlike many industrial companies, substantially all of the assets and
virtually all of the liabilities of the Company are monetary in nature. As a
result, interest rates have a more significant impact on the Company's
performance than the general level of inflation. Over short periods of time,
interest rates may not necessarily move in the same direction or in the same
magnitude as inflation.

Impending Accounting Changes.

Effective January 1, 1997, the Company will adopt SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
This Statement is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996 and is to be
applied prospectively. However, SFAS No. 127, "Deferral of the Effective Date of
Certain Provisions of SFAS No. 125," requires the deferral of implementation as
it relates to repurchase agreements, dollar-rolls, securities lending and
similar transactions until years beginning after December 31, 1997. Earlier or
retroactive applications of this Statement is not permitted. SFAS No. 125
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. Those standards are based
on an approach that focuses on control, whereby after a transfer of financial
assets, an entity recognizes the financial and servicing assets it controls and
the liabilities it has incurred, derecognizes financial assets when control has
been surrendered, and derecognizes liabilities when extinguished. This Statement
provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that are secured borrowings.

Forward-Looking Statements.

Certain statements contained herein are not based on historical facts and are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements which are based on
various assumptions (some of which are beyond the Company's control), may be
identified by reference to a future period or periods, or by the use of
forward-looking terminology, such as "may," "will," "believe," "expect,"
"estimate," "anticipate," "continue," or similar terms or variations on those
terms, or the negative of those terms. Actual results could differ materially
from those set forth in forward-looking statements due to a variety of factors,
including, but not limited to, those related to the economic environment,
particularly in the market areas in which the Company operates, competitive
products and pricing, fiscal and monetary policies of the U.S. Government,
changes in government regulations affecting financial institutions, including
regulatory fees and capital requirements, changes in prevailing interest rates,
acquisitions and the integration of acquired businesses, credit risk management,
asset/liability management, the financial and securities markets and the
availability of and costs associated with sources of liquidity.


                                                                              29
<PAGE>   33

Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
December 31,
--------------------------------------------------------------------------------------------------------------------------
(In Thousands, Except Number of Shares and Per Share Data)                                         1996           1995
--------------------------------------------------------------------------------------------------------------------------
<S>                                                                                             <C>            <C>
ASSETS
Cash and due from banks                                                                         $   276,995    $   190,436
Federal funds sold                                                                                   83,000        100,255
Securities available for sale, at market value (Notes 3, 11 and 12)                               1,045,069        766,648
Loans held for sale, market value $103,790 in 1996
   and $71,872 in 1995, respectively                                                                103,270         70,979
Loans and leases (Notes 4 and 12)                                                                 3,654,600      2,778,583
   Less: Allowance for loan and lease losses (Note 5)                                                67,488         60,975
                                                                                                -----------    -----------
     Net loans and leases                                                                         3,587,112      2,717,608
                                                                                                -----------    -----------
Premises and equipment (Note 6)                                                                      73,956         56,021
Goodwill and other intangibles (Note 7)                                                              71,649         22,792
Mortgage servicing rights (Note 8)                                                                   33,314         20,309
Other assets (Notes 9 and 10)                                                                       124,033        113,078
                                                                                                -----------    -----------
                                                                                                $ 5,398,398    $ 4,058,126
                                                                                                ===========    ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
  Regular savings                                                                               $   760,340    $   557,896
  Money market access accounts                                                                      525,518        490,575
  Certificates of deposit (including certificates of $100 or more
    of $232,880 and $116,472 in 1996 and 1995, respectively)                                      1,796,521      1,363,095
  NOW accounts                                                                                      497,930        351,481
  Demand deposits                                                                                   604,980        434,091
                                                                                                -----------    -----------
                                                                                                  4,185,289      3,197,138
                                                                                                -----------    -----------
Federal funds purchased                                                                                  --          1,500
Securities sold under repurchase agreements (Note 11)                                               197,005        180,957
Borrowings from the Federal Home Loan Bank of Boston (Note 12)                                      470,080        252,446
Other borrowings                                                                                     23,884         22,029
Other liabilities (Notes 10 and 16)                                                                  85,130         49,131
                                                                                                -----------    -----------
  Total liabilities                                                                               4,961,388      3,703,201
                                                                                                -----------    -----------
Commitments and contingent liabilities (Notes 13, 14, 15 and 16)
Shareholders' equity (Notes 2, 3, 13, 15, 18 and 19):
  Preferred stock, par value $0.01; 5,000,000 shares
    authorized, none issued                                                                              --             --
  Common stock, par value $0.01; 100,000,000 and 30,000,000 shares authorized,
    28,576,885 and 25,596,550 shares issued in 1996 and 1995, respectively                              286            256
  Paid-in capital                                                                                   271,790        224,268
  Retained earnings                                                                                 170,855        134,443
  Net unrealized gain (loss) on securities available for sale, net of applicable income taxes          (582)         3,763
  Treasury stock at cost (355,385 shares and
    524,062 shares, respectively)                                                                    (5,339)        (7,805)
                                                                                                -----------    -----------
      Total shareholders' equity                                                                    437,010        354,925
                                                                                                -----------    -----------
                                                                                                $ 5,398,398    $ 4,058,126
                                                                                                ===========    ===========
--------------------------------------------------------------------------------------------------------------------------
</TABLE>

See accompanying notes to Consolidated Financial Statements.


30
<PAGE>   34

                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
   Year Ended December 31,
-----------------------------------------------------------------------------------------------------------
(In Thousands, Except Number of Shares and Per Share Data)      1996             1995               1994
-----------------------------------------------------------------------------------------------------------
<S>                                                          <C>              <C>              <C>
Interest and dividend income:
   Interest on loans and leases (Note 4)                     $    288,999     $    253,787     $    215,177
   Interest on mortgage-backed investments                         18,629           12,627           12,409
   Interest on other investments                                   31,620           37,521           27,241
   Dividends on equity securities                                   1,924            1,914            1,770
                                                             ------------     ------------     ------------
    Total interest and dividend income                            341,172          305,849          256,597
                                                             ------------     ------------     ------------
Interest expense:
   Interest on deposits                                           120,443          108,209           87,920
   Interest on borrowed funds                                      30,156           26,686           20,082
                                                             ------------     ------------     ------------
      Total interest expense                                      150,599          134,895          108,002
                                                             ------------     ------------     ------------
      Net interest income                                         190,573          170,954          148,595
Provision for loan and lease losses (Note 5)                          900            4,230            3,374
                                                             ------------     ------------     ------------
    Net interest income after provision
      for loan and lease losses                                   189,673          166,724          145,221
                                                             ------------     ------------     ------------
Noninterest income:
   Customer services                                               15,353           11,908           10,481
Mortgage banking services (Note 8)                                 12,940           10,849            8,446
   Trust and investment advisory services                           7,233            5,850            5,471
   Net securities gains (losses) (Note 3)                             507              116             (254)
   Other noninterest income                                         2,415            2,694            3,482
                                                             ------------     ------------     ------------
                                                                   38,448           31,417           27,626
                                                             ------------     ------------     ------------
Noninterest expenses:
   Salaries and employee benefits (Notes 15 and 16)                73,303           67,472           61,799
   Data processing                                                 12,528            8,924            7,306
   Occupancy                                                       12,320           10,574           10,454
   Equipment                                                        8,479            6,844            6,233
   Advertising and marketing                                        4,327            4,642            4,642
   Deposit and other assessments                                    3,050            4,497            7,899
   Collection and carrying costs of nonperforming assets            1,573            2,595            6,033
   Merger expenses                                                  5,105            4,958              559
   Other noninterest expenses (Note 7)                             27,388           19,774           20,212
                                                             ------------     ------------     ------------
                                                                  148,073          130,280          125,137
                                                             ------------     ------------     ------------
Income before income tax expense                                   80,048           67,861           47,710
Applicable income tax expense (Note 10)                            27,568           23,375           13,662
                                                             ------------     ------------     ------------
    Net income                                               $     52,480     $     44,486     $     34,048
                                                             ============     ============     ============
Weighted average shares outstanding                            25,035,041       24,696,393       24,849,800
Earnings per share                                           $       2.10     $       1.80     $       1.37
-----------------------------------------------------------------------------------------------------------
</TABLE>

See accompanying notes to Consolidated Financial Statements.


                                                                              31
<PAGE>   35
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------




CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
(In Thousands, Except                    Number                                                   Net
Number of Shares                        of Shares        Par         Paid-in     Retained     Unrealized     Treasury
and Per Share Data)                      Issued         Value        Capital     Earnings     Gain (Loss)      Stock        Total
------------------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>           <C>           <C>           <C>          <C>           <C>           <C>
Balances at December 31, 1993          25,602,106    $      256    $  224,306    $  72,535    $    2,964    $  (12,353)   $ 287,438

Treasury stock purchased
   (105,000 shares at an
   average price of $12.02)                    -0-           -0-           -0-          -0-           -0-       (1,262)      (1,262)

Treasury stock issued for employee
   benefit plans (179,426 shares at
   an average price of $7.42)                  -0-           -0-           -0-      (1,027)           -0-        2,655        1,628

Purchase and retirement of
   common stock                            (5,680)           -0-          (60)          -0-           -0-           -0-         (60)

Change in unrealized gains (losses)
   on securities available for sale,
   net of tax of $6,900                        -0-           -0-           -0-          -0-      (11,773)           -0-     (11,773)

Compensation cost of employee
   stock plan                                  -0-           -0-           21           -0-           -0-           -0-          21

Net income                                     -0-           -0-           -0-      34,048            -0-           -0-      34,048

Cash dividends $0.23 per share                 -0-           -0-           -0-      (5,601)           -0-           -0-      (5,601)
                                       ----------    ----------    ----------    ---------    ----------    ----------    ---------

Balances at December 31, 1994          25,596,426    $      256    $  224,267    $  99,955    $   (9,079)   $  (10,960)   $ 304,439


Treasury stock purchased
   (647,357 shares at an
   average price of $12.85)                    -0-           -0-           -0-          -0-           -0-       (8,317)      (8,317)

Treasury stock issued for employee
   benefit plans (132,022 shares at
   an average price of $9.76)                  -0-           -0-           -0-        (401)           -0-        1,908        1,507

Reissuance of treasury stock
   pursuant to acquisition
   (751,600 shares at $15.00)                  -0-           -0-           -0-       1,710            -0-        9,564       11,274

Changes in unrealized gains (losses)
   on securities available for sale,
   net of tax effect of $7,293                 -0-           -0-           -0-          -0-       12,842            -0-      12,842

Compensation cost of employee
   stock plan                                 124            -0-            1           -0-           -0-           -0-           1

Net income                                     -0-           -0-           -0-      44,486            -0-           -0-      44,486

Cash dividends $0.46 per share                 -0-           -0-           -0-     (11,307)           -0-           -0-     (11,307)
                                       ----------    ----------    ----------    ---------    ----------    ----------    ---------

Balances at December 31, 1995          25,596,550    $      256    $  224,268    $ 134,443    $    3,763    $   (7,805)   $ 354,925
                                       ==========    ==========    ==========    =========    ==========    ==========    =========
</TABLE>

--------------------------------------------------------------------------------
See accompanying notes to Consolidated Financial Statements.




32
<PAGE>   36
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------




CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (CONT'D)

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
(In Thousands, Except                    Number                                                   Net
Number of Shares                        of Shares        Par         Paid-in     Retained     Unrealized     Treasury
and Per Share Data)                      Issued         Value        Capital     Earnings     Gain (Loss)      Stock        Total
------------------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>           <C>           <C>           <C>          <C>           <C>           <C>
Balances at December 31, 1995          25,596,550    $      256    $  224,268    $ 134,443    $   3,763     $  (7,805)    $ 354,925

Treasury stock issued for employee
   benefit plans (168,677 shares at
   an average price of $14.62)                 -0-           -0-           -0-        (134)          -0-        2,466         2,332

Purchase of 2,500,000 of treasury
   stock pursuant to acquisition of
   Family Bank                                 -0-           -0-           -0-          -0-          -0-      (60,342)      (60,342)

Issuance of common stock and
   2,500,000 shares from treasury
   stock pursuant to acquisition of
   Family Bank                          2,980,335            30        47,522           -0-         344        60,342       108,238

Change in unrealized gains (losses)
   on securities available for sale,
   net of taxes of $2,194                      -0-           -0-           -0-          -0-      (4,689)           -0-       (4,689)

Net income                                     -0-           -0-           -0-      52,480           -0-           -0-       52,480

Cash dividends $0.65 per share                 -0-           -0-           -0-     (15,934)          -0-           -0-      (15,934)
                                       ----------    ----------    ----------    ---------    ---------     ---------     ---------

Balances at December 31, 1996          28,576,885    $      286    $  271,790    $ 170,855    $    (582)    $  (5,339)    $ 437,010
                                       ==========    ==========    ==========    =========    =========     =========     =========
</TABLE>

--------------------------------------------------------------------------------
See accompanying notes to Consolidated Financial Statements.




                                                                              33
<PAGE>   37
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------




CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------
                                                                      Year Ended December 31,
-------------------------------------------------------------------------------------------------------
(In Thousands)                                                      1996           1995           1994
-------------------------------------------------------------------------------------------------------
<S>                                                          <C>            <C>            <C>
Cash flows from operating activities:
   Net income                                                $    52,480    $    44,486    $    34,048
   Adjustments to reconcile net income to
   net cash provided by operating activities:
      Provision for loan losses                                      900          4,230          3,374
      Provision for depreciation                                   7,409          6,286          5,399
      Provision for losses and writedowns of
         other real estate owned                                     100           (958)           143
      Amortization of goodwill and other intangibles               4,874          2,211          2,045
      Net (increase) decrease in net deferred tax assets            (394)         3,919         (2,486)
      Net losses realized from sales
         of other real estate owned                                  335            528             64
      Net (gains) losses realized from sales
         of securities and consumer loans                           (507)          (116)           254
      Net (gains) losses realized from sales
         of loans held for sale (a component
         or mortgage banking services)                            (7,108)           664            491
      Net decrease (increase) in mortgage servicing rights        (9,305)        (3,034)       (10,792)
      Proceeds from sales of loans held for sale               1,057,261        552,774        273,287
      Residential loans originated and purchased for sale     (1,082,444)      (613,171)      (218,034)
      Net decrease (increase) in interest and
         dividends receivable and other assets                    (9,101)        (2,925)        10,459
      Net increase (decrease) in other liabilities                29,743            366          8,227
                                                             -----------    -----------    -----------

Net cash provided by operating activities                    $    44,243    $    (4,740)   $   106,479
                                                             -----------    -----------    -----------

-------------------------------------------------------------------------------------------------------

Cash flows from investing activities:
   Proceeds from maturities and principal
      repayments of investment securities                    $        --    $   125,540    $   158,211
   Purchase of investment securities                                  --       (114,491)      (186,396)
   Proceeds from sales of securities available for sale           42,620          9,814         65,380
   Proceeds from maturities and principal repayments of
      securities available for sale                              516,395        135,972        110,446
   Purchases of securities available for sale                   (487,789)      (184,040)      (168,173)
   Net (increase) decrease in loans and leases                  (398,152)      (184,323)      (215,590)
   Proceeds from sales of loans                                       --         31,425          7,550
   Premiums paid on deposits purchased                           (18,230)        (4,290)           (75)
   Net additions to premises and equipment                       (12,155)       (15,800)        (5,323)
   Proceeds from sales of other real estate owned                  3,992         12,722         13,420
   Net decrease in repossessed assets owned                        1,396          2,360          4,020
   Net cash provided by acquisitions                              72,835             --             --
                                                             -----------    -----------    -----------

Net cash provided (used) by investing activities             $  (279,088)   $  (185,111)   $  (216,530)
                                                             -----------    -----------    -----------
</TABLE>

--------------------------------------------------------------------------------
See accompanying notes to Consolidated Financial Statements.




34
<PAGE>   38
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------




CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------
                                                                      Year Ended December 31,
------------------------------------------------------------------------------------------------------
(In Thousands)                                                      1996           1995           1994
------------------------------------------------------------------------------------------------------
<S>                                                          <C>            <C>            <C>
Cash flows from financing activities:
   Net increase (decrease) in deposits                       $   213,572    $   311,293    $   (53,981)
   Net increase (decrease) in securities sold under
      repurchase agreements                                       10,675         53,438         26,831
   Proceeds from Federal Home Loan Bank
      of Boston borrowings                                       481,998        415,998        390,284
   Payments on Federal Home Loan Bank
      of Boston borrowings                                      (328,507)      (526,002)      (279,594)
   Net increase (decrease) in other borrowings                     1,855         11,055          5,087
   Sale of treasury stock                                          2,332          1,507          1,628
   Purchase of treasury stock                                    (60,342)        (8,317)        (1,262)
   Reissuance of treasury stock pursuant
      to acquisition                                                  --         11,274             --
   Cash dividends paid to shareholders                           (15,934)       (11,307)        (5,601)
   Other shareholders' equity, net                                    --             --             39
                                                             -----------    -----------    -----------

Net cash provided by financing activities                    $   305,649    $   258,939    $    83,431
                                                             -----------    -----------    -----------

------------------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents                  70,804         69,088        (26,620)
   Cash and cash equivalents at beginning of period              289,191        220,103        246,723
                                                             -----------    -----------    -----------
   Cash and cash equivalents at end of period                $   359,995    $   289,191    $   220,103
                                                             ===========    ===========    ===========

Supplemental disclosures of information:
   Interest paid on deposits and borrowings                  $   147,785    $   132,301    $   107,927
   Income taxes paid                                              22,905         18,272          2,429

Noncash investing transactions:
   Common stock and treasury stock issued
      for acquisition (1)                                        108,238             --             --
   Investment securities transferred to
      securities available for sale                                   --        275,528             --
   Loans transferred to other real estate owned                    5,188         12,828          9,304
   Loans originated to finance the sales of
      other real estate owned                                      3,602          6,020         12,161
   Increases (decreases) related to SFAS No. 115:
      Securities available for sale                                6,883         20,133        (18,547)
      Deferred income taxes - liabilities                          2,194          7,291         (6,859)
      Net unrealized gain (loss) on
         securities available for sale, net of tax                 4,689         12,842        (11,688)
</TABLE>

--------------------------------------------------------------------------------

(1) The Company purchased Family Bank whereby each share of Family Bank was
    exchanged for 1.26 shares of the Company's stock. In conjunction with the
    acquisition, liabilities were assumed as follows:

       Fair value of assets acquired         $959,089
       Less liabilities assumed               850,851
                                             --------
       Net effect on capital                 $108,238
                                             ========

See accompanying notes to Consolidated Financial Statements.




                                                                              35
<PAGE>   39
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 1996, 1995 and 1994
(All Dollar Amounts Expressed in Thousands, Except Per Share Data)
--------------------------------------------------------------------------------

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accounting and reporting policies of Peoples Heritage Financial Group, Inc.
(the "Company") and its subsidiaries conform to generally accepted accounting
principles and to general practice within the banking industry. The Company's
principal business activities are retail, commercial and mortgage banking as
well as trust and investment advisory services, and are conducted through the
Company's direct wholly-owned subsidiaries located in Maine, New Hampshire and
northern Massachusetts. The Company and its subsidiaries are subject to
competition from other financial institutions and are also subject to regulation
of, and periodic examination by, the Federal Deposit Insurance Corporation, the
Office of Thrift Supervision, the Maine Bureau of Banking, the New Hampshire
Bank Commissioner and the Federal Reserve Board. The following is a description
of the more significant accounting policies.

Financial Statement Presentation.

The consolidated financial statements include the accounts of Peoples Heritage
Financial Group, Inc., the Company's direct wholly-owned subsidiaries Peoples
Heritage Savings Bank (the "Bank"), Bank of New Hampshire Corporation ("BNHC"),
which wholly owns the Bank of New Hampshire ("BNH") and Peoples Heritage Merger
Corporation, which wholly owns Family Bank, FSB ("Family"), and other
subsidiaries which are wholly-owned by the Company's direct wholly-owned
subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation. Certain amounts in prior periods have been
reclassified to conform to the current presentation.

   Assets held in a fiduciary capacity by subsidiary trust departments are not
assets of the Company and, accordingly, are not included in the Consolidated
Balance Sheets.

   In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that effect the reported amount of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Material estimates that are particularly susceptible to
change relate to the determination of the allowance for possible loan and lease
losses and the net deferred tax asset.

Cash and Cash Equivalents.

The Company is required to comply with various laws and regulations of the
Federal Reserve Bank which require that the Company maintain certain amounts of
cash on deposit and is restricted from investing those amounts.

   For purposes of reporting cash flows, cash and cash equivalents include cash
and due from banks, interest-bearing deposits in banks, and federal funds sold
minus federal funds purchased.

Securities Available for Sale.

Securities available for sale consist of debt and equity securities that are
available for sale in response to changes in market interest rates, liquidity
needs, changes in funding sources and other similar factors.

These assets are specifically identified and are carried at market value.
Changes in market value, net of applicable income taxes, are reported as a
separate component of shareholders' equity. When a decline in market value of a
security is considered other than temporary, the loss is charged to net
securities gains (losses) in the consolidated statements of income as a
writedown. Premiums and discounts are amortized and accreted over the term of
the securities on the level yield method adjusted for prepayments. Gains and
losses on the sale of securities are recognized at the time of the sale using
the specific identification method.

Loans.

Loans are carried at the principal amounts outstanding reduced by partial
charge-offs and net deferred loan fees. Loans are generally placed on nonaccrual
status when they are past due 90 days as to either principal or interest, or
when in management's judgment the collectibility of interest or principal of the
loan has been significantly impaired. When a loan has been placed on nonaccrual
status, previously accrued and uncollected interest is reversed against interest
on loans. A loan can be returned to accrual status when collectibility of
principal is reasonably assured and the loan has performed for a period of time,
generally six months. Loans are classified as impaired when it is probable that
the Company will not be able to collect all amounts due according to the
contractual terms of the loan agreement. Factors considered by management in
determining impairment include payment status and collateral value.

Allowance for Loan and Lease Losses.

The allowance for loan and lease losses is maintained at a level determined to
be adequate by management to absorb future charge-offs of loans and leases
deemed uncollectible. This allowance is increased by provisions charged to
operating expense and by recoveries on loans previously charged off, and
reduced by charge-offs on loans and leases.

   Arriving at an appropriate level of allowance for loan and lease losses
necessarily involves a high degree of judgment. Primary considerations in this
evaluation are prior loan loss experience, the character and size of the loan
portfolio, business and economic conditions and management's estimation of
future potential losses. Although management uses available information to
establish the appropriate level of the allowance for loan and lease losses,
future additions to the allowance may be necessary based on estimates that are
susceptible to change as a result of changes in economic conditions and other
factors. In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan and
lease losses. Such agencies may require the Company to recognize adjustments to
the allowance based on their judgments about information available to them at
the time of their examination.

Premises and Equipment.

Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed on the straight-line
method over the estimated useful lives of related assets.


36
<PAGE>   40
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------



   Long-lived assets are evaluated periodically for other-than-temporary
impairment. An assessment of recoverability is performed prior to any writedown
of the asset. If circumstances suggest that their value may be permanently
impaired, then an expense would be charged in the current period.

Goodwill and Other Intangibles.

Goodwill is amortized on a straight-line basis over various periods not
exceeding twenty years; core deposit premiums are amortized on a level-yield
basis over the estimated life of the associated deposits. Goodwill and other
intangible assets are reviewed for possible impairment when events or changed
circumstances may affect the underlying basis of the asset.

Mortgage Banking and Loans Held for Sale.

Loans originated for sale are classified as held for sale. These loans are
specifically identified and carried at the lower of aggregate cost or estimated
market value. Market value is estimated based on outstanding investor
commitments or, in the absence of such commitment, current investor yield
requirements.

   Forward commitments to sell residential real estate mortgages are contracts
which the Company enters into for the purpose of reducing the market risk
associated with originating loans for sale. In the event the Company is unable
to originate loans to fulfill the contracts, it would normally purchase loans
from correspondents or in the open market to deliver against the contract. Such
loans are also classified as held for sale.

   Gains and losses on sales of mortgage loans are determined using the specific
identification method and recorded as mortgage sales income, a component of
mortgage banking services income. The gains and losses resulting from the sales
of loans with servicing retained are adjusted to recognize the present value of
future servicing fee income over the estimated lives of the related loans.
Purchased mortgage servicing rights are recorded at cost upon acquisition.

   In May 1995, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 122, "Accounting for Mortgage Servicing Rights, an amendment of FASB
Statement No. 65." SFAS No. 122 changed the Company's method of accounting for
certain mortgage banking activities. The Company elected early adoption of SFAS
No. 122 effective for all mortgage banking activities in 1995.

   Mortgage servicing rights are amortized on an accelerated method over the
estimated weighted average life of the loans. Amortization is recorded as a
charge against mortgage service fee income, a component of mortgage banking
services income. The Company's assumptions with respect to prepayments, which
affect the estimated average life of the loans, are adjusted periodically to
reflect current circumstances. In evaluating the estimated life of its servicing
portfolio based on data which is disaggregated to reflect note rate, type and
term on the underlying loans.

   Mortgage servicing fees received from investors for servicing their loan
portfolios are recorded as mortgage servicing fee income when received. Loan
servicing costs are charged to noninterest expenses when incurred.

Other Real Estate and Repossessed Assets Owned.

Other real estate and repossessed assets owned are initially carried at the
lower of cost or fair value of the collateral less estimated cost to sell.
Losses arising from the acquisition of such properties are charged against the
allowance for loan losses. Operating expenses and any subsequent provisions to
reduce the carrying value are charged to current period earnings. Gains upon
disposition are reflected in earnings as realized; losses are charged to the
valuation allowance.

Pension Accounting.

The Company provides pension benefits to its employees under a noncontributory
defined benefit plan which is funded on a current basis in compliance with the
requirements of the Employee Retirement Income Security Act of 1974 and
recognizes costs over the estimated employee service period.

Income Taxes.

The Company uses the asset and liability method of accounting for income taxes.
Under this method, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. If current available information raises doubt as to the
realization of the deferred tax assets, a valuation allowance is established.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.

Earnings Per Share.

Earnings per share have been computed on the basis of the weighted average
number of shares of common stock outstanding. Common stock equivalents were not
considered in the calculation of weighted average shares outstanding since their
effect was not material.

2. MERGERS AND ACQUISITIONS

On December 6, 1996, the Company completed its purchase of Family Bank located
in northern Massachusetts. The purchase included 22 branch offices and $473.8
million in loans and $774.6 million in deposits. The transaction was treated as
a purchase for accounting purposes, and, accordingly, the Company's financial
statements reflect the acquisition from the time of purchase. The Company issued
5,480,335 shares of common stock.

   On April 2, 1996, the Company completed its merger with the Bank of New
Hampshire Corporation which was accounted for under the pooling-of-interests
method. Accordingly, the consolidated financial statements of the Company have
been restated to reflect the acquisition at the beginning of each period
presented. At December 31, 1995, BNHC had total assets of $977.8 million and
total shareholders' equity of $84.5 million.

   On February 16, 1996, the Company acquired five branch offices and
approximately $160 million of related deposits from Fleet Bank NH. In addition
to various assets related to the acquired branches, the Company also acquired
approximately $216.4 million of loans in connection with this transaction and
assumed $160.8 million in deposits.

   In 1995 the Company had two acquisitions. On July 1, the Company acquired
Bankcore, Inc. ("Bankcore"), the New Hampshire-based holding company for North
Conway Bank. At the time of acquisition, Bankcore had $132.8 million in total
assets and shareholders' equity of $17.8 million. The Bankcore acquisition was
treated as a purchase for accounting purposes and, accordingly, the Company's
financial statements reflect the acquisition from the time of purchase only.


                                                                              37
<PAGE>   41
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------




   On July 15, 1995, the Company purchased all the branches and associated
deposits, as well as certain loans, of Fleet Bank of Maine located in Aroostook
County, Maine. The purchase resulted in the transfer of $46.1 million in
deposits and $17.1 million in loans.

   During 1994, the Company acquired Mid-Maine Savings, F.S.B. and was accounted
for under the pooling of interest method. Accordingly, the consolidated
financial statements of the Company have been restated to reflect the
acquisition at the beginning of the period presented.


3. SECURITIES AVAILABLE FOR SALE

A summary of the amortized cost and market values of securities available for
sale follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------
                                                         Gross             Gross
                                       Amortized       Unrealized        Unrealized         Market
                                         Cost            Gains             Losses           Value
----------------------------------------------------------------------------------------------------
<S>                                   <C>              <C>              <C>               <C>
December 31, 1996:
   U. S. Government obligations
     and obligations of U.S.
     Government agencies and
     corporations                     $  432,367       $      934       $   (1,071)       $  432,230
   Tax-exempt bonds and notes             17,789               39               --            17,828
   Other bonds and notes                   7,858               11              (50)            7,819
   Mortgage-backed securities            444,613            2,217           (2,835)          443,995
   Collateralized mortgage
     obligations                         103,237              286             (706)          102,817
                                      ----------       ----------       ----------        ----------
      Total debt securities            1,005,864            3,487           (4,662)        1,004,689
                                      ----------       ----------       ----------        ----------

   Federal Home Loan Bank of
     Boston stock                         37,948               --               --            37,948
   Other equity securities                 2,330              102               --             2,432
                                      ----------       ----------       ----------        ----------
     Total equity securities              40,278              102               --            40,380
                                      ----------       ----------       ----------        ----------
     Total securities available
      for sale                        $1,046,142       $    3,589       $   (4,662)       $1,045,069
                                      ==========       ==========       ==========        ==========
</TABLE>

--------------------------------------------------------------------------------

   The excess of amortized cost over market value of $1.1 million, net of tax
effect of $491 thousand, is recorded as a separate component of shareholders'
equity.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------
                                                         Gross             Gross
                                      Amortized        Unrealized        Unrealized         Market
                                        Cost             Gains             Losses           Value
----------------------------------------------------------------------------------------------------
<S>                                   <C>              <C>               <C>               <C>
December 31, 1995:
   U. S. Government obligations
     and obligations of U.S.
     Government agencies and
     corporations                     $522,822          $  3,981         $   (227)         $526,576
   Tax-exempt bonds and notes           10,796                43               (2)           10,837
   Other bonds and notes                 5,645                55               (6)            5,694
   Mortgage-backed securities          194,018             2,224             (419)          195,823
                                      --------          --------         --------          --------
      Total debt securities            733,281             6,303             (654)          738,930
                                      --------          --------         --------          --------

   Federal Home Loan Bank of
     Boston stock                       23,793                --               --            23,793
   Other equity securities               3,764               170               (9)            3,925
                                      --------          --------         --------          --------
     Total equity securities            27,557               170               (9)           27,718
                                      --------          --------         --------          --------

     Total securities available
      for sale                        $760,838          $  6,473         $   (663)         $766,648
                                      ========          ========         ========          ========
</TABLE>

--------------------------------------------------------------------------------

   The excess of market value over amortized cost of $5.8 million, net of tax
effect of $2.0 million, is recorded as a separate component of shareholders'
equity.



38
<PAGE>   42
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------




The amortized cost and market values of debt securities available for sale at
December 31, 1996 by contractual maturity are shown below. Actual maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties. At
December 31, 1996, the Company had $24.9 million of securities available for
sale with call provisions.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                              Amortized Cost        Market Value
--------------------------------------------------------------------------------
<S>                                           <C>                   <C>
December 31, 1996:
Due in one year or less                           $  230,555          $  230,786
Due after one year through five years                228,560             228,105
Due after five years through ten years                49,305              49,293
Due after ten years                                  497,444             496,605
                                                  ----------          ----------
   Total debt securities                          $1,005,864          $1,004,689
                                                  ==========          ==========
</TABLE>

--------------------------------------------------------------------------------

A summary of realized gains and losses on securities available for sale for
1996, 1995 and 1994 follows:

<TABLE>
<CAPTION>
                               Gross              Gross
                             Realized           Realized
                               Gains             Losses
--------------------------------------------------------
<S>                          <C>                <C>
     1996                      $533               $ 26
     1995                       305                189
     1994                       549                803
</TABLE>

--------------------------------------------------------------------------------




                                                                              39
<PAGE>   43
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------




4. LOANS AND LEASES

The Company's lending activities are conducted principally in Maine, New
Hampshire and northern Massachusetts. The principal categories of loans in the
Company's portfolio are residential real estate loans, which are secured by
single-family (one to four units) residences; commercial real estate loans,
which are secured by multi-family (five or more units) residential and
commercial real estate; commercial business loans and leases; and consumer loans
and leases.

A summary of loans and leases follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                            December 31,
--------------------------------------------------------------------------------
                                                           1996             1995
<S>                                                  <C>              <C>
Residential real estate mortgages:
   Adjustable-rate                                   $  617,323       $  402,695
   Fixed-rate                                           559,551          395,381
                                                     ----------       ----------
                                                      1,176,874          798,076
                                                     ----------       ----------
Commercial real estate mortgages:
   Commercial real estate                               901,105          753,857
   Construction and development                          61,270           43,829
                                                     ----------       ----------
                                                        962,375          797,686
                                                     ----------       ----------
Commercial business loans and leases:
   Business loans                                       463,011          397,652
   Leases                                                14,391           10,940
                                                     ----------       ----------
                                                        477,402          408,592
                                                     ----------       ----------

Consumer loans and leases:
   Home equity                                          362,105          283,008
   Mobile home                                          206,061          214,761
   Automobile                                           192,295          127,969
   Education loans                                      106,900           38,685
   Boat and recreational vehicle                         31,969           22,716
   Other                                                138,619           87,090
                                                     ----------       ----------
                                                      1,037,949          774,229
                                                     ----------       ----------

Total loans and leases                               $3,654,600       $2,778,583
                                                     ==========       ==========
</TABLE>

--------------------------------------------------------------------------------

Loan and lease balances are stated net of deferred loan fees totaling $3,324 and
$5,022 at December 31, 1996 and 1995, respectively.

Related Party Transactions

Loans to officers, directors and related parties are made in the ordinary course
of business and on the same terms and conditions prevailing at the time for
comparable transactions. A summary of loans to related parties during 1996 and
1995 follows:

<TABLE>
<S>                                                                    <C>
   Balance at December 31, 1994                                        $ 20,760
     Loans made/advanced and additions                                    4,224
     Repayments and reductions                                           (4,191)
     Other changes                                                       (1,380)
                                                                       --------
   Balance at December 31, 1995                                        $ 19,413
     Loans made/advanced and additions                                      557
     Repayments and reductions                                           (2,415)
     Other changes                                                       (5,571)
                                                                       --------
   Balance at December 31, 1996                                        $ 11,984
                                                                       ========
</TABLE>

--------------------------------------------------------------------------------




40
<PAGE>   44
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------




NONPERFORMING LOANS

The following table sets forth information regarding nonperforming loans at the
dates indicated:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                               December 31,
--------------------------------------------------------------------------------
                                                              1996          1995
--------------------------------------------------------------------------------
<S>                                                        <C>           <C>
Residential real estate mortgages:
   Nonaccrual loans                                        $ 3,867       $ 5,713
   Accruing loans which are 90 days overdue                  5,560         3,728
                                                           -------       -------
     Total                                                   9,427         9,441
                                                           -------       -------

Commercial real estate loans:
   Nonaccrual loans                                         15,270        17,029
   Accruing loans which are 90 days overdue                     --            --
   Troubled debt restructurings                              1,581         3,186
                                                           -------       -------
     Total                                                  16,851        20,215
                                                           -------       -------

Commercial business loans and leases:
   Nonaccrual loans                                          8,016         6,735
   Accruing loans which are 90 days overdue                     --            25
   Troubled debt restructurings                                579         1,859
                                                           -------       -------
     Total                                                   8,595         8,619
                                                           -------       -------

Consumer loans:
   Nonaccrual loans                                          5,097         3,586
   Accruing loans which are 90 days overdue                  2,478           659
                                                           -------       -------
     Total                                                   7,575         4,245
                                                           -------       -------

Total nonperforming loans:
   Nonaccrual loans                                         32,250        33,063
   Accruing loans which are 90 days overdue                  8,038         4,412
   Troubled debt restructurings                              2,160         5,045
                                                           -------       -------
     Total                                                 $42,448       $42,520
                                                           =======       =======
</TABLE>

--------------------------------------------------------------------------------

The ability and willingness of the residential real estate, commercial real
estate, commercial business and consumer borrowers to repay loans is generally
dependent on current economic conditions and real estate values within the
borrowers' geographic areas.

   During 1996 and 1995, the Company's policy was generally to limit new loans
to one borrower to $10.0 million. These limitations are substantially below the
limitations set forth in applicable laws and regulations.

   Interest income that would have been recognized for 1996, 1995 and 1994, if
nonperforming loans at December 31, 1996, 1995 and 1994 had been performing in
accordance with their original terms, approximated $4.7 million, $5.3 million
and $8.2 million, respectively. The actual amount that was collected on these
loans during the periods and included in interest income approximated $1.9
million, $1.6 million and $1.8 million, respectively. As a result, the reduction
in interest income for 1996, 1995, and 1994 associated with nonperforming loans
held at the end of such periods approximated $2.8 million, $3.7 million and $6.4
million, respectively.

   Impaired loans are commercial, commercial real estate, and individually
significant mortgage and consumer loans for which it is probable that the
Company will not be able to collect all amounts due according to the contractual
terms of the loan agreement. The definition of "impaired loans" is not the same
as the definition of "nonaccrual loans," although the two categories overlap.
Nonaccrual loans include impaired loans and loans on which the accrual of
interest is discontinued when collectibility of principal or interest is
uncertain or on which payments of principal or interest have become
contractually past due 90 days. The Company may choose to place a loan on
nonaccrual status due to payment delinquency or uncertain collectibility, while
not classifying the loan as impaired, if (i) it is probable that the Company
will collect all amounts due in accordance with the contractual terms of the
loan or (ii) the loan is not a commercial, commercial real estate or an
individually significant mortgage or consumer loan. Factors considered by
management in determining impairment include payment status and collateral
value. The amount of impairment for these types of impaired loans is determined
by the difference between the present value of the expected cash flows related
to the loan, using the original contractual interest rate, and its recorded
value, or, as a practical expedient in the case of collateralized loans, the
difference between the fair value of the collateral and the recorded amount of
the loans. When foreclosure is probable, impairment is measured based on the
fair value of the collateral. Mortgage and consumer loans which are not
individually significant are measured for impairment collectively. Loans that
experience insignificant payment delays and insignificant shortfalls in payment
amounts generally are not classified as impaired. Management determines the
significance of payment delays and payment shortfalls on a case-by-case basis,
taking into the consideration all of the circumstances surround-



                                                                              41
<PAGE>   45
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------




ing the loan and the borrower, including the length of the delay, the reasons
for the delay, the borrower's prior payment record, and the amount of the
shortfall in relation to the principal and interest owed.

   At December 31, 1996 and 1995, total impaired loans were $28.3 million and
$27.8 million, of which $22.7 million and $24.7 million had related allowances
of $4.2 million and $5.7 million, respectively. During the years ended December
31, 1996 and 1995, the income recognized related to impaired loans was $1.6
million and $1.5 million and the average balance of outstanding impaired loans
was $25.2 million and $29.1 million, respectively. The Company recognizes
interest on impaired loans on a cash basis when the ability to collect the
principal balance is not in doubt; otherwise, cash received is applied to
principal balance of loan.

5. ALLOWANCE FOR LOAN AND LEASE LOSSES

Changes in the allowance for loan and lease losses follow:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                       December 31,
--------------------------------------------------------------------------------
                                               1996          1995          1994
--------------------------------------------------------------------------------
<S>                                        <C>           <C>           <C>
Balance at beginning of period             $ 60,975      $ 63,675      $ 67,385
Allowance on acquired loans                  11,365         2,314            --
Provisions charged to operations                900         4,230         3,374
Loans and leases charged off                (18,173)      (17,968)      (17,202)
Recoveries                                   12,421         8,724        10,118
                                           --------      --------      --------
Balance at end of period                   $ 67,488      $ 60,975      $ 63,675
                                           ========      ========      ========
</TABLE>

--------------------------------------------------------------------------------

6. PREMISES AND EQUIPMENT

A summary of premises and equipment follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                             December 31,
--------------------------------------------------------------------------------
                                                           1996             1995
--------------------------------------------------------------------------------
<S>                                                    <C>              <C>
Land                                                   $ 10,227         $ 11,754
Buildings and improvements                               61,398           45,302
Leasehold improvements                                   12,273           10,090
Furniture, fixtures and equipment                        65,326           47,372
                                                       --------         --------
                                                        149,224          114,518
                                                       --------         --------
Less accumulated depreciation
   and amortization                                      75,268           58,497
                                                       --------         --------
                                                       $ 73,956         $ 56,021
                                                       ========         ========
</TABLE>

--------------------------------------------------------------------------------

7. GOODWILL AND OTHER INTANGIBLES

A summary of goodwill and other intangibles follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                             December 31,
--------------------------------------------------------------------------------
                                                         1996               1995
--------------------------------------------------------------------------------
<S>                                                   <C>                <C>
Goodwill                                              $53,554            $20,761
Core deposit premiums                                  18,095              2,031
                                                      -------            -------
                                                      $71,649            $22,792
                                                      =======            =======
</TABLE>

--------------------------------------------------------------------------------

Amortization of goodwill is included in other noninterest expenses and amounted
to $2,215, $1,925 and $1,801 for the years ended December 31, 1996, 1995 and
1994, respectively.

   Amortization of core deposit premiums is included in interest on deposits and
amounted to $2,659, $286 and $244 for the years ended December 31, 1996, 1995
and 1994, respectively.

8. MORTGAGE SERVICING RIGHTS

An analysis of mortgage servicing rights for the years ended December 31, 1996,
1995 and 1994 follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                               1996          1995          1994
--------------------------------------------------------------------------------
<S>                                        <C>           <C>           <C>
Balance at beginning of period             $ 20,309      $ 17,275      $  6,483
Mortgage servicing rights capitalized        17,299         9,101        12,535
Mortgage servicing rights acquired
   through acquisition                        3,700            --            --
Amortization charged against
   mortgage service fee income               (4,375)       (3,483)       (1,743)
Mortgage servicing rights sold               (3,619)       (2,584)           --
                                           --------      --------      --------
Balance at end of period                   $ 33,314      $ 20,309      $ 17,275
                                           ========      ========      ========
</TABLE>

--------------------------------------------------------------------------------

The Company generally continues to service the residential real estate mortgages
sold in the secondary market. The Company pays the investor an agreed-upon rate
on the loan, which is less than the interest rate the Company receives from the
borrower. The difference is retained by the Company as a fee for servicing the
residential real estate mortgages. As required by SFAS No. 122, the Company
capitalizes mortgage servicing rights at their allocated cost based on relative
fair values upon sale of the related loans.

   The Company periodically purchases and sells residential mortgage servicing
rights through a closed bid process from brokers representing financial
institutions with mortgage servicing portfolios. Residential real estate
mortgages serviced for investors at December 31, 1996, 1995 and 1994 amounted to
$3.2 billion, $2.6 billion and $2.1 billion, respectively.

9. OTHER REAL ESTATE AND REPOSSESSED ASSETS OWNED

The following table summarizes the composition of other real estate and
repossessed assets owned, net of related reserves, which is included in other
assets.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                         December 31,
--------------------------------------------------------------------------------
                                                1996          1995          1994
--------------------------------------------------------------------------------
<S>                                          <C>           <C>           <C>
Real estate properties acquired
   in settlement of loans                    $ 9,941       $12,679       $20,073
Other assets repossessed in
   settlement of non-real
   estate loans                                1,877         1,553         2,003
                                             -------       -------       -------
                                             $11,818       $14,232       $22,076
                                             =======       =======       =======
</TABLE>

--------------------------------------------------------------------------------




42
<PAGE>   46
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------




10. INCOME TAXES

The current and deferred components of income tax expense (benefit) follow:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                        December 31,
--------------------------------------------------------------------------------
                                                1996         1995          1994
--------------------------------------------------------------------------------
<S>                                          <C>          <C>          <C>
Current (including $1,381, $805,
   and $302 respectively, of state
   income tax)                               $27,134      $19,480      $ 16,129
Deferred                                         434        3,895        (2,467)
                                             -------      -------      --------
                                             $27,568      $23,375      $ 13,662
                                             =======      =======      ========
</TABLE>

--------------------------------------------------------------------------------




The following table reconciles the expected income tax expense (computed by
applying the federal statutory tax rate to income before taxes) to recorded
income tax expense:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                       December 31,
--------------------------------------------------------------------------------
                                               1996          1995          1994
--------------------------------------------------------------------------------
<S>                                        <C>           <C>           <C>
Computed tax expense                       $ 28,017      $ 23,585      $ 16,572
State income tax, net of
   federal benefits                             898           523           196
Benefit of tax-exempt income                   (740)         (585)         (495)
Merger Expenses                                 623           380            --
Amortization of goodwill and
   other intangibles                            916           839           842
Low income/rehabilitation credits            (1,231)       (1,265)       (1,265)
Tax bad debt reserve recapture on
   Mid Maine acquisition                         --            --         1,022
Change in valuation allowance                    --            --        (3,322)
Other, net                                     (915)         (102)          112
                                           --------      --------      --------
                                           $ 27,568      $ 23,375      $ 13,662
                                           ========      ========      ========
</TABLE>

--------------------------------------------------------------------------------

The tax effects of temporary differences that give rise to deferred tax assets
and deferred tax liabilities which are included in Other Assets and Other
Liabilities, respectively, at December 31, 1996 and 1995 follow:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------
                                                                                         1996        1995
---------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>         <C>
Deferred tax assets:
   Allowance for loan and lease losses                                                $25,003     $23,007
   Reserve for mobile home dealers                                                      2,000       2,119
   Accrued pension expense                                                              2,085         848
   Difference of tax and book basis of other real estate owned                            666         391
   Deferred loan fees                                                                     272         527
   Interest accrued and payments received on nonperforming loans for tax purposes       1,032       1,096
   Unrealized depreciation on securities                                                  491          --
   Other                                                                                3,835       4,984
                                                                                      -------     -------
     Total gross deferred tax assets                                                   35,384      32,972
                                                                                      -------     -------

Deferred tax liabilities
   Difference of tax and book basis of leases                                             313         420
   Difference of tax and book basis of premises and equipment                           1,819       1,747
   Difference of tax and book basis of securities                                         256         522
   Difference of tax and book basis of partnership investments                          2,606         397
   Tax bad debt reserve                                                                 6,143       5,518
   Unrealized appreciation of securities                                                   --       2,025
   Other                                                                                  942       1,948
     Total gross deferred tax liabilities                                              12,079      12,577
                                                                                      -------     -------
     Net deferred tax asset                                                           $23,305     $20,395
                                                                                      =======     =======
</TABLE>

--------------------------------------------------------------------------------




                                                                              43
<PAGE>   47
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

The Company's net deferred tax asset was increased by $828 thousand during 1996
to reflect the purchase of Family Bank. In assessing the realizability of
deferred tax assets, the Company considers whether it is more likely than not
that some portion or all of the deferred tax assets will not be realized. The
ultimate realization of deferred tax assets is dependent upon the generation of
future taxable income during the periods in which those temporary differences
become deductible. The Company considers the scheduled reversal of deferred tax
liabilities and projected future taxable income in making this assessment. The
Company estimates that substantially all of its gross deferred tax assets and
liabilities will reverse within the next five years. In order to fully realize
the net deferred tax asset, the Company will need to generate future taxable
income of approximately $66.6 million. Pre-tax book income for the year ended
December 31, 1996 was $80.0 million. Based upon the level of 1996 taxable income
and projections for future taxable income over the periods which the deferred
tax assets are deductible, the Company believes it is more likely than not that
it will realize the benefits of these deductible temporary differences at
December 31, 1996. Accordingly, no valuation allowance has been recorded at
December 31, 1996.

   In August, 1996, the provisions repealing the current thrift bad debt rules
were passed by Congress as part of "The Small Business Job Protection Act of
1996." The new rules eliminate the 8% of taxable income method for deducting
additions to the tax bad debt reserves for all thrifts for tax years beginning
after December 31, 1995. These rules also require that all thrift institutions
recapture all or a portion of their bad debt reserves added since the base year
(last taxable year beginning before January 1, 1988). The Bank has previously
recorded a deferred tax liability equal to the bad debt recapture and as such,
the new rules will have no effect on net income or federal income tax expense.

   The unrecaptured base year reserves will not be subject to recapture as long
as the institution continues to carry on the business of banking. In addition,
the balance of the pre-1988 bad debt reserves continue to be subject to
provisions of present law that require recapture in the case of certain excess
distributions to shareholders. The tax effect of pre-1988 bad debt reserves
subject to recapture in the case of certain excess distributions is
approximately $610 thousand.

11. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS

A summary of securities sold under repurchase agreements follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                          At of for the Year Ended December 31,
--------------------------------------------------------------------------------
                                             1996         1995         1994
--------------------------------------------------------------------------------
<S>                                        <C>          <C>          <C>
Balance outstanding at
   end of period                           $197,005     $180,957     $127,519
Market value of collateral at
   end of period                            205,084      195,861      137,304
Amortized cost of
   collateral at end of period              204,470      194,560      141,104
Average balance outstanding                 140,365      152,411      109,216
Maximum outstanding at any
   month end during the period              197,005      213,104      153,710
Average interest rate
   during the period                           4.47%        4.90%        3.36%
Average interest rate at end of period         4.06%        4.64%        4.62%
--------------------------------------------------------------------------------
</TABLE>

Securities sold under repurchase agreements generally have maturities of 180
days or less and are collateralized by mortgage backed securities and U.S.
Government obligations with the aggregate market value and aggregate amortized
costs for the respective periods noted above.

--------------------------------------------------------------------------------

12. BORROWINGS FROM THE FEDERAL HOME LOAN BANK OF BOSTON

A summary of the borrowings from the Federal Home Loan Bank of Boston is as
follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------
                                   December 31, 1996
--------------------------------------------------------------
Principal Amounts           Interest Rates    Maturity Dates
--------------------------------------------------------------
<S>                         <C>               <C>
    $ 90,983                 4.81% - 6.87%         1997
      62,500                 5.19% - 5.87%         1998
     225,000                 5.30% - 5.65%         1999
      75,025                 4.70% - 6.05%         2000
       4,728                 5.20% - 5.82%         2003
       5,793                 5.68% - 5.72%         2004
       6,051                 6.14% - 6.90%         2005
    --------
    $470,080
    ========

--------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
                                  December 31, 1995
--------------------------------------------------------------
Principal Amounts           Interest Rates    Maturity Dates
--------------------------------------------------------------
<S>                         <C>               <C>
    $ 31,500                 4.26% - 6.57%         1996
      72,950                 5.82% - 6.87%         1997
      82,500                 5.30% - 6.02%         1998
      64,000                 5.71% - 5.78%         2000
       1,496                 6.70% - 6.90%         2005
    --------
    $252,446
    ========

--------------------------------------------------------------
</TABLE>

Short and long-term borrowings from the Federal Home Loan Bank of Boston, which
consist of both fixed and adjustable rate borrowings, are secured by a blanket
lien on qualified collateral consisting primarily of loans with first mortgages
secured by 1 to 4 family properties, certain unencumbered investment securities
and other qualified assets.

13. SHAREHOLDERS' EQUITY

Regulatory Capital Requirements
Bank regulatory agencies have established capital adequacy standards which are
used extensively in their monitoring and control of the industry. These
standards relate capital to level of risk by assigning different weighing to
assets and certain off-balance sheet activity. The Company must maintain a
minimum total risk-based, Tier I risk-based, Tier I leverage ratios as set forth
in the table below.


44


<PAGE>   48
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------
                                                                                     For Capital
                                                                Actual            Adequacy Purposes         Excess
                                                        Amount          Ratio     Amount       Ratio   Amount     Ratio
------------------------------------------------------------------------------------------------------------------------------
<S>                                                    <C>              <C>      <C>         <C>       <C>        <C>
As of December 31, 1996:
Total capital (to risk weighted assets)                $409,144         12.24%   $267,428      8.00%   $141,716    4.24%
Tier 1 capital (to risk weighted assets)                367,041         10.98     133,714      4.00     233,327    6.98
Tier 1 leverage capital ratio (to average assets)       367,041          7.96     184,445      4.00     182,596    3.96
as of December 31, 1995:
Total capital (to risk weighted assets)                 361,991         12.88     204,728      8.00     157,353    4.88
Tier 1 capital (to risk weighted assets)                329,645         14.15     102,364      4.00     227,231   10.15
Tier 1 leverage capital ratio (to average assets)       329,645          8.33     158,369      4.00     171,276    4.33
------------------------------------------------------------------------------------------------------------------------------
</TABLE>

At December 31, 1996 and 1995, the Company and each of its banking subsidiaries
were in compliance with all applicable regulatory capital requirements and had
capital ratios in excess of federal regulatory risk-based and leverage
requirements.

--------------------------------------------------------------------------------

Dividend Limitations
Dividends paid by subsidiaries are the primary source of funds available to the
Company for payment of dividends to its shareholders. The Company's subsidiary
banks are subject to certain requirements imposed by state and federal banking
laws and regulations. These requirements, among other things, establish minimum
levels of capital and restrict the amount of dividends that may be distributed
by the subsidiary banks to the Company.

Stockholder Rights Plan
In 1989, the Company's Board of Directors adopted a Stockholder Rights Plan
declaring a dividend of one preferred Stock Purchase Right for each outstanding
share of Common Stock. The rights will remain attached to the Common Stock and
are not exercisable except under limited circumstances relating to acquisition
of, the right to acquire beneficial ownership of, or tender offer for 20% or
more of the outstanding shares of Common Stock. The Rights have no voting or
dividend privileges and, until they become exercisable, have no dilutive effect
on the earnings of the Company.

14. COMMITMENTS, CONTINGENT LIABILITIES AND OTHER OFF-BALANCE SHEET RISKS

The Company is party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers and to
reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to originate loans, standby letters of credit,
recourse arrangements on serviced loans, and forward commitments to sell loans.
The instruments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the Consolidated Balance Sheets.
The contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.

   The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments, standby letters of
credit and recourse arrangements is represented by the contractual amount of
those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments. For forward commitments to sell loans, the contract or notional
amounts do not represent exposure to credit loss. The Company controls the
credit risk of its forward commitments to sell loans through credit approvals,
limits and monitoring procedures.

Financial instruments with off-balance sheet risk at December 31, 1996 and 1995
follow:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------
                                          Contract or Notional Amount
-----------------------------------------------------------------------
                                                  December 31,
-----------------------------------------------------------------------
                                               1996         1995
-----------------------------------------------------------------------
<S>                                           <C>         <C>
Financial instruments with contract
   amounts which represent credit risk:
   Commitments to originate loans,
   unused lines, standby letters of credit
   and unadvanced portions of
   construction loans                         $828,845    $716,251
   Loans serviced with recourse                 38,286      48,213
Financial instruments with notional or
   contract amounts which exceed the
   amount of credit risk:
     Forward commitments to
     sell loans                               $149,330    $128,000

-----------------------------------------------------------------------
</TABLE>


                                                                              45
<PAGE>   49
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

Commitments to originate loans, unused lines of credit and unadvanced portions
of construction loans are agreements to lend to a customer provided there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Because many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Company evaluates each customer's creditworthiness 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
of the borrower.

   Standby letters of credit are conditional commitments issued by the Company
to guarantee the performance by a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers.

   The Company has retained credit risk on certain residential mortgage loans
sold with full or partial recourse and on certain residential mortgage loans
whose servicing rights were acquired during 1990.

Derivative Financial Instruments
The Company has only limited involvement with derivative financial instruments.

   Forward commitments to sell residential mortgage loans are contracts which
the Company enters into for the purpose of reducing the market risk associated
with originating loans for sale. Risks may arise from the possible inability of
the Company to originate loans to fulfill the contracts, in which case the
Company would normally purchase loans from correspondent banks or in the open
market to deliver against the contract.

Legal Proceedings
The Company and certain of its subsidiaries have been named as defendants in
various legal proceedings arising from their normal business activities.
Although the amount of any ultimate liability with respect to such proceedings
cannot be determined, in the opinion of management, based upon the opinions of
counsel, any such liability will not have a material effect on the consolidated
financial position or results of operations of the Company and its subsidiaries.

Lease Obligations
The Company leases certain properties used in operations under terms of
operating leases which include renewal options. Rental expense under these
leases approximated $4.5 million, $3.4 million and $3.6 million for the years
ended 1996, 1995 and 1994, respectively.

Approximate minimum lease payments over the remaining terms of the leases at
December 31, 1996 follow:

<TABLE>
<CAPTION>
---------------------------------------------
       <S>                     <C>
       1997                    $ 4,216
       1998                      3,734
       1999                      3,394
       2000                      3,077
       2001                      2,169
       2002 and after            5,940
                               -------
                               $22,530
                               =======
---------------------------------------------
</TABLE>

15. STOCK BASED COMPENSATION PLANS

Profit Sharing Employee Stock Ownership Plan
In 1989 the Company adopted a Profit Sharing Employee Stock Ownership Plan which
is designed to invest primarily in Common Stock of the Company. Substantially
all employees are eligible for the Plan following one year of service. Employees
may not make contributions to the Plan but may receive a discretionary
contribution from the Company based on their pro-rata share of eligible
compensation. For 1996, 1995 and 1994 the Directors voted to contribute 4%, 3%
and 5% of eligible compensation, respectively. The approximate expense of this
contribution for 1996, 1995 and 1994 was $1.5 million, $850 thousand and $1.4
million, respectively.

Stock Option Plans
The Company has adopted various stock option and stock appreciation rights plans
for key employees. In 1996, the Company adopted a stock option plan (the "1996
Option Plan") which replaced a plan that had existed since 1986 (the "1986
Option Plan"). The 1996 Option Plan authorizes grants of options to purchase up
to 1,250,000 shares of authorized but unissued common stock. Stock options are
granted with an exercise price equal to the stock's fair market value at the
date of the grant and expire 10 years from the date of the grant. At December
31, 1996, there were 903,050 additional shares available for grant under the
1996 Option Plan. The Company issued no stock appreciation rights in 1996 or
1995.

   The Company has adopted a stock option plan for non-employee directors. The
maximum number of shares which may be granted under the plan is 75,000 shares,
of which 20,000 were granted in 1996 at $20.88 per share and 18,000 granted in
1995 at $13.63 per share. 1,627 shares had been issued upon exercise of the
stock options cumulatively through December 31, 1996.

The per share weighted-average fair value of stock options granted during 1996
and 1995 was $7.91 and $7.04 on the date of the grants using the Black Scholes
option-pricing model with the following average assumptions:

<TABLE>
<CAPTION>
--------------------------------------------------------------
                                   1996          1995
--------------------------------------------------------------
<S>                               <C>           <C>
Expected dividend yield            2.50%         2.50%
Risk-free interest rate            6.06%         5.84%
Expected life                      5.56 YEARS    5.63 Years
Volatility                        34.50%        36.60%

--------------------------------------------------------------
</TABLE>

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

<TABLE>
<CAPTION>
-------------------------------------------------------------------
                                   1996            1995
-------------------------------------------------------------------
<S>                               <C>             <C>
Net Income
   As reported                    $52,480         $44,486
   Pro Forma                      $51,399         $44,263
Earnings Per Share
   As Reported                    $  2.10         $  1.80
   Pro Forma                      $  2.05         $  1.79

-------------------------------------------------------------------
</TABLE>


46
<PAGE>   50
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

Pro forma net income reflects only stock options granted in 1996 and 1995.
Therefore, the full impact of calculating cost for stock options under SFAS No.
123 is not reflected in the pro forma net income amounts presented above because
cost is reflected over the options' vesting period and cost for options granted
prior to January 1, 1995 is not considered.

Stock option activity during the periods indicated was as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------
                                Number of     Weighted Average
                                 Shares        Exercise Price
----------------------------------------------------------------
<S>                             <C>           <C>
Balance at December 31, 1994    1,135,683         $10.31
   Granted                        417,139          20.68
   Exercised                       73,790           7.78
   Forfeited                       24,902          12.50
   Expired                             --             --
Balance at December 31, 1995    1,454,130          13.36
   Granted                        366,950          23.73
   Exercised                      137,973           9.54
   Forfeited                       30,296          18.59
   Expired                             --             --
   Assumed in acquisitions         91,665           7.34
                                ---------
Balance at December 31, 1996    1,744,476         $15.44
                                =========
----------------------------------------------------------------
</TABLE>

The range of per share prices for outstanding exercisable stock options at
December 31, 1996 and 1995 were as follows:

<TABLE>
<CAPTION>
---------------------------------------------------------------------
                       December 31, 1996        December 31, 1995
---------------------------------------------------------------------
                     Options      Options      Options      Options
                   Outstanding  Exercisable  Outstanding  Exercisable
---------------------------------------------------------------------
<S>                <C>          <C>          <C>          <C>
$ 2.65 to $ 5.00      135,608      135,608      109,392    109,392
$ 5.01 to $15.00      256,329      256,329      291,270    147,463
$10.01 to $15.00      607,181      494,540      654,558    379,174
$15.01 to $20.00           --           --           --         --
$20.01 to $25.38      745,358      158,429      398,910         --
                   ----------   ----------   ----------   --------
  Total Options     1,744,476    1,044,906    1,454,130    636,029
                   ==========   ==========   ==========   ========
  Weighted
    average price  $    15.44   $    11.67   $    13.36   $   9.73
</TABLE>

Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan covering all full-time employees
with one year of service. The maximum number of shares which may be issued under
the Employee Stock Purchase Plan is 676,000 shares. Employees have the right to
authorize payroll deductions up to 10% of their salary. As of December 31, 1996,
327,250 shares had been purchased under this plan.

16. RETIREMENT AND OTHER BENEFIT PLANS

Defined Benefit Pension Plan
The Company and its subsidiaries have noncontributory defined benefit plans
covering substantially all permanent, full-time employees. Benefits are based on
career average earnings and length of service. The Company's funding policy is
to contribute annually the maximum amount that can be deducted for federal
income tax purposes.

The following tables set forth the plans' funded status and amounts recognized
in the Company's consolidated balance sheets at December 31, 1996 and 1995.

<TABLE>
<CAPTION>
------------------------------------------------------------------------
                                                      December 31,
------------------------------------------------------------------------
                                                   1996          1995
------------------------------------------------------------------------
<S>                                              <C>            <C>
Actuarial present value of benefit obligations:
   Accumulated benefit obligation,
   including vested benefits of $34,285
   and $30,020                                   $ 36,161       $ 30,890
                                                 ========       ========
Projected benefit obligation for service
   rendered to date                              $ 42,628       $ 34,087

Plan assets at fair value, primarily listed
   stocks and corporate bonds                     (42,331)       (31,602)
                                                 --------       --------
Plan assets (greater) less than projected
   benefit obligation                                 297          2,485

Unrecognized net loss from past experi-
   ence different from that assumed and
   effects of changes in assumptions                 (114)        (3,721)

Unrecognized prior service cost                        72            550

Unrecognized net asset at adoption of
   SFAS No. 87, net of amortization                 1,814          1,921
                                                 --------       --------
Accrued pension cost included
   in other liabilities                          $  2,069       $  1,235
                                                 ========       ========

------------------------------------------------------------------------
</TABLE>

Net pension cost for 1996, 1995 and 1994 included the following components:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                      1996          1995         1994
--------------------------------------------------------------------------------
<S>                                 <C>           <C>           <C>
Service cost during the period      $ 1,667       $ 1,650       $ 1,562
Interest cost on projected
   benefit obligation                 2,515         2,268         2,181
Actual return on plan assets         (3,673)       (5,518)          283
Net amortization and deferral           693         3,158        (2,560)
                                    -------       -------       -------
Net periodic pension cost           $ 1,202       $ 1,558       $ 1,466
                                    =======       =======       =======

--------------------------------------------------------------------------------
</TABLE>

Assumptions used to determine actuarial present value of benefit obligations
were as follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                    December 31,
--------------------------------------------------------------------------------
Weighted average                             1996       1995     1994
--------------------------------------------------------------------------------
<S>                                          <C>        <C>       <C>
Discount rate                                7.50%      7.25%     7.50%
Increase in compensation levels              4.50       4.50      4.50
Expected long term return on assets          8.25       8.25      8.50
--------------------------------------------------------------------------------
</TABLE>


                                                                              47
<PAGE>   51
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

Thrift Incentive Plan
The Company has a Contributory Thrift Incentive Plan, covering substantially all
permanent employees after completion of one year of service. The Company matches
employee contributions based on a predetermined formula and may make additional
discretionary contributions. The total expense for 1996, 1995 and 1994 was $870
thousand, $659 thousand and $620 thousand, respectively.

Supplemental Retirement Plans
The Company has adopted supplemental retirement plans for several key officers.
These plans were designed to offset the impact of changes in the Pension Plan
which reduced benefits for highly paid employees. The cost of these plans was
$343 thousand, $823 thousand and $342 thousand for 1996, 1995 and 1994,
respectively.

Postretirement Benefits Other Than Pensions
The Company and its subsidiaries sponsor postretirement benefit programs which
provide medical coverage and life insurance benefits to employees and directors
who meet minimum age and service requirements.

   The Company and its subsidiaries recognize costs related to post retirement
benefits under the accrual method, which recognizes costs over the employee's
period of active employment. The impact of adopting SFAS No. 106 is being
amortized over a twenty year period beginning January 1, 1993.

   The following reconciles the program's funded status with amounts recognized
in the Company's Consolidated Balance Sheet at December 31, 1996 and 1995:

<TABLE>
<CAPTION>
----------------------------------------------------------------------
                                                 1996       1995
----------------------------------------------------------------------
<S>                                             <C>        <C>
Accumulated postretirement benefit obligation:
   Retirees                                     $4,146     $4,170
   Fully eligible active program participants      427        817
   Other active program participants             1,476      1,704
                                                ------     ------
                                                 6,049      6,691
Plan assets                                         --         --
                                                ------     ------
Accumulated postretirement benefit
   obligation in excess of plan assets           6,049      6,691
Unrecognized net gain                            1,067        269
Unrecognized prior service cost                 (4,764)    (5,219)
                                                ------     ------
Accrued postretirement benefit cost
   included in other liabilities                $2,352     $1,741
                                                ======     ======

----------------------------------------------------------------------
</TABLE>

Net postretirement benefit cost for the year ended December 31, 1996, 1995 and
1994 included the following components:

<TABLE>
<CAPTION>
---------------------------------------------------------------
                                    1996      1995      1994
---------------------------------------------------------------
<S>                                 <C>       <C>     <C>
Service cost                        $127      $100    $  145
Interest cost                        417       469       514
Amortization of accumulated
   postretirement obligation         263       313       342
                                    ----      ----    ------
Net periodic postretirement
   benefit cost                     $807      $882    $1,001
                                    ====      =====   ======

---------------------------------------------------------------
</TABLE>

17. FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company discloses fair value information about financial instruments,
whether or not recognized in the balance sheet, for which it is practicable to
estimate fair value. Fair value estimates are made as of a specific point in
time based on the characteristics of the financial instruments and relevant
market information. Where available, quoted market prices are used. In other
cases, fair values are based on estimates using present value or other valuation
techniques. These techniques involve uncertainties and are significantly
affected by the assumptions used and judgments made regarding risk
characteristics of various financial instruments, discount rates, estimates of
future cash flows, future expected loss experience and other factors. Changes in
assumptions could significantly affect these estimates. Derived fair value
estimates cannot be substantiated by comparison to independent markets and, in
many cases, could not be realized in an immediate sale of the instrument. Also,
because of differences in methodologies and assumptions used to estimate fair
values, the Company's fair values should not be compared to those of other
banks.

   Fair value estimates are based on existing financial instruments without
attempting to estimate the value of anticipated future business and the value of
assets and liabilities that are not considered financial instruments.
Accordingly, the aggregate fair value amounts presented do not purport to
represent the underlying market value of the Company. For certain assets and
liabilities, the information required under SFAS No. 107 is supplemented with
additional information relevant to an understanding of the fair value. Also,
fair values are presented for certain assets that are not financial instruments
under the definition in SFAS No. 107.

   The following describes the methods and assumptions used by the Company in
estimating the fair values of financial instruments and certain non-financial
instruments:

   CASH AND CASH EQUIVALENTS, INCLUDING CASH AND DUE FROM BANKS,
INTEREST-BEARING DEPOSITS IN BANKS AND FEDERAL FUNDS SOLD. For these cash and
cash equivalents, which have maturities of 90 days or less, the carrying amounts
reported in the balance sheet approximate fair values.

   SECURITIES AVAILABLE FOR SALE AND LOANS HELD FOR SALE. Fair values, are based
on quoted bid market prices, where available. Where quoted market prices for an
instrument are not available, fair values are based on quoted market prices of
similar instruments, adjusted for differences between the quoted instruments and
the instrument being valued. Fair values are calculated based on the value of
one unit without regard to premiums or discounts that might result from selling
all of the Company's holdings of a particular security in one transaction.

   LOANS AND LEASES. The fair values of commercial, commercial real estate,
residential real estate, and certain consumer loans and leases are estimated by
discounting the contractual cash flows using interest rates currently being
offered for loans with similar terms to borrowers of similar quality.

   For certain variable-rate consumer loans, including home equity lines of
credit and credit card receivables, carrying value approximates fair value. This
method of estimating the fair value of the credit card portfolio excluded the
value of the ongoing customer relationships, a factor which can represent a
significant premium over book value.

   For nonperforming loans and certain loans where the credit quality of the
borrower has deteriorated significantly, fair values are estimated by
discounting cash flows at a rate commensurate with the risk associated with
those cash flows.


48


<PAGE>   52
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------


   MORTGAGE SERVICING RIGHTS. The fair value of the Company's mortgage servicing
rights is based on the expected present value of future mortgage servicing
income, net of estimated servicing costs.

   DEPOSITS. The fair value of deposits with no stated maturity is equal to the
carrying amount. The fair value of time deposits is based on the discounted
value of contractual cash flows, applying interest rates currently being offered
on the deposit products of similar maturities.

   The fair value estimates for deposits do not include the benefit that results
from the low-cost funding provided by the deposit liabilities compared to the
cost of alternative forms of funding ("deposit base intangibles")

   BORROWINGS, INCLUDING FEDERAL FUNDS PURCHASED, SECURITIES SOLD UNDER
REPURCHASE AGREEMENTS, BORROWINGS FROM THE FEDERAL HOME LOAN BANK OF BOSTON,
SUBORDINATED CAPITAL NOTES AND OTHER BORROWINGS. The fair value of the Company's
long-term borrowings is estimated based on quoted market prices for the issues
for which there is a market, or by discounting cash flows based on current rates
available to the Company for similar types of borrowing arrangements. For
short-term borrowings that mature or reprice in 90 days or less, carrying value
approximates fair value.

OFF-BALANCE SHEET INSTRUMENTS:
COMMITMENTS TO ORIGINATE LOANS AND COMMITMENTS TO EXTEND CREDIT AND STANDBY
LETTERS OF CREDIT. In the course of originating loans and extending credit and
standby letters of credit, the Company will charge fees in exchange for its
lending commitment. While these commitment fees have value, the Company has not
estimated their value due to the short-term nature of the underlying
commitments.

   FORWARD COMMITMENTS TO SELL LOANS. The fair value of the Company's forward
commitments to sell loans reflects the value of origination fees and excess
servicing recognizable upon sale of loans net of any cost to the Company if it
fails to meet its sale obligation. Of the $149.3 million of forward sales
commitments at December 31, 1996, the Company had $103.3 million of loans
available to sell at that date as well as sufficient loan originations
subsequent to December 31, 1996 to fulfill the commitments. Consequently, the
Company has no unmet sales obligation to value and due to the short-term nature
of the commitments has not estimated the value of the fees and servicing.

   LOANS SERVICED WITH RECOURSE. Under certain of the Company's servicing
arrangements with investors, the Company has recourse obligation to those
serviced loan portfolios. In the event of foreclosure on a serviced loan, the
Company is obligated to repay the investor to the extent of the investor's
remaining balance after application of proceeds from the sale of the underlying
collateral. To date, losses related to these recourse arrangements have been
insignificant and while the Company cannot project future losses, the fair value
of this recourse obligation is deemed to be likewise insignificant.

A summary of the fair values of the Company's significant financial instruments
at December 31, 1996 and 1995 follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
                                                      1996                               1995
--------------------------------------------------------------------------------------------------------
                                            CARRYING           FAIR           Carrying           Fair
                                              VALUE            VALUE            Value            Value
--------------------------------------------------------------------------------------------------------
<S>                                        <C>              <C>              <C>              <C>
Assets:
   Cash and cash equivalents               $  359,995       $  359,995       $  290,691       $  290,691
   Securities                               1,045,069        1,045,069          766,648          766,648
   Loans held for sale                        103,270          103,790           70,979           71,872
   Loans and leases                         3,587,112        3,767,093        2,717,608        2,776,912
   Mortgage servicing rights                   33,314           35,908           20,309           22,140

Liabilities:
   Deposit (with no stated maturity)       $2,388,768       $2,388,768       $1,834,043       $1,834,043
   Time deposits                            1,796,521        1,823,214        1,363,095        1,382,145
   Borrowings                                 690,969          689,003          456,932          458,116

--------------------------------------------------------------------------------------------------------
</TABLE>


49



<PAGE>   53
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

18. CONDENSED PARENT INFORMATION

Condensed Financial Statements of the Parent Company

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                                                                                 December 31,
---------------------------------------------------------------------------------------------------------------------------
Balance sheets                                                                        1996                      1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>                       <C>
Assets
   Cash and due from banks                                                          $  2,401                  $ 22,568
   Securities                                                                             --                     1,045
   Investment in bank subsidiaries                                                   418,074                   311,907
   Goodwill and other intangibles                                                     13,206                    14,392
   Amounts receivable from subsidiaries                                                6,331                     9,363
   Other assets                                                                        4,088                     5,315
                                                                                    --------                  --------
      Total assets                                                                  $444,100                  $364,590
                                                                                    ========                  ========

Liabilities and shareholders' equity
   Amounts payable to subsidiaries                                                      $188                      $132
   Notes payable                                                                       6,530                     7,836
   Other liabilities                                                                     372                     1,697
   Shareholders' equity                                                              437,010                   354,925
                                                                                    --------                  --------
      Total liabilities and shareholders' equity                                    $444,100                  $364,590
                                                                                    ========                  ========
</TABLE>

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                                                             Year Ended December 31,
---------------------------------------------------------------------------------------------------------------------------
Statements of Income                                     1996                         1995                      1994
---------------------------------------------------------------------------------------------------------------------------
<S>                                                    <C>                          <C>                       <C>
Operating income:
   Dividends from banking subsidiaries                 $ 67,710                     $ 23,007                  $ 10,590
   Gain (loss) on intercompany loan sales                    --                           --                      (430)
   Other operating income                                   625                          474                       452
                                                       --------                     --------                  --------
      Total operating income                             68,335                       23,481                    10,612
                                                       --------                     --------                  --------
Operating expenses:
   Interest on borrowings                                   609                          363                        --
   Amortization of goodwill                               1,505                        1,505                     1,505
   Amortization of acquisition premiums                     359                          359                       359
   Merger                                                    37                        4,958                        --
   Other operating expenses                                 907                          731                     1,242
                                                       --------                     --------                  --------
      Total operating expenses                            3,417                        7,916                     3,106
                                                       --------                     --------                  --------
Income before income taxes and equity
   in undistributed net income of subsidiaries           64,918                       15,565                     7,506

Income tax benefit                                          (25)                      (1,492)                     (432)
                                                       --------                     --------                  --------
Income before equity in undistributed
   net income of subsidiaries                            64,943                       17,057                     7,938

Equity in undistributed net income
   of subsidiaries (1)                                  (12,463)                      27,429                    26,110
                                                       --------                     --------                  --------
Net income                                             $ 52,480                     $ 44,486                  $ 34,048
                                                       ========                     ========                  ========

---------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Amounts in parenthesis represent the excess of dividends over net income
from subsidiaries.


50
<PAGE>   54
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
                                                                                 Year Ended December 31,
--------------------------------------------------------------------------------------------------------------------
Statements of Cash Flows                                                  1996            1995             1994
--------------------------------------------------------------------------------------------------------------------
<S>                                                                     <C>             <C>             <C>
Cash flows from operating activities:
   Net income                                                           $ 52,480        $ 44,486        $ 34,048
   Adjustments to reconcile net income to net
   cash (used) provided by operating activities:
      Undistributed net income from subsidiaries                          12,463         (27,429)        (26,110)
      Amortization of goodwill                                             1,505           1,505           1,505
      Amortization of acquisition premiums                                   359             359             359
      Securities losses (gains)                                               --               1            (165)
      Loss (gain) on intercompany loan sales                                  --              --             430
      (Increase) decrease in amounts receivable from subsidiaries          3,032          (7,973)           (459)
      Decrease (increase) in other assets                                    549            (119)           (130)
      Increase (decrease) in amounts payable to subsidiaries                  56              47              79
      Increase (decrease) in other liabilities                            (1,325)            488            (325)
      Other, net                                                          (2,081)         (1,021)           (609)
                                                                        --------        --------        --------
Net cash (used) provided by operating activities                          67,038          10,344           8,623
                                                                        --------        --------        --------
Cash flows from investing activities:
   Reissuance of treasury stock pursuant to acquisition                       --          11,274              --
   Issuance of notes payable pursuant to acquisition (net)                    --           7,836              --
   Sales of available for sale securities                                  1,045             622             255
   Purchase of available for sale securities                                  --            (622)             --
   Payment of notes payable                                               (1,306)             --              --
   Capital contribution to subsidiary                                    (13,000)             --              --
                                                                        --------        --------        --------
Net cash used (provided) by investing activities                         (13,261)         19,110             255
                                                                        --------        --------        --------
Cash flows from financing activities:
   Dividends paid to shareholders                                        (15,934)        (11,307)         (5,601)
   Treasury stock acquired                                               (60,342)         (8,317)         (1,322)
   Treasury stock sold                                                     2,332           1,507           1,628
                                                                        --------        --------        --------
Net cash provided (used) by financing activities                         (73,944)        (18,117)         (5,295)
                                                                        --------        --------        --------
Net increase (decrease) in cash and due from banks                       (20,167)         11,337           3,583

Cash and due from banks at beginning of year                              22,568          11,231           7,648
                                                                        --------        --------        --------
Cash and due from banks at end of year                                  $  2,401        $ 22,568        $ 11,231
                                                                        ========        ========        ========

--------------------------------------------------------------------------------------------------------------------
Supplemental disclosure information:
   Interest paid on borrowings                                          $    609        $    363             $--
--------------------------------------------------------------------------------------------------------------------
</TABLE>


                                                                              51
<PAGE>   55
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

19. SUBSEQUENT EVENT (UNAUDITED)

On January 24, 1997, the Company sponsored the creation of Peoples Heritage
Capital Trust I (the "Trust") a statutory business trust created under the laws
of Delaware. The Company is the owner of all of the common securities of the
Trust. On January 31, 1997, the Trust issued $100.0 million of 9.06% Capital
Securities (the "Capital Securities," and with the "Common Securities," the
"Trust Securities"), the proceeds from which were used by the Trust, along with
the Company's $3.1 million capital contribution for the Common Securities, to
acquire $103.1 million aggregate principal amount of the Company's 9.06% Junior
Subordinated Deferrable Interest Debentures due February 1, 2027 (the
"Debentures"), which constitute the sole assets of the Trust. The Company has,
through the Declaration of Trust establishing the Trust, Common Securities and
Capital Securities Guarantee Agreements, the Debentures and a related Indenture,
taken together, fully irrevocably and unconditionally guaranteed all of the
Trust's obligations under the Trust Securities. The Capital Securities will be
presented as a separate line item in future consolidated balance sheets of the
Company, entitled "Company-obligated mandatorily redeemable capital securities
of subsidiary trust holding solely junior subordinated debentures of the
Company." The Company has sought treatment that separate financial statements of
the Trust are not required pursuant to Staff Accounting Bulletin 53 of the
Securities and Exchange Commission.


20. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                                     1996                                                1995
-------------------------------------------------------------------------------------------------------------------------------
                                   FOURTH     THIRD       SECOND      FIRST            Fourth      Third     Second     First
                                  QUARTER    QUARTER     QUARTER     QUARTER          Quarter     Quarter    Quarter   Quarter
-------------------------------------------------------------------------------------------------------------------------------
<S>                               <C>        <C>         <C>        <C>               <C>        <C>        <C>        <C>
Interest income                   $90,827    $85,506     $84,085    $80,754           $80,162    $79,490    $74,364    $71,833
Interest expense                   40,168     37,562      37,254     35,615            35,854     35,344     32,970     30,727
Provision for loan losses              --         --         450        450             1,080      1,080      1,040      1,030
Net interest income after
   provision for loan losses       50,659     47,944      46,381     44,689            43,228     43,066     40,354     40,076
Noninterest income                  9,979      9,804       9,196      9,469             8,379      8,325      7,616      7,097
Noninterest expenses               37,649     36,256      39,586     34,582            35,253     31,901     30,983     32,143
Income before income taxes         22,989     21,492      15,991     19,576            16,354     19,490     16,987     15,030
Income tax expense                  7,450      7,300       5,848      6,970             5,930      6,701      5,776      4,968
Net income                         15,539     14,192      10,143     12,606            10,424     12,789     11,211     10,062
Earnings per share                   0.63       0.56        0.40       0.51              0.42       0.51       0.46       0.41
Cash earnings per share              0.69       0.61        0.45       0.54              0.44       0.53       0.49       0.43

-------------------------------------------------------------------------------------------------------------------------------
</TABLE>


52


<PAGE>   56
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------


INDEPENDENT AUDITORS' REPORT

The Board of Directors
Peoples Heritage Financial Group, Inc.:


We have audited the accompanying consolidated balance sheets of Peoples Heritage
Financial Group, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1996. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
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 Peoples Heritage
Financial Group, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1996, in conformity with generally accepted
accounting principles.

As discussed in Note 1, the Company changed its method of accounting for
mortgage servicing rights effective January 1, 1995.


                                            KPMG PEAT MARWICK LLP

January 22, 1997
Boston, Massachusetts


                                                                              53

<PAGE>   57
PEOPLES HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARIES
-------------------------------------------------------------------------------














54
<PAGE>   58
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------

CORPORATE DIRECTORY

--------------------------------------------------------------------------------

PEOPLES HERITAGE
FINANCIAL GROUP, INC.
BOARD OF DIRECTORS

[PHOTO]




WILLIAM J. RYAN (1,4)
Chairman of the Board
President & Chief Executive Officer
Chairman, Governance & Nominating Committee
Peoples Heritage Financial Group, Inc.
President & Chief Executive Officer
Peoples Heritage Bank

ROBERT A. MARDEN (1,4)
Vice Chairman of the Board
Chairman, Executive/ALCO Committee
Attorney-at-Law
Marden, Dubord, Bernier & Stevens

PAMELA P. PLUMB (1,3,4)
Vice Chairman of the Board
Pamela Plumb & Associates
Former President - National League of Cities


ROBERT P. BAHRE (1)
President & Chief Executive Officer
New Hampshire International Speedway

EVERETT W. GRAY (2,3,5)
Retired Attorney
Real Estate Investor

DAVIS P. THURBER
Chairman
Bank of New Hampshire

ANDREW W. GREENE (1,3,5)
President
Blue Cross/Blue Shield of Maine

KATHERINE M. GREENLEAF (1,3)
Chairman, Human Resources Committee
Principal
Katherine M. Greenleaf Consulting


MALCOLM W. PHILBROOK, JR. (1,2,5)
Chairman, Audit Committee Attorney & President
Crockett, Philbrook & Crouch, P.A.

CURTIS M. SCRIBNER (1,2,5)
Chairman, Asset Review
President
C. M. Scribner & Company

DANA S. LEVENSON (3,5)
President
Quatro Realty Corp.

PAUL R. SHEA
President & CEO
Bank of New Hampshire

JOHN E. VEASEY
President
Cedardale, Inc.

1.    Executive/ALCO Committee

2.    Audit Committee

3.    Human Resources Committee

4.    Governance & Nominating Committee

5.    Asset Review Committee



--------------------------------------------------------------------------------

PEOPLES HERITAGE BANK
BOARD OF DIRECTORS

[PHOTO]




[PEOPLES HERITAGE LOGO]




ROBERT A. MARDEN (1,3,6)
Chairman of the Board
Attorney-at-Law
Marden, Dubord, Bernier & Stevens

WILLARD B. ARNOLD III (1,3,4)
Chairman, Nominating Committee
Retired Sales Executive

EARL B. AUSTIN, JR. (1,2,4)
Accountant
Earl B. Austin, JL & Assoc., P.A.

CHARLES BELLEGARDE, JR. (2,4)
Consultant & President
Charles Bellegarde & Son, Inc.

PETER B. CHAPMAN (2,3,5)
President & Chief Executive Officer
Paris Farmers Union

MADELEINE R. FREEMAN (2)
Chairman
Audit Committee
Retired Executive Director
Eastern Area Agency on Aging


EVERETT W. GRAY (1,2,3,5)
Retired Attorney
Real Estate Investor

GUY A. HARTNETT (1,3,5)
President, Treasurer, Owner
One-Right Systems, Inc.
President
Lydimap Corp.

GALEN N. HOGAN (2,4)
President, Treasurer, Chief Executive Officer
Hogan Tire Co.

MALCOLM W. PHILBROOK, JR. (1,3,4,5,6)
Chairman, Executive Committee
Chairman, Liquidity & Funds Management Committee
Chairman, Trust Committee
Attorney & President
Crockett, Philbrook & Crouch P.A.

CURTIS M. SCRIBNER (1,4,5)
Chairman
Asset Review Committee
Principal
C.M. Scribner & Company


WILLIAM J. RYAN (1,3,4,5)
Chairman,
President & Chief Executive Officer
Peoples Heritage Financial Group, Inc.
President & Chief Executive Officer
Peoples Heritage Bank

DAVID M. MACMAHON (6)
President
Gates Formed-Fibre Products, Inc.

SHELTON S. WHITE, JR. (4)
President
H.E. Callahan Construction Co.

MEG BAXTER
President
United Way of Greater Portland

1.    Executive Committee

2.    Audit Committee

3.    Nominating Committee

4.    Liquidity & Funds Management Committee

5.    Asset Review Committee

6.    Trust Committee




                                                                              55
<PAGE>   59
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------



--------------------------------------------------------------------------------

PEOPLES HERITAGE
FINANCIAL GROUP, INC.
SENIOR MANAGEMENT




WILLIAM J. RYAN
President & Chief Executive Officer

PETER J. VERRILL, CPA
Executive Vice President & Chief Operating Officer & Chief Financial Officer

JOHN W. FRIDLINGTON
Executive Vice President
Commercial Lending


GLENN H. MCALLISTER
Executive Vice President
Residential and Consumer Lending

WENDY P. SUEHRSTEDT
Executive Vice President
Retail Delivery

R. SCOTT BACON
Executive Vice President
Bank of New Hampshire


DAVID D. HINDLE
Executive Vice President
Family Bank

CAROL L. MITCHELL, ESQ.
Executive Vice President General Counsel, Clerk & Secretary




--------------------------------------------------------------------------------

PEOPLES HERITAGE BANK
SENIOR MANAGEMENT




WILLIAM J. RYAN
President & Chief Executive Officer

PETER J. VERRILL, CPA
Executive Vice President, Chief Operating Officer & Chief Financial Officer

JOHN W. FRIDLINGTON
Executive Vice President
Commercial Lending

GLENN H. MCALLISTER
Executive Vice President
Residential and Consumer Lending

CAROL L. MITCHELL, ESQ.
Executive Vice President & General Counsel
Legal Affairs, Human Resources, Facilities

WENDY P. SUEHRSTEDT
Executive Vice President
Retail Banking


ANNE T. DUNNE
President
Heritage Investment Planning Services

NORMAND J. ALBERT
Senior Vice President
Commercial Lending

THOMAS P. HOGAN
Senior Vice President
Consumer Lending

JOSEPH W. HANSON, JR.
Senior Vice President
Operations

MAURICE C. GALLANT, JR.
Senior Vice President
Audit

THEODORE N. SCONTRAS
Senior Vice President
Public Finance

STEPHEN J. BOYLE
Senior Vice President
Controller


CYNTHIA H. HAMILTON
Senior Vice President
Human Resources

ELIZABETH K. WARN
Senior Vice President
Retail Mortgage

GARY L. ROBINSON
Senior Vice President
Trust and Investment Group

WENDY P. SUEHRSTEDT
Executive Vice President
Retail Banking

HALL THOMPSON
Senior Vice President
Investments

RICHARD J. VAIL
Senior Vice President
Commercial Lending

BRIAN E. WOOD
Senior Vice President
Marketing



--------------------------------------------------------------------------------

OXFORD BANK & TRUST
a division of Peoples Heritage Bank

SENIOR MANAGEMENT


EDWARD L. DILWORTH, JR.
Division President


NEIL R. ELDER
Senior Vice President




56
<PAGE>   60
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------



--------------------------------------------------------------------------------

PEOPLES HERITAGE
BANKING CENTERS




ASHLAND
10 Main Street

AUBURN
223 Center Street
Great Falls Plaza
Auburndale Plaza
600 Center Street

AUGUSTA
101 Western Ave

BANGOR
1067 Union Street
74 Hammond Street
353 Main Street
54 Springer Drive

BIDDEFORD
299 Elm Street

BREWER
508 Wilson Street

BRUNSWICK
208 1/2 Maine Street

CAMDEN
89 Elm Street

CARIBOU
Sweden Street
Caribou Mall

EAGLE LAKE
Church Street

EASTON
Main Street

ELLSWORTH
204 Main Street

FAIRFIELD
112 Main Street

FALMOUTH
223 U.S. Route #1

FARMINGTON
60 Main Street
Mount Blue Shopping Center,
Rts. 2 & 4

FORT FAIRFIELD
206 Main Street

FORT KENT
Pleasent Street Plaza


GRAY
Gray Plaza, Rt. # 26

HOULTON
6 North Street

KENNEBUNK
56 Portland Road

KITTERY
30 State Road

LEWISTON
217 Main Street
664 Main Street
790 Lisbon Street

LIMESTONE
222 Main Street

LINCOLN
Lincoln Plaza

LISBON FALLS
38 Main Street

MARS HILL
37 Main Street

NEWPORT
Main Street

NORTH WINDHAM
Route #302 Roosevelt Trail
Shaw's Supermarket,
Route #302

OAKLAND
11 Main Street

PITTSFIELD
60 Main Street

PORTLAND
One Portland Square
481 Congress Street
605 Congress Street
Westgate Shopping Center,
1370 Congress Street
449 Forest Avenue
Northgate Shopping Center,
3 Auburn Street

PRESQUE ISLE
551 Main Street

ROCKLAND
34 School Street


SACO
Saco Valley Shopping Center,
11 Scammon Street

SANFORD
Shaw's Shopping Plaza

SCARBOROUGH
Oak Hill Plaza

SEARSPORT
Main Street

SOUTH PORTLAND
Millcreek Shopping Center
415 Philbrook Road

THOMASTON
115 Main Street

VAN BUREN
29 Main Street

WASHBURN
12 Main Street

WATERVILLE
182 Main Street
Shaw's Plaza,
251 Kennedy Memorial Drive

WESTBROOK
835 Main Street

YARMOUTH
Shop 'N Save Plaza,
U.S. Route #1

YORK
127 Long Sands Road

----------------------------

OXFORD BANK & TRUST
BANKING CENTERS

OXFORD
Route 26

MECHANIC FALLS
80 Lewiston Street

WEST PARIS
Main Street

CASCO
Leach Hill Road

SOUTH PARIS
45 Main Street




                                                                              57
<PAGE>   61
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------



--------------------------------------------------------------------------------

BANK OF
NEW HAMPSHIRE
BOARD OF DIRECTORS

[PHOTO]


[BANK OF NEW HAMPSHIRE LOGO]




DAVIS P. THURBER
Chairman of the Board

PAUL R. SHEA
President & Chief Executive Officer

ARTHUR E. COMOLLI, DMD
General Dentistry

RAYMOND G. COTE
President (Retired)
Harvey Construction Co., Inc.

RAYMOND J. CRETEAU
President (Retired)
Riverside Millwork Co., Inc.

JOSEPH A. DESMOND
Chairman & Chief Executive Officer
The Concord Group Insurance Companies


RALPH GABARRO
Chief Operating Officer
Charter Brookside

PETER J. GRIFFIN
President
Great Bay Marine, Inc.

DONALD G. HAYES
President
Ricci Supply Company, Inc.

DIANA JURIS
Vice President and Chief Operating Officer
Nashua Motor Express

DANA S. LEVENSON
President
Quatro Realty Corp.

JOHN E. MENARIO
Special Assistant to the President
Peoples Heritage Financial Group, Inc.

JOHN M. PARSONS
Treasurer
MH Parsons & Son Lumber Co.

PETER PRUDDEN, JR.
Senior Account Executive
Moore Business Forms, Inc.

GERRY S. WEIDEMA
Partner
Weidema & Lavin, CPAs




--------------------------------------------------------------------------------

BANK OF
NEW HAMPSHIRE
SENIOR OFFICERS




PAUL R. SHEA
President & CEO

R. SCOTT BACON
Chief Operating Officer
Executive Vice President

HAROLD R. ACRES
Senior Executive Vice President
Chief Lending Officer

MARK A. COLLINS
Executive Vice President
Marketing & Strategic Planning

ROBERT B. ESAU
Executive Vice President
Trust Services

MARY A. SCHNOBRICH
Executive Vice President
Branch Administration


CAROLYN A. CLOUTIER
Senior Vice President
Commercial Lending

MAUREEN F. DONOVAN
Senior Vice President
Human Resources

THOMAS FURLONG
Senior Vice President
Trust Services

JOANNE T. HOWARD
Senior Vice President
Branch Administration

CORNEILUS J. JOYCE
Senior Vice President
Consumer & Mortgage Banking

DAVID H. MCARDLE
Senior Vice President
Commercial Lending


ROBERT J. MCDONALD
Senior Vice President
Loan Administration

STEVEN C. WEBB
Senior Vice President
Commercial Lending

DONNA F. CLARICO
Senior Vice President
Financial Services

PAUL E. DUFFY
Senior Vice President
Commercial Lending

MARY W. MCLAUGHLIN
Senior Vice President
Commercial Lending




58
<PAGE>   62
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------



--------------------------------------------------------------------------------


BANK OF
NEW HAMPSHIRE
LOCATIONS




BARRINGTON
Route 125 & Province Road

BEDFORD
184 Route 101

BRISTOL
Central Square

CONCORD
143 North Main Street
216 Loudon Road

CONTOOCOOK
884 Maine Street

CONWAY
51 White Mountain Highway

DOVER
353 Central Ave
Shaw's Plaza,
845 Central Ave

EPSOM
Epsom Circle

GLEN
Junction Routes 16 & 302

GOFFSTOWN
3 Elm Street

GREENLAND
650 Portsmouth Avenue

HAMPTON
853 Lafayette Road
40 High Street


HILLSBOROUGH
School Street

HOOKSETT
1288 Hooksett Road

HUDSON
80 Derry Road

LITTLETON
76 Main Street

MANCHESTER
300 Franklin Street
Two South Beech Street
293 South Main Street
1255 South Willow
70 Bay Street

MERRIMACK
300 Daniel Webster Highway
Harris Pond,
32 Daniel Webster Highway

NASHUA
191 Main Street
Nashua Mall
300 Main Street
4 Northwest Boulevard
Daniel Webster Plaza,
225 Daniel Webster Highway

NEWINGTON
2033 Woodbury Avenue

NEWMARKET
72 Exeter Street


NORTH CONWAY
Routes 16 & 302
Mountain Valley Mall

NORTHWOOD
Route 4

PORTSMOUTH
Two Harbour Place
325 State Street
Market Basket Plaza,
1500 Lafayette Road

ROCHESTER
1 Merchants Plaza,
Intersection Rts. 125 & 16B

RYE
500 Washington Road

STRATHAM
28 Portsmouth Avenue

SUNCOOK
50 Glass Street

WEST OSSIPEE
Junction Routes 16 & 25




                                                                              59
<PAGE>   63
Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------



--------------------------------------------------------------------------------

FAMILY BANK
BOARD OF DIRECTORS

[PHOTO]


[FAMILY BANK LOGO]


DAVID D. HINDLE
President & Chief Executive Officer

CHARLES GEORGE, JR.
President
Donahue & George Associates, Inc.

ELKIN B. MCCALLUM
President & Chief Executive Officer
Joan Fabrics

KENNETH L. PAUL
Vice President
Process Engineering, Inc.

JOHN E. VEASEY
President
Cedardale, Inc.


RICHARD L. BAILLY
Executive Vice President
UFP Technologies, Inc.

FRANCIS J. BERUBE
President & Treasurer
Westville Enterprises, Inc.

NELSON D. BLINN
Principal
Blinn & Farrell, CPAs

LAWRENCE J. EWING, JR.
Retired

WILLIAM J. LETOILE, JR.
President & Treasurer
Letoile Roofing Co., Inc.


DONALD R. MAIN
President
Don Main Auto Center, Inc.

JOHN F. REILLY, JR.
President & Chief Executive Officer
Fred C. Church, Inc.

NICOLA S. TSONGAS
Former Partner
Tsongas & Murphy, P.C.

L. DAVID VINCOLA
Principal
Lyman Associates, Management Consultants




--------------------------------------------------------------------------------

FAMILY BANK
SENIOR OFFICERS


DAVID D. HINDLE
Chairman
President & Chief Executive Officer


DAVID J. LAFLAMME
Senior Vice President
Commercial


RONALD G. TROMBLEY
Senior Vice President
Retail



--------------------------------------------------------------------------------

FAMILY BANK
LOCATIONS




MASSACHUSETTS
BRANCH OFFICES


HAVERHILL
Main Office,
153 Merrimack Street
Plainstow Road,
Route 125
Whittier Regional Vo-Tech HS,
115 Amesbury Line Road

ANDOVER
77 Main Street

BOXFORD
7 Elm Street

BRADFORD
860 South Main Street

CHELMSFORD
41 Drum Hill Road

DRACUT
1255 Bridge Street


GEORGETOWN
63 Central Street

GROVELAND
280 Main Street

LOWELL
45 Central Street,
33 Mammouth Road,
350 Westford Street

MIDDLETON
230 South Main Street,
Route 114

TOPSFIELD
16 Main Street,
Masconomet Regional High School,
20 Endicott Road

TYNGSBORO
One Pondview Place,
Middlesex Road



NEW HAMPSHIRE
BRANCH OFFICES


EXETER
82 Portsmouth Avenue


HAMPSTEAD
Main Street,
Route 21

KINGSTON
Carriage Town Plaza

PLAINSTOW
47 Plainstow Road

SEABROOK
270 Lafayette Road




60
<PAGE>   64
                         Peoples Heritage Financial Group, Inc. and Subsidiaries
--------------------------------------------------------------------------------
SHAREHOLDER INFORMATION
--------------------------------------------------------------------------------

ANNUAL MEETING

The 1997 Annual Meeting of the Shareholders of Peoples Heritage Financial Group,
Inc. will be held at 10:30 a.m. on Tuesday, April 22, 1997 at the Portland
Marriott at Sable Oaks, 200 Sable Oaks Drive, South Portland, Maine.

CORPORATE HEADQUARTERS
One Portland Square
Portland, Maine 04101
Mail Address:
P.O. Box 9540
Portland, ME  04112-9540

Contact: Brian S. Arsenault, Vice President,
Corporate Communications
(207)761-8517
1-800-462-3666 Outside Maine
1-800-462-6606 Outside Greater Portland

or

Peter J. Verrill
Executive Vice President, Chief Operating Officer and
Chief Financial Officer
(207)761-8507

STOCK LISTING

Peoples Heritage Financial Group, Inc. is traded over the counter on the NASDAQ
National Market System under the symbol: PHBK.

FORM 10-K AND OTHER REPORTS

Peoples Heritage will send a copy of its 1996 Annual Report on Form 10-K to
shareholders upon request. Requests should be addressed to Investor Relations at
the Corporate Headquarters.

TRANSFER AGENT

Shareholder inquiries regarding change of address or title should be directed
to:
American Stock Transfer & Trust Company
40 Wall Street
New York, NY 10005
Phone: 718-921-8206

INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

KPMG Peat Marwick LLP
One Boston Place
Boston, MA  02110

RESEARCH COVERAGE

Recent research coverage on Peoples Heritage Financial Group, Inc. is available
from Legg Mason Wood Walker, Inc., Keefe, Bruyette & Woods, Inc., Friedman
Billings Ramsey & Co., Merrill, Lynch, Pierce, Fenner & Smith, Inc., First
Albany Corp., Tucker Anthony Inc., Lehman Brothers, Inc., Southeast Research
Partners, Inc., Capital Resources, Inc. Research, and Maine Securities Corp.

MARKET MAKERS

The following companies have generally been market makers for Peoples Heritage
Financial Group, Inc. Common Stock as of December 31, 1996:

Advest, Inc.
Bear, Stearns & Co., Inc.
Dean Witter Reynolds, Inc.
First Albany Corporation
Fox-Pitt Kelton, Inc.
Friedman Billings Ramsey & Co.
Herzog, Heine, Geduld, Inc.
Keefe, Bruyette & Woods, Inc.
Knight Securities L.P.
Legg Mason Wood Walker, Inc.
Lehman Brothers, Inc.
M.A. Schapiro & Co., Inc.
Macallister Pitfield Mackay
Mayer & Schweitzer, Inc.
Merrill Lynch, Pierce,
   Fenner & Smith, Inc.
Morgan Stanley & Co., Inc.
Nash Weiss/Div. of Shatkin Inv.
PaineWebber, Inc.
Prudential Securities Inc.
Ryan Beck & Co., Inc.
Salomon Brothers Inc.
Sherwood Securities Corp.
Smith Barney, Inc.
Tucker Anthony Incorporated

--------------------------------------------------------------------------------

COMMON STOCK PRICES

Market prices for Peoples Heritage Financial Group, Inc.'s common stock and
dividends declared per quarter during 1996 and 1995 are as follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                               DIVIDENDS DECLARED
1996 QUARTERS                           PER SHARE       HIGH            LOW
--------------------------------------------------------------------------------
<S>                                     <C>             <C>             <C>
FIRST                                   $    .17        $ 22 3/4        $ 19
SECOND                                       .17          22 1/4          19 3/8
THIRD                                        .17          23 5/8          19
FOURTH                                       .18          28 5/8          22 1/2

1995 Quarters
--------------------------------------------------------------------------------
First                                   $    .11        $ 14            $ 11 3/4
Second                                       .13          16 3/4          12 3/8
Third                                        .13          20 1/2          15 1/4
Fourth                                       .15          22 7/8          18 1/4
--------------------------------------------------------------------------------
</TABLE>

         As of December 31, 1996, the Company had approximately 5,700
shareholders of record of the 28,407,603 shares outstanding. These numbers do
not reflect the number of individuals or institutional investors holding stock
in nominee name through banks, brokerage firms and others.

<PAGE>   65

--------------------------------------------------------------------------------
               PEOPLES HERITAGE                ONE PORTLAND SQUARE
               FINANCIAL GROUP, INC.          POST OFFICE BOX 9540
                                        PORTLAND, MAINE 04112-9540
--------------------------------------------------------------------------------