<PAGE>
 
                                                      [LOGO OF IROQUOIS BANCORP]

                    Meeting Challenges of a Changing Market




                   1998 Iroquois Bancorp, Inc. Annual Report
<PAGE>
 
Contents

Financial Highlights
A Message to Our
Shareholders
1

Cayuga Bank
2

The Homestead
Savings (FA)
3

Selected Consolidated
Financial Data
4

Management's
Discussion and Analysis
5

Report of Management
24

Consolidated Financial
Statements
23

Report of Independent
Auditors
24

Quarterly Information
46

Directors and Officers
47

Corporate Data
47
<PAGE>
 
We are certain the key to success continues to be achieving profitable revenue
growth, improving credit quality, and striking a balance between operating
efficiency and the delivery of exceptional personal service.
<PAGE>
 
          [BAR CHART APPEARS HERE]           [BAR CHART APPEARS HERE]

<TABLE> 
<CAPTION>
FINANCIAL HIGHLIGHTS
-----------------------------------------------------------------------------
(dollars in thousands,
except share data)                               1998      1997       1996
-----------------------------------------------------------------------------
<S>                                        <C>        <C>        <C> 
For the Year:
 Net interest income                       $   20,185    20,305     19,411
 Provision for loan losses                      1,470     1,520      1,334
 Non-interest income                            3,717     3,227      1,735
 Non-interest expense                          14,879    14,121     13,586

 Net income applicable to common shares         4,655     4,456      3,328
 
Per Common Share:
 Net income -- basic                       $     1.96      1.89       1.43
 Net income -- diluted                           1.92      1.85       1.41
 Cash dividends declared                          .40       .36        .32
 Book value at year end                         16.11     14.42      12.71
 Closing price                                  21.00     25.75      17.00
 
Ratios:
 Net interest margin                             4.01%     4.37       4.42
 Return on average assets                         .92      1.00        .82
 Return on average total equity                 12.82     13.54      11.51
 Return on average common equity                13.05     14.24      11.96
 Equity as a percent of average assets           7.14      7.39       7.12
 Dividend payout ratio                          20.41     19.05      22.38
 
At Year-End:
 Assets                                    $  547,420   509,778    472,908
 Loans, net                                   400,277   369,984    345,074
 Borrowings                                    61,591    50,164     25,536
 Deposits                                     443,239   417,011    410,222
 Shareholders' equity                          38,342    39,029     34,802
 
Number of:
 Common shares outstanding                  2,409,980 2,388,936  2,367,940
 Common shareholders of record                  1,302     1,365      1,206
 Employees (full time equivalent)                 195       200        191
 Banking offices (full service)                    11        11         12
</TABLE>
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
A MESSAGE TO OUR SHAREHOLDERS


[PICTURE OF RICHARD D. CALLAHAN APPEARS HERE]

Throughout 1998 we aggressively pursued our focused strategy for community
banking. This approach has permitted Iroquois to improve shareholder value in
the face of a rapidly changing marketplace.

     Our mission of strengthening member banks' competitive niche, while
simultaneously improving their operating efficiency, contributed to this year's
results.

     We took several important steps in 1998 to improve the Company's
performance and prepare for the Year 2000. These included:

     .  Enhancing revenue growth by using technology combined with customer
        knowledge to provide high-quality personal service and customized
        products.

     .  Improving efficiency by centralizing and standardizing deposit and loan
        operations, finance, human resources, and marketing services.

     .  Introducing a proactive service culture by implementing standards and
        comprehensive training for our staff to assure the delivery of superior
        service. Our research confirms the importance of professional, caring
        employees who know their customers.

     .  Strengthening underwriting criteria for commercial and retail loans
        through the introduction of new management and a more rigorous,
        disciplined process for tracking problem loans. Taking these steps will
        minimize future nonperforming assets.

     .  Preparing our member banks to ensure a smooth transition for the Year
        2000 date change by adopting the FFIEC Five Step Program and diligently
        working to complete the assessment, remediation, and testing of our
        technical systems. Management is satisfied with progress toward the
        objective of assuring our banking customers of no critical service
        interruptions.

The following financial highlights of 1998 demonstrate the value of these
efforts.

     .  Earnings available to common shareholders increased 4.5% to $4,655,000
        and earnings per share reached new highs of $1.96 basic and $1.92
        diluted.

     .  Book value per common share increased 11.7%, to $16.11.

     .  Return on common equity was 13.1%, marking six consecutive years of
        double digit returns to our shareholders.

     .  All $4.9 million of the Company's outstanding preferred stock was
        redeemed.

     As we move forward into the new millennium, we are prepared to address the
growing challenges facing this industry: net interest margins continue to
narrow; growth in fee income is more challenging; noninterest expense reductions
are more difficult to find; and loan provisions may increase with the
possibility of a more adverse credit climate.

     We are certain the key to success continues to be achieving profitable
revenue growth, improving credit quality, and striking a balance between
operating efficiency and the delivery of exceptional personal service. The
business strategy we have in place supports our belief in community banking and
its value to customers and communities.

     We thank our shareholders, customers, staff, and our communities for their
ongoing support.

Very truly yours,

/s/ Richard D. Callahan

Richard D. Callahan
President and Chief Executive Officer
<PAGE>
 
               IROQUOIS BANCORP, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------
               REPORT OF CAYUGA BANK

"... dedicated to the vital roles we play as community banks in our local
markets through involvement, economic development, and our assurance to provide
superior personal service."


     Cayuga Bank reinforced our competitive position in 1998 by combining
technology with greater understanding of our customers, making us more
responsive to the financial service needs of our community.

     Our expanded database marketing program has allowed us to develop one-on-
one relationships with a large number of established, multiservice customers,
adding value through direct, personal contact.

     We continued to offer our customers tailored products and services. With
the introduction of the VISA Check Card, we now provide the ultimate convenience
of a debit card that can replace checks, cash, and credit cards. We also
enhanced service delivery by launching 24-hour telephone banking. In addition,
plans for initiating Cash Management Services will result in the flexibility and
access our commercial customers need.

     Cayuga achieved a new record for mortgage loan production this year with
closings totaling $62 million. A combination of low interest rates and an
increase in the direct sales origination team resulted in a dramatic rise in our
new construction home lending as well as mortgages on existing properties. In
addition, we addressed our market's specific lending needs through the
introduction of Biweekly Mortgages, the marketing of Land Loans and Summer Home
Loans, and the continuation of our 24-hour mortgage approval program.

     We established processes to protect and improve the quality of our assets
including the Quarterly Classified Asset Review system designed to formalize and
rigorously manage all criticized and classified assets. Improvements made to our
commercial underwriting process allow us to better meet our customers' needs.

     Cayuga Bank recognizes our responsibility to reinvest in the communities we
serve. Renovations completed at our Main Office lead the way for the
rejuvenation of downtown Auburn. By establishing the Auburn Housing Partnership
with the City of Auburn and local businesses, we play a significant role in
renovating low income areas of Auburn and providing financing for qualified
families.

     We remain dedicated to the vital roles we play as community banks in our
local markets through involvement, economic development, and our assurance to
provide superior personal service.


  1998 HIGHLIGHTS FOR CAYUGA BANK 
  --------------------------------------------------------------------------

Introduced Saturday Banking at the Lacona Office.

Installed a new phone system and voice mail at the Main Office.
Active member in the local United Way Campaign.

Major sponsor of the "Made In Auburn and Nearby" Tradeshow, providing the
opportunity for over 70 local businesses to educate the community on the
diversity of businesses that thrive in Cayuga County.

Pledged a 3-year contribution to the Cayuga/Seneca Community Action Agency's
"Growing with the Community for a Better Future" campaign.
Continued support of capital campaigns at the Auburn YMCA-WEIU and The Cayuga
Museum with significant 3-year contributions.
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Report of The Homestead Savings (FA)

     Homestead Savings continued to answer the needs of our customers in 1998
through the introduction of relevant, creative products and enhanced service
delivery.

     We recognize the importance of knowing our customers and adding value to
these relationships through highly personal service. Instituting the database
marketing program has facilitated proactive, personal contact with our best
customers.

     Homestead's introduction of the Reverse Mortgage products, Home Keeper
Fannie Mae and HECM  FHA, addresses the lending needs of our senior customer
base by using the equity they have established in their homes. By initiating the
125% Home Equity Loan Program, we are the only bank in our market offering a
product that helps newer homeowners, without established equity, to borrow
against their home's value. In addition, we established credit card services for
our customers in 1998.

     We have also realigned our business products and services this year by
introducing Small Business Checking, maintaining competitive pricing, and
establishing night depository units at our Clinton and Main offices.

     We realized record mortgage and home equity loan volume in 1998. With
closings in excess of $28 million, Homestead is one of the leading lenders in
our market. In addition, our loan production office in Old Forge and our newly
established office in Lake Placid has allowed us to create a niche in the higher
yielding vacation home loan market. Deposits also increased this year by 7%, due
primarily to our continued success with the high-yield Investors Money Market
Account.

     Forging partnerships for economic development remains a top priority. We
provided mortgage financing to low-income individuals as part of the Rural
Housing Development Partnership. We also played active roles in the Downtown
Utica Development Association, the Utica Industrial Development Corporation, and
on the board of our regional economic development agency, the Mohawk Valley
EDGE.

     The Homestead Savings continues our commitment to provide exceptional
personal service and maintain our competitive position through efficient
delivery of the financial products and services our customers need.

"... committed to provide exceptional personal service and maintain our
competitive position through efficient delivery of the financial products and
services our customers need."


& THE HOMESTEAD SAVINGS
-------------------------------------------------------------------------

1998 Recipient of the Business and Professional Women's (BPW) Outstanding
Employer of the Year award.

Added a business development manager to cultivate new opportunities within our
core market.

Instituted Saturday Banking at the Waterville Office.

Participated in: the United Way campaign, as a "Pacesetter" organization; the
"Adopt A Family" program through Headstart; the American Heart Association's Run
and Walk; and Special Olympics sponsorships.

Provided continued support for an inner city tutoring program with the Utica
City School District.

Assisted in the 18th Annual "Spirit Of The Season" gift drive for the Mohawk
Valley Psychiatric Center.
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES

Selected Consolidated Financial Data
 
<TABLE> 
<CAPTION> 
--------------------------------------------------------------------------------------
                                            At, or for the year ended, December 31,
--------------------------------------------------------------------------------------
(dollars in thousands, except
share data)                                1998      1997     1996     1995     1994
--------------------------------------------------------------------------------------
<S>                                      <C>        <C>      <C>      <C>      <C>
BALANCE SHEET DATA
Total assets                             $547,420   509,778  472,908  437,803  423,977
Securities                                108,487   103,620   98,287   84,105   81,991
Total loans, net                          400,277   369,984  345,074  325,707  316,432
Deposits                                  443,239   417,011  410,222  369,101  358,876
Borrowings                                 61,591    50,164   25,536   35,250   34,778
Shareholders' equity                       38,342    39,029   34,802   31,846   28,110
--------------------------------------------------------------------------------------
INCOME STATEMENT DATA
Interest income                          $ 39,404    37,522   35,763   33,713   30,639
Interest expense                           19,219    17,217   16,352   15,752   12,521
--------------------------------------------------------------------------------------
Net interest income                        20,185    20,305   19,411   17,961   18,118
Provision for loan losses                   1,470     1,520    1,334      917      830
Noninterest income                          3,717     3,227    1,735    2,461    1,556
Noninterest expense                        14,879    14,121   13,586   12,650   13,138
Income tax expense                          2,711     2,994    2,447    2,704    2,283
--------------------------------------------------------------------------------------
Net income                                  4,842     4,897    3,779    4,151    3,423
Dividends on preferred stock                  187       441      451      469      415
--------------------------------------------------------------------------------------
Net income applicable to
 common shares                           $  4,655     4,456    3,328    3,682    3,008
--------------------------------------------------------------------------------------
PER COMMON SHARE DATA
Net income per common share:
 Basic                                   $   1.96      1.89     1.43     1.60     1.32
 Diluted                                     1.92      1.85     1.41     1.59     1.31
Cash dividends declared                       .40       .36      .32      .30      .28
Book value                                  16.11     14.42    12.71    11.60    10.02
--------------------------------------------------------------------------------------
RATIOS
Yield on interest-earning assets             7.83%     8.08     8.15     8.18     7.73
Cost of interest-bearing liabilities         4.19      4.07     4.03     4.11     3.37
Interest rate spread                         3.64      4.01     4.12     4.07     4.36
Net interest margin                          4.01      4.37     4.42     4.36     4.57
Return on average assets                      .92      1.00      .82      .97      .83
Return on average total equity              12.82     13.54    11.51    14.05    12.80
Return on average common equity             13.05     14.24    11.96    15.04    13.91
Equity as a percent of average assets        7.14      7.39     7.12     6.89     6.49
Dividend payout ratio                       20.41     19.05    22.38    18.75    21.21
--------------------------------------------------------------------------------------
</TABLE>

4
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

INTRODUCTION

     Iroquois Bancorp, Inc. ("Iroquois" or the "Company") is a New York
corporation and the bank holding company of two financial institutions: Cayuga
Bank ("Cayuga") of Auburn, New York, a New York state-chartered commercial bank
and trust company, and The Homestead Savings (FA) ("Homestead") of Utica, New
York, a federally chartered savings association. Iroquois, through its member
banks, Cayuga and Homestead ("the Banks"), provides banking services to
individuals and businesses in upstate New York, primarily in Cayuga, Oswego,
Oneida and Madison counties and surrounding areas. The Banks, reflective of
their market area, provide a range of financial services, including residential
mortgage loans, consumer and commercial loans, credit cards, insurance
brokerage, investment brokerage, trust services and safe deposit facilities.

     The following discussion and analysis reviews the Company's consolidated
results of operations for the years 1996 through 1998 and its consolidated
financial position at December 31, 1998 and 1997. This section should be
reviewed in conjunction with the consolidated financial statements and
accompanying notes and with other statistical information included elsewhere in
this 1998 Annual Report.

     In addition to historical information, this discussion and analysis
includes certain forward-looking statements based on current management
expectations. These statements relate to, among other things, sources of loan
and deposit growth, loan loss reserve adequacy, simulation changes in interest
rates, and Year 2000 activities. The Company's actual results could differ
materially from these management expectations. Factors that could cause future
results to vary from current management expectations include, but are not
limited to, general economic conditions, legislative and regulatory changes,
monetary and fiscal policies of the federal government, changes in tax policies,
rates and regulations of federal, state, and local tax authorities, changes in
interest rates, deposit flows, the cost of funds, demand for loan products,
demand for financial services, competition, changes in accounting principles,
policies or guidelines, and other economic, competitive, governmental, and
technological factors affecting the Company's operations, markets, products,
services, and prices.

PERFORMANCE OVERVIEW

     Iroquois reported 1998 diluted earnings per common share of $1.92 compared
with $1.85 per share in 1997. Net income available to common shareholders was
$4,655,000 in 1998, an increase of 4.5%, compared with $4,456,000 in 1997.
Return on common shareholders' equity and return on assets were 13.1% and .92%,
respectively, in 1998, compared with 14.2% and 1.0%, respectively, in 1997.

     Net interest income for 1998 totaled $20.2 million, compared with $20.3
million in 1997. Noninterest income, excluding net gains on sales of loans and
securities, increased $366,000, or 11.7%, for 1998. The Company recorded
$223,000 in gains on the sale of loans and securities for 1998, compared with
$99,000 for 1997. Noninterest expense increased from $14.1 million in 1997 to
$14.9 million in 1998.

     Total assets grew 7.4% in 1998 to end the year at $547.4 million. Net loans
increased 8.2% to $400.3 million, compared to $370.0 million at December 31,
1997. Total deposits were $443.2 million at December 31, 1998, compared to
$417.0 million at year end 1997, an increase of 6.3%. Total shareholders' equity
at December 31, 1998 was $38.3 million, down 1.8% from year end 1997, reflecting
net income for the year less dividend payments and the redemption in 1998 of all
$4.9 million of the Company's outstanding preferred stock.

                                                                               5
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

RESULTS OF OPERATIONS
REVIEW OF 1998 COMPARED TO 1997

NET INTEREST INCOME

     Net interest income, the principal source of earnings for the Company,
represents the difference between income from interest-earning assets, primarily
loans and securities, and expense of interest-bearing liabilities, primarily
deposits and borrowings. Net interest income is significantly affected by the
mix and volume of interest-earning assets and liabilities, as well as related
interest rates and cost of funds. While Iroquois has the ability to control the
effect of some of these factors through its asset and liability management and
planning strategies, external factors, such as competitive pressures, economic
conditions, and U.S. monetary policy, can also influence changes in net interest
income from one period to another.

     Two key ratios are used to measure relative profitability of net interest
income. Net interest spread measures the difference between the yield on earning
assets and the rate paid on interest-bearing liabilities. Net interest margin
measures net interest income as a percentage of average total earning assets.
Net interest margin, unlike net interest spread, takes into account the level of
earning assets funded by interest-free sources such as noninterest-bearing
demand deposits and equity capital.

     Net interest income totaled $20.2 million for 1998, a slight decrease
compared to $20.3 million in net interest income for 1997. Net interest income
was maintained through increased volumes despite declines in the Company's net
interest spread and net interest margin. Declines in longer term market interest
rates combined with changes in the mix of interest earning assets caused the
yield on earning assets to decline from 8.08% for 1997 to 7.83% for 1998. In
contrast, the cost of interest-bearing liabilities increased from 4.07% for 1997
to 4.19% for 1998, reflecting the flatter interest rate yield curve and a
continued reliance on higher costing time deposits and borrowings as a funding
source. The decline in yield and increase in cost of funds, resulted in a
contraction of 37 basis points in net interest spread from 4.01% for 1997 to
3.64% for 1998. Net interest margin decreased a similar amount from 4.37% for
1997 to 4.01% for 1998.

     Average securities, which continue to represent approximately 21% of
interest-earning assets, increased from $103.2 million for 1997 to $105.6
million for 1998. Securities yielded an average of 6.08% for 1998, compared to
6.40% for 1997.

     Average loans increased $32.7 million, or 9.2%, in 1998 and continue to
represent approximately 77% of interest-earning assets. Within the loan
portfolio, however, average mortgage loans increased 14.4% while other loans
declined 1.8%. Mortgage loans, which yielded 7.94%, represented 54.9% of average
interest-earning assets in 1998, compared to 1997 when average mortgage loans,
which yielded 8.17%, represented 51.9% of earning assets. Interest income earned
on mortgage loans increased $2.2 million primarily as a result of increased
residential mortgage lending volumes. The lower yield on the mortgage portfolio,
which contributed significantly to the overall decline in the yield on earning
assets for 1998, reflects the continued decline in market interest rates for
residential mortgages. Reflecting the average change in the prime rate from 1997
to 1998, the yield on other loans decreased from 9.44% in 1997 to 9.26% in 1998.

     Average interest-bearing liabilities increased 8.3% to $458.5 million in
1998 from $423.3 million in1997. Average savings deposits, which include
savings, money market and interest checking accounts, remained flat at $193.5
million with an average cost of 2.5%. However, as a percentage of interest-
bearing liabilities, savings deposits declined from 45.7% in 1997 to 42.2% in
1998. Average borrowings increased from $29.9 million, or 7.1% of average
interest-bearing liabilities, in 1997 to $52.0 million, or 11.3%, in 1998. The
average cost of borrowings remained at 5.9%, reflecting fairly constant short-
term rates and an increase in the use of term advances. Average time deposits
increased 6.5% from $200.0 million in 1997 to $213.0 million in 1998 and
continued to represent approximately 47% of interest-bearing liabilities. The
average cost of time deposits increased from 5.30% in 1997 to 5.36% in 1998,
primarily reflecting the continued growth in public fund (municipal) time
deposits, which carry a higher interest cost than retail time deposits.

6
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

     Average noninterest bearing liabilities, consisting primarily of commercial
and retail demand deposits, increased 8.7% from $29.9 million in 1997 to $32.5
million in 1998. Combined with the increase in average shareholders' equity,
noninterest-bearing funding sources contributed 37 basis points to net interest
margin in 1998, compared to 36 basis points in 1997.

     A summary of net interest income as well as average balances for interest-
earning assets and interest-bearing liabilities for the years 1996 through 1998
is presented in Table 1. Table 2 provides the detail of changes in interest
income, interest expense, and net interest income due to changes in volumes and
rates. A discussion of interest rate sensitivity is included in the Market Risk
and Interest Rate Risk Management section.

Table 1 -- NET INTEREST INCOME ANALYSIS

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                   Year ended December 31,
------------------------------------------------------------------------------------------------------------------------------------
                                                            1998                         1997                        1996
------------------------------------------------------------------------------------------------------------------------------------
Average                                         Average             Average   Average           Average                     Average
(dollars in thousands)                          Balance   Interest    Rate    Balance  Interest   Rate    Balance  Interest  Rate
------------------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>       <C>       <C>       <C>      <C>      <C>       <C>      <C>      <C>
INTEREST EARNING ASSETS                      
Mortgage loans1                                 $276,140    21,934     7.94%  241,355    19,713     8.17  232,907    19,378  8.32
Other loans1                                     113,035    10,467     9.26   115,135    10,866     9.44  109,286    10,225  9.36
Securities                                       105,606     6,421     6.08   103,218     6,606     6.40   91,924     5,838  6.35
Federal funds sold and                       
 other investments                                 8,577       582     6.79     4,883       337     6.90    4,933       322  6.53
------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning                       
 assets                                          503,358    39,404     7.83   464,591    37,522     8.08  439,050    35,763  8.15
Noninterest-earning                          
 assets                                           25,424                       24,803                      22,185
------------------------------------------------------------------------------------------------------------------------------------
Total Assets                                    $528,782                      489,394                     461,235
------------------------------------------------------------------------------------------------------------------------------------
INTEREST BEARING LIABILITIES                 
Savings deposits                                $193,483     4,735     2.45%  193,451     4,866     2.52  194,097     4,907  2.53
Time deposits                                    213,016    11,417     5.36   200,010    10,591     5.30  184,401     9,852  5.34
Borrowings                                        52,024     3,067     5.90    29,869     1,760     5.89   27,757     1,593  5.74
------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing                       
 liabilities                                     458,523    19,219     4.19   423,330    17,217     4.07  406,255    16,352  4.03
Noninterest-bearing                          
 liabilities                                      32,479                       29,879                      22,130
------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities                                491,002                      453,209                     428,385
Shareholders' Equity                              37,780                       36,185                      32,850
------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and                        
 Shareholders' Equity                           $528,782                      489,394                     461,235
------------------------------------------------------------------------------------------------------------------------------------
Net interest income and                      
 interest rate spread                                     $ 20,185     3.64%             20,305     4.01             19,411  4.12
Net interest margin                          
 on earning assets                                                     4.01                         4.37                     4.42
Ratio of interest-earning                    
 assets to interest-bearing                  
 liabilities                                                         109.78                       109.75                   108.07
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1)  Nonaccrual loans are included in the average asset totals presented above.

                                                                               7
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

[BAR CHART OF NONINTEREST INCOME APPEARS HERE]

<TABLE>
<CAPTION>
Table 2 -- RATE/VOLUME ANALYSIS
--------------------------------------------------------------------------------------------------------
                                         Comparison of the                Comparison of the
                                            Years Ended                       Years Ended
                                    December 31, 1998 and 1997        December 31, 1997 and 1996
--------------------------------------------------------------------------------------------------------
                                        Increase (Decrease)               Increase (Decrease)
                                         Due to Change In:                 Due to Change In:
                                                           Total                             Total
                                 Average       Average   Increase  Average    Average      Increase
(dollars in thousands)           Balance        Rate    (Decrease) Balance      Rate      (Decrease)
--------------------------------------------------------------------------------------------------------
<S>                              <C>           <C>      <C>        <C>        <C>         <C>  
Loans                             $2,358       (536)      1,822     1,210       (234)        976
Securities                           (89)       (96)       (185)      722         46         768
Federal funds sold and           
 other investments                   235         10         245        (3)        18          15
-------------------------------------------------------------------------------------------------------- 
Interest income                    2,504       (622)      1,882     1,929       (170)      1,759
-------------------------------------------------------------------------------------------------------- 
Savings deposits                      87       (218)       (131)     (292)       251         (41)
Time deposits                        684        142         826       846       (107)        739
Borrowings                         1,418       (111)      1,307       124         43         167
-------------------------------------------------------------------------------------------------------- 
Interest expense                   2,189       (187)      2,002       678        187         865
-------------------------------------------------------------------------------------------------------- 
Net interest income               $  315       (435)       (120)    1,251       (357)        894
-------------------------------------------------------------------------------------------------------- 
</TABLE> 

Note: The changes that are not due solely to volume or rate are allocated to
volume and rate based on the proportion of the change in each category.

NONINTEREST INCOME

     Noninterest income, excluding net gains on sales of loans and securities,
totaled $3.5 million for 1998, up 11.7%, compared to $3.1 million for 1997.
Service charges, the Company's primary source of noninterest income, represent
revenue from such sources as service charges on deposits and loans and
processing fees relating to electronic banking and credit card services. Revenue
from service charges for 1998 increased $399,000, or 15.7%, compared to 1997,
primarily due to increased loan and deposit related service fees, ATM
surcharges, and increased credit card processing income.

[BAR CHART OF OVERHEAD RATIO APPEARS HERE]

NONINTEREST EXPENSE

     Noninterest expense increased 5.4% from $14.1 million in 1997 to $14.9
million in 1998, primarily reflecting increases in computer and product service
fees and salaries and benefits. The Company's overhead ratio, noninterest
expense as a percentage of average assets, improved from 2.89% for 1997 to 2.81%
for 1998.

     Salaries and benefits for 1998 increased $236,000, or 3.2%, compared to
1997, and was primarily attributable to overall merit increases. Salaries and
benefits represented 50.8% of total noninterest expense for 1998, compared to
51.9% for 1997.

     Computer and product service fees increased 26.2%, from $1.3 million in
1997 to $1.7 million in 1998. Computer service fees increased $259,000 in 1998,
reflecting a full year of services with Fiserv, Inc., the Company's primary data
processing and item processing provider. Computer service fees include the cost
of item processing services that were outsourced to Fiserv, Inc. in mid-1997 and
that have provided savings to the Company through reduced internal staffing and
equipment costs. Increases in 1998 for third party processing costs relating to
the Company's credit card services also contributed to the overall increase in
computer and product service fees.

     Occupancy and equipment expense declined $70,000, or 4.1%, in 1998,
compared to 1997. This decline was a result of savings in property taxes,
utilities and equipment costs, offset by increased depreciation expense relating
to Cayuga's main office renovation completed in 1998.

8
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis


     Promotion and marketing expense increased 29.5% from $356,000 in 1997 to
$461,000 in 1998. The increase was principally attributable to promotional costs
relating to retail loan and deposit products, as well as primary market research
costs.

PROVISION FOR INCOME TAXES

     For 1998, the provision for income taxes was $2.7 million with an effective
tax rate of 35.9%. The provision for income taxes for 1997 was $3.0 million with
an effective tax rate of 37.9%. The decline in the Company's effective tax rate
is primarily attributable to the increased investment in tax exempt municipal
securities. A more comprehensive analysis of income tax expense is included in
Note 8 to the consolidated financial statements included in this Annual Report.

REVIEW OF 1997 COMPARED TO 1996

     Iroquois reported net income applicable to common shareholders of $4.5
million in 1997, or $1.85 per common share, compared to $3.3 million, or $1.41
per share, reported in 1996. Return on assets improved from .82% in 1996 to
1.00% in 1997. Return on average equity improved from 11.51% in 1996 to 13.54%
in 1997, while the return on common shareholders' equity improved from 11.96% in
1996 to 14.24% in 1997. Growth in net income and earnings per share in 1997
reflected increases in net interest income and noninterest income compared to
1996, when earnings were unfavorably affected by a $1.1 million loss on the sale
of certain classified commercial mortgage loans and a $556,000 assessment for
the recapitalization of the Federal Deposit Insurance Corporation's Saving
Association Insurance Fund (SAIF).

     Net interest income totaled $20.3 million for the year ended December 31,
1997, compared to $19.4 million for 1996. The $894,000, or 4.6%, increase was
principally the result of a 5.8% increase in average interest-earning assets in
1997 and a 20.2% increase in noninterest bearing funding sources including
demand deposits, other liabilities, and shareholders' equity. Net interest
margin for 1997 decreased to 4.37% from 4.42% in 1996. The decrease in net
interest margin was primarily attributable to the decrease in net interest
spread from 4.12% in 1996 to 4.01% in 1997. The average yield on interest-
earning assets declined 7 basis points in 1997, to 8.08%, while the average cost
of interest-bearing liabilities increased 4 basis points, to 4.07%, for 1997.

     Noninterest income totaled $3.2 million for 1997, up 86.0% compared to $1.7
million for 1996. The increase of $1.5 million over the prior year was due
primarily to the net loss of $1.0 million on the sale of loans and securities in
1996, compared to a net gain of $99,000 in 1997. In addition, revenue from
service charges increased $336,000, or 15.2%, for 1997 compared to the prior
year, principally due to an increase in the service fees earned by Cayuga
through the Business Manager accounts receivable management program as well as
increases in retail loan and deposit fees.

     The 1997 provision for loan losses increased $186,000, to $1.5 million,
compared to $1.3 million in 1996. The increase in the provision reflects
additions to the allowance for loan losses to maintain a sufficient coverage
level given increases in net charge-offs and nonperforming loans.

     Noninterest expense totaled $14.1 million for 1997, compared to $13.6
million for 1996. Increases in 1997 for salaries and benefits, computer and
product service fee expenses, and other expenses were offset by a $645,000
decrease in deposit insurance expense. The decrease in deposit insurance was
attributable to the 1996 assessment that recapitalized SAIF and lowered premiums
for federally insured savings and loans, such as Homestead. Noninterest expense,
as a percentage of average assets, was 2.89% for 1997, compared to 2.95% for
1996.

     Salaries and benefits increased $631,000, to $7.3 million for 1997,
compared to $6.7 million for 1996, due to increased staffing, general merit
increases, and the full implementation of a Company-wide incentive compensation
plan. Computer and product service fees increased $283,000, or 27.1%, due
principally to expenses relating to the Company's data processing conversion in
1997, the outsourcing of the Company's item processing services,

                                                                               9
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

and an increase in service fees relating to the Business Manager product. Other
real estate expenses decreased $55,000 to $333,000 for 1997, compared to
$388,000 for 1996. Other noninterest expenses increased $290,000 to $3.0 million
for 1997, compared to $2.7 million for 1996. Other expenses included a $154,000
increase for a full year of amortization of the intangible asset recognized in
the acquisition of branches and related deposits from OnBank & Trust Co. in May
1996. In addition, legal and consulting fees increased $148,000 due to Cayuga's
costs in defending a civil suit along with consulting services incurred in 1997
for corporate and employee benefit plan analyses.

     For 1997, the provision for income taxes was $3.0 million for an effective
tax rate of 37.9%. The provision for income taxes for 1996 was $2.4 million with
an effective tax rate of 39.3%.

FINANCIAL CONDITION

LOANS

     Total loans at December 31, 1998 were $404.1 million, up $30.8 million or
8.3%, compared to $373.3 million in total loans at December 31, 1997. The
increase in total loans came exclusively from the growth in residential mortgage
loans. Table 3 provides a five-year summary of the loan portfolio.

     Loans, the largest component of the Company's earning assets, continue to
represent approximately 73% of total assets. Mortgage loans represent the
largest portion of the loan portfolio, increasing from 68.8% of total loans at
year end 1997, to 72.8% of total loans at December 31, 1998. The mortgage
portfolio consists of loans secured by first or second liens on residential or
commercial properties located principally in upstate New York. Residential
mortgage loans are underwritten and documented in accordance with secondary
market standards. Commercial mortgage loans have generally been originated on
properties in and around Cayuga's market area.

<TABLE>
<CAPTION>
Table 3 -- SUMMARY OF THE LOAN PORTFOLIO
----------------------------------------------------------------------------
                                                  December 31,
----------------------------------------------------------------------------
(dollars in thousands)              1998     1997     1996     1995     1994
----------------------------------------------------------------------------
<S>                             <C>       <C>      <C>      <C>      <C>
Mortgage loans
 Residential                    $254,755  215,255  188,187  171,883  169,518
 Commercial                       39,497   41,678   46,022   53,363   54,321
----------------------------------------------------------------------------
Total mortgage loans             294,252  256,933  234,209  225,246  223,839
----------------------------------------------------------------------------
Other loans
 Home equity lines of credit      26,473   27,110   25,486   24,200   24,589
 Consumer                         45,358   45,401   46,551   40,974   32,499
 Commercial                       37,573   41,920   40,009   35,904   35,118
 Education                           436    1,905    2,208    2,763    3,651
----------------------------------------------------------------------------
Total other loans                109,840  116,336  114,254  103,841   95,857
----------------------------------------------------------------------------
Total loans                      404,092  373,269  348,463  329,087  319,696
Allowance for loan losses          3,815    3,285    3,389    3,380    3,264
----------------------------------------------------------------------------
Loans, net                      $400,277  369,984  345,074  325,707  316,432
----------------------------------------------------------------------------
</TABLE>

10
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

The following table shows maturities of certain loan classifications at December
31, 1998 and an analysis of the rate structure for such loans due in over one
year.

<TABLE>
<CAPTION>
SELECTED LOAN MATURITY AND INTEREST RATE SENSITIVITY
--------------------------------------------------------------------------------------------------------------
                                                                                  RATE STRUCTURE FOR LOANS
                                          MATURITY                                 MATURING OVER ONE YEAR
--------------------------------------------------------------------------------------------------------------
                              ONE       OVER ONE YEAR      OVER                PREDETERMINED      FLOATING OR
                            YEAR OR     THROUGH FIVE       FIVE                   INTEREST        ADJUSTABLE
(DOLLARS IN THOUSANDS)       LESS           YEARS         YEARS      TOTAL          RATE             RATE
--------------------------------------------------------------------------------------------------------------
<S>                         <C>          <C>              <C>       <C>        <C>                <C> 
Commercial Loans            $33,739         2,366         1,468     37,573         3,834              --
--------------------------------------------------------------------------------------------------------------
</TABLE>

                             [GRAPH APPEARS HERE]

     Residential mortgage loans increased 18.5% from $215.3 million at December
31, 1997, to $254.8 million at December 31, 1998. Cayuga originated $62 million
in residential mortgage loans, including $31 million originated through mortgage
brokers for properties located in the greater Rochester and Syracuse markets,
outside Cayuga's primary market area. Homestead generated $28 million in local
mortgage loans during 1998, including loans originated through loan production
offices located in Old Forge and Lake Placid, NY.

     Commercial mortgage loans, which represent 9.8% of total loans at December
31, 1998, declined $2.2 million, or 5.2%, from year end 1997 to year end 1998.
Continued high rates of amortization and prepayment, stricter underwriting
standards, along with slower demand and increased competition have caused the
commercial mortgage portfolio to decline over the past five years.

     Consumer loans, which include auto loans, fixed-rate home equity and home
improvement loans, overdraft protection, credit cards, and other personal
installment loans, declined less than 1% at December 31, 1998, compared to year
end 1997. Consumer loans represent 11.2% of total loans at year end 1998,
compared to 12.2% at year end 1997. Competition from large credit card
companies, auto leasing, and dealer financing programs have kept consumer loan
balances relatively constant over the past three years.

     Home equity lines of credit, which provide customers with check writing
privileges against an accessible line of credit secured by a lien on residential
real estate, continue to be a very competitive product in the Banks' market
areas. Outstanding balances against home equity lines of credit declined 2.3%
from $27.1 million at December 31, 1997 to $26.5 million at year end 1998. With
the decline in mortgage rates in 1998, many customers refinanced and
consolidated their outstanding home equity lines into first mortgages. Home
equity lines of credit represented 6.6% and 7.3% of total loans at December 31,
1998 and 1997, respectively.

     Educational loans, which consist of loans originated through federal and
state sponsored student lending programs, declined $1.5 million in 1998 because
of the Company's decision to sell all of its education loans that had reached a
full disbursement status. Previously, education loans were held in portfolio and
sold when the loan reached repayment status, which typically consisted of two to
four annual disbursement cycles, depending on the student's graduation date.

     Commercial loans declined $4.3 million, or 10.3%, from $41.9 million at
December 31, 1997 to $37.6 million at year end 1998. Declines were primarily a
result of increases in corporate liquidity leading to lower borrowing demands.
Commercial loans represented 9.3% of total loans at December 31, 1998, compared
to 11.2% at December 31, 1997. Cayuga continues to be the only subsidiary to
offer commercial lending, offering a variety of loan products to its business
customers, including notes, lines of credit, installment loans, and an accounts
receivable management program. Commercial lending is generally considered to
involve a higher degree of risk than the Banks' other forms of lending. These
loans tend to

                                                                              11
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

have larger balances, and repayment is typically dependent on the successful
operations and income stream of the borrower. Underlying collateral for these
loans typically consists of business assets, which can be subject to market
obsolescence. Such risks can be significantly affected by economic and
competitive factors. To control this risk, the Company generally limits its
lending to any one borrower, or group of related borrowers, to a maximum of 10%
of its capital.

At December 31, 1998, Iroquois had no significant concentration of loans in any
single industry, nor did the loan portfolio contain any loans to finance highly
speculative transactions. Management expects new lending volume in 1999 to be
generated primarily through residential mortgage and home equity loans along
with targeted growth in commercial loans and mortgages.

ALLOWANCE FOR LOAN LOSSES

     The allowance for loan losses represents amounts available for future loan
losses and is based on management's ongoing evaluation of the loan portfolio
taking into consideration such factors as historical loan loss experience, the
detailed review of specific loans identified under the Company's internal review
processes, estimated losses on impaired loans, current economic conditions, and
other pertinent factors. Management monitors the entire loan portfolio in an
attempt to identify problem loans or risks in the portfolio in a timely manner
and to maintain an appropriate allowance for loan losses.

     The primary responsibility and accountability for daily lending activities
rests with the Banks. Loan personnel at each Bank have the authority to extend
credit under board approved lending policies. Each Bank maintains a continuous
and comprehensive loan review program developed in conjunction with the type,
level, and risk of its particular loan portfolio. The loan review program is
designed to evaluate credit quality, loan documentation, and the adequacy of the
allowance for loan losses. Loan review procedures, including a grading system
and independent loan review of large loan relationships, are utilized to ensure
that potential problem loans are identified early in order to lessen any
potentially negative impact on earnings.

     At December 31, 1998, the allowance for loan losses was $3.8 million,
compared to $3.3 million at year end 1997, an increase of 16.1%. The provision
for loan losses remained flat at approximately $1.5 million for both 1998 and
1997. This provision expense represents additions to the allowance for loan
losses to maintain sufficient coverage levels given portfolio composition and
levels of net charge-offs and nonperforming loans.

     Net charge-offs for 1998 declined $684,000, or 42.1%, compared to 1997. The
decline was attributable to the inclusion in 1997 of a $667,000 charge-off of
one significant commercial mortgage loan.  Excluding that particular loan, net
charge-offs of commercial mortgages declined for 1998, compared to 1997, while
net charge-offs of residential mortgages, consumer and commercial loans
increased year over year. Consumer loan charge-offs exhibited the largest
percentage increase from 1997 to 1998, primarily related to an increase in
bankruptcy filings.

     The allowance for loan losses as a percent of total loans increased to .94%
at December 31, 1998, compared to .88% at the prior year end. The allowance for
loan losses continues to reflect the risk diversification of the loan portfolio.
Residential mortgage loans, which generally carry a lower risk of loss or net
charge-off, have increased as a percentage of total loans. Management believes
that the allowance for loan losses at December 31, 1998 is adequate based on all
currently available information.

     Table 4 summarizes changes in the allowance for loan losses for the years
1994 through 1998 and shows an allocation of the year end balances, along with
related statistics for the allowance and net charge-offs. The allowance for loan
losses has been allocated according to the amount considered to be necessary to
provide for the possibility of losses within the various loan categories. The
allocation is based primarily on actual net charge-off experience, adjusted for
changes in the risk profile of each category, plus additional amounts based on
potential losses identified through the loan review process. The anticipated
effect of

12
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

economic conditions on both individual loans and loan categories is also
considered in quantifying amounts allocated to each loan category. Because the
allocation is based on management's judgement and estimates, it is not
necessarily indicative of the charge-offs that may ultimately occur.

NONPERFORMING ASSETS

     Nonperforming assets include nonperforming loans and real estate acquired
by foreclosure. Nonperforming loans include loans that have been placed in
nonaccrual status and loans past due ninety days or more and still accruing
interest. Table 5 provides a five year summary of nonperforming assets.

<TABLE>
<CAPTION>
TABLE 4 -- ALLOWANCE FOR LOAN LOSSES
------------------------------------------------------------------------------------------------------
                                                             Year ended December 31,
------------------------------------------------------------------------------------------------------
(dollars in thousands)                               1998      1997       1996    1995      1994
------------------------------------------------------------------------------------------------------
<S>                                                 <C>        <C>        <C>     <C>        <C>
Balance at beginning of period                      $ 3,285    3,389      3,380   3,264      2,824

Provision for loan losses                             1,470    1,520      1,334     917        830

Charge-offs
 Residential mortgages                                 (204)    (216)      (247)   (225)      (103)
 Commercial mortgages                                  (163)  (1,065)      (634)   (205)        --
 Commercial loans                                      (183)    (140)      (180)   (157)       (92)
 Consumer loans                                        (511)    (387)      (345)   (353)      (318)
------------------------------------------------------------------------------------------------------
Total charge-offs                                    (1,061)  (1,808)    (1,406)   (940)      (513)

Recoveries
 Residential mortgages                                   --       57          2       7          7
 Commercial mortgages                                    --       25         --      --         --
 Commercial loans                                        46       22         11      33         35
 Consumer loans                                          75       80         68      99         81
------------------------------------------------------------------------------------------------------
Total recoveries                                        121      184         81     139        123
------------------------------------------------------------------------------------------------------
Net charge-offs                                        (940)  (1,624)    (1,325)   (801)      (390)
------------------------------------------------------------------------------------------------------
Balance at end of period                            $ 3,815    3,285      3,389   3,380      3,264
------------------------------------------------------------------------------------------------------
Ratio of charge-offs net of
 recoveries to loans outstanding                        .23%     .44        .38     .24        .13
Allowance for loan losses as a
 percent of:
 Total loans                                            .94      .88        .97    1.03       1.02
 Nonperforming loans                                  63.18    53.21      93.28   63.67      75.75
------------------------------------------------------------------------------------------------------
Allocation of Allowance for Loan Losses at December 31,
------------------------------------------------------------------------------------------------------
                             1998            1997            1996            1995            1994
------------------------------------------------------------------------------------------------------
                                % OF            % OF            % OF            % OF            % OF
                               LOANS           LOANS           LOANS           LOANS           LOANS
                              TO TOTAL        TO TOTAL        TO TOTAL        TO TOTAL        TO TOTAL
                          AMT  LOANS      AMT  LOANS      AMT  LOANS      AMT  LOANS      AMT  LOANS
------------------------------------------------------------------------------------------------------
Residential mortgages  $  533   63.04%    585    57.67    471    54.00    402    52.23    201    53.02
Commercial mortgages    1,484    9.77   1,246    11.16  1,677    13.21  1,452    16.22  1,201    16.99
Commercial loans        1,159    9.30     826    11.23    617    11.48    807    10.91  1,297    10.99
Consumer loans            639   17.89     628    19.94    624    21.31    719    20.64    565    19.00
------------------------------------------------------------------------------------------------------
Total                  $3,815  100.00%  3,285   100.00  3,389   100.00  3,380   100.00  3,264   100.00
------------------------------------------------------------------------------------------------------
</TABLE>

                                                                              13
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

<TABLE>
<CAPTION>
TABLE 5 -- SUMMARY OF NONPERFORMING ASSETS
--------------------------------------------------------------------------------
                                                  December 31,
--------------------------------------------------------------------------------
(dollars in thousands)                  1998    1997   1996   1995   1994
--------------------------------------------------------------------------------
<S>                                   <C>      <C>    <C>    <C>    <C>   
Loans in nonaccrual                   $5,255   5,902  3,288  4,299  3,383
Loans past due 90 days or
 more and still accruing                 783     272    345  1,010    813
--------------------------------------------------------------------------------
Total nonperforming loans              6,038   6,174  3,633  5,309  4,196
Other real estate                        665     565    618    427    193
--------------------------------------------------------------------------------
Total nonperforming assets            $6,703   6,739  4,251  5,736  4,389
--------------------------------------------------------------------------------
Percent of:
 Total loans and real estate
  acquired by foreclosure               1.66%   1.80   1.22   1.74   1.37
 Total assets                           1.22    1.32    .90   1.31   1.04
 
Nonperforming loans as a
 percent of total loans                 1.49    1.65   1.04   1.61   1.31
--------------------------------------------------------------------------------
</TABLE>

     Nonperforming assets totaled $6.7 million at December 31, 1998, down
slightly compared to year end 1997. As a percent of total assets, nonperforming
assets declined from 1.3% at December 31, 1997 to 1.2% at year end 1998.

     At December 31, 1998, nonperforming loans, which declined $136,000, or
2.2%, from the prior year end, consisted of $4.8 million in mortgages, $529,000
in commercial loans, and $704,000 in consumer loans. Residential mortgage loans
represented $2.5 million, or 41.0%, of total nonperforming loans at year end
1998, compared to $3.0 million, or 48.4%, at December 31, 1997. The decline in
nonperforming residential mortgage loans primarily reflects increased collection
efforts directed toward this portfolio in 1998. Commercial mortgages represented
$2.3 million, or 38.6%, of nonperforming loans at December 31, 1998, an amount
and level comparable to year end 1997. All nonperforming commercial mortgage
loans at December 31, 1998 were either in the process of foreclosure or
operating under an agreed upon workout plan. Similar to year end 1997, one loan
continued to represent approximately 50% of the nonperforming commercial
mortgage balance at December 31, 1998. Adherence to the established repayment
plan has significantly reduced the delinquent status of this loan at year end
1998 compared to year end 1997. Management believes there to be adequate
collateral supporting the loan and that continuation of the current repayment
plan would return this loan to a performing status in 1999.

     Management believes that, through its loan review program, it has taken a
conservative approach in evaluating nonperforming loans and the loan portfolio
in general, both in acknowledging the general condition of the portfolio and in
establishing the allowance for loan loss. Nonperforming and past due loans are
monitored on a continual basis in order to guard against further deterioration
in their condition. Management has identified, through normal internal credit
review procedures, $4.0 million in "potential problem loans" at December 31,
1998. These problem loans are defined as loans not included as nonperforming
loans above, but about which management has developed information regarding
possible credit problems, which may cause the borrowers future difficulties in
complying with loan repayments. There were no loans classified for regulatory
purposes as loss, doubtful, substandard, or special mention that have not been
identified as impaired or nonperforming or that cause management to have serious
doubts as to the ability of the borrower to comply with the loan repayment
terms. In addition, there were no material commitments at December 31, 1998 to
lend additional funds to borrowers whose loans were classified as nonperforming.

     Iroquois will continue to focus on improving asset quality through
proactive management of problem assets, early detection of potential problem
assets, consistent and adequate collection procedures, and timely charge-offs.

14
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

SECURITIES

     At December 31, 1998, the securities portfolio totaled $108.5 million,
consisting of $61.4 million of securities available for sale and $47.1 million
of securities held to maturity. This compares with a total portfolio of $103.6
million, comprised of $51.9 million of securities available for sale and $51.7
million of securities held to maturity, at December 31, 1997. At December 31,
1998, securities represented 19.8% of total assets, compared to 20.3% at year
end 1997. The composition of the two securities portfolios by type of security
is presented in Table 6.  Certain information pertaining to the composition,
yields, and maturities of the two portfolios is presented in Table 7.

     Securities available for sale, which are carried at fair value, increased
18.3% in 1998, and represented 56.6% of the total securities portfolio, compared
to 50.1% at December 31, 1997. The portfolio consists primarily of US Government
and agencies obligations. Holdings of state and municipal obligations increased
in 1998, to 11.5% of the portfolio, to provide diversity and tax-advantaged
yield to the portfolio. Securities held to maturity, which are carried at
amortized cost, declined to 43.4% of the total portfolio at December 31, 1998,
compared to 49.9% at December 31, 1997. The held to maturity portfolio consists
primarily of corporate bonds and mortgage-backed securities.

     The Company's investment strategy is for its Banks to maintain securities
portfolios that provide a source of liquidity through maturities and selling
opportunities, contribute to overall profitability, support pledging
requirements, and provide a balance to interest rate and credit risk in other
categories of the balance sheet. The Company does not engage in securities
trading or derivatives activities in carrying out its investment strategies.

<TABLE>
<CAPTION>
Table 6 -- SECURITIES
---------------------------------------------------------------------------------------------------
                                                           December 31,
---------------------------------------------------------------------------------------------------
(dollars in thousands)                      1998                 1997                1996
---------------------------------------------------------------------------------------------------
                                   AMORTIZED     FAIR    AMORTIZED    FAIR   AMORTIZED     FAIR     
                                     COST       VALUE      COST      VALUE     COST        VALUE    
---------------------------------------------------------------------------------------------------
<S>                               <C>          <C>       <C>        <C>      <C>          <C>    
Securities available for sale:                                                                      
 U.S. Government &                                                                                  
  agencies obligations            $ 40,172     40,734     42,187    42,537    33,654      33,784    
 State and municipal                                                                                
  obligations                        6,959      7,090        231       232        --          --    
 Corporate                           3,362      3,471      1,507     1,517       500         501    
 Other                               3,000      2,957      3,000     2,983     3,000       2,976    
 Mortgage-backed securities          7,120      7,179      4,664     4,675     6,648       6,634    
---------------------------------------------------------------------------------------------------
                                    60,613     61,431     51,589    51,944    43,802      43,895    
---------------------------------------------------------------------------------------------------
Securities held to maturity:                                                                        
 U.S. Government &                                                                                  
  agencies obligations                  --         --         25        25        60          60    
 State and municipal                                                                                
  obligations                        5,818      5,903      3,729     3,795     1,489       1,519    
 Corporate                          25,893     26,190     27,717    27,887    27,638      27,723    
 Mortgage-backed securities         15,345     15,624     20,205    20,475    25,205      25,316    
---------------------------------------------------------------------------------------------------
                                    47,056     47,717     51,676    52,182    54,392      54,618    
---------------------------------------------------------------------------------------------------
Total                             $107,669    109,148    103,265    04,126    98,194      98,513     
---------------------------------------------------------------------------------------------------
</TABLE>

                                                                              15
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

[Bar Chart]

<TABLE>
<CAPTION>
Table 7 -- MATURITY SCHEDULE OF SECURITIES
---------------------------------------------------------------------------------------------------
                                                                 at December 31, 1998
----------------------------------------------------------------------------------------------------------------
                                                                        MATURING
                                             WITHIN          AFTER ONE BUT     AFTER FIVE BUT      AFTER
                                            ONE YEAR       WITHIN FIVE YEARS  WITHIN TEN YEARS   TEN YEARS
(dollars in thousands)                  AMOUNT   YIELD      AMOUNT   YIELD     AMOUNT  YIELD   AMOUNT YIELD
--------------------------------------------------------------------------------------------------------------
<S>                                     <C>      <C>       <C>       <C>      <C>      <C>     <C>    <C> 
Securities available for sale:
 U.S. Government &
  agencies obligations                  $ 7,025   6.22%     29,313     5.97       --     --    3,834   6.05       
 State and municipal                                                                                              
  obligations                                --     --          --       --    5,993   4.32      966   4.41       
 Corporate                                   --     --       1,954     6.44      965   6.41      443   6.59       
 Other                                    3,000   5.55          --       --       --     --       --     --       
 Mortgage-backed securities                  --     --          --       --       --     --    7,120   5.90       
--------------------------------------------------------------------------------------------------------------
                                         10,025   6.02      31,267     6.00    6,958   4.61   12,363   5.86       
--------------------------------------------------------------------------------------------------------------
Securities held to maturity:                                                                                      
 State and municipal                                                                                              
  obligations                             2,858   4.19       1,036     4.80    1,559   4.67      365   4.77       
 Corporate                                8,013   6.36      17,880     6.26       --     --       --     --       
 Mortgage-backed securities                 925   7.39       2,584     6.41    3,298   6.98    8,538   6.79       
--------------------------------------------------------------------------------------------------------------
                                         11,796   5.92      21,500     6.21    4,857   6.24    8,903   6.71       
--------------------------------------------------------------------------------------------------------------
Total                                   $21,821   5.97%     52,767     6.09   11,815   5.28   21,266   6.22        
--------------------------------------------------------------------------------------------------------------
</TABLE>

DEPOSITS AND OTHER SOURCES OF FUNDS

     Customer deposits, consisting of interest-bearing time deposits, savings,
money market and NOW accounts, and noninterest bearing checking accounts
represent the primary source of asset funding for the Banks. Other sources of
funds include overnight borrowings from other financial institutions and short-
term borrowings or term advances under agreements with the Federal Home Loan
Bank (FHLB). Table 8 provides a three year summary of deposits.

     Total deposits increased $26.2 million, or 6.3%, from $417.0 million at
December 31, 1997, to $443.2 million at December 31, 1998. During 1998, total
deposits averaged $434.7 million and represented 88.5% of total liabilities,
compared with $419.9 million and 92.7%, respectively, in 1997. Continued growth
in public fund (municipal) deposits held at Cayuga contributed $12.1 million in
additional deposits at year end 1998 compared to 1997. The net growth of $14.1
million in personal and commercial deposits at December 31, 1998, compared to
December 31, 1997, came primarily from increases in checking, money market, and
time deposits. Savings deposits, reflecting a five year downward trend,
decreased $2.9 million in 1998 and declined from 26.0% of total deposits at
December 31, 1997, to 23.9% at year end 1998. Time deposits of $100,000 or
greater, derived entirely from within the Banks' local market areas, increased
$15.4 million in 1998, with 75% representing municipal time deposits. Table 9
presents a maturity schedule of time deposits of $100,000 and over.

     Total borrowings at December 31, 1998 were $61.6 million, or 12.1% of total
liabilities, compared to $50.2 million, or 10.7%, at December 31, 1997.
Borrowings averaged 10.6% and 6.6% of total liabilities during 1998 and 1997,
respectively. During 1998, the Company continued to extend the maturity of its
borrowings as part of its interest rate risk management program. A maturity
schedule of outstanding borrowings can be found in Note 7 of the accompanying
consolidated financial statements.

     Iroquois believes that deposit growth will continue to be adversely
affected by investment alternatives pursued by customers in response to
perceived opportunities for strong returns in the mutual fund and equity
markets. The Banks will continue to focus on building upon existing
relationships with their customers through targeted marketing and personal 

16
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Management's Discussion and Analysis

<TABLE>
<CAPTION>
Table 8 -- DEPOSITS
-------------------------------------------------------------------------------------
                                                          December 31,
-------------------------------------------------------------------------------------
(dollars in thousands)                          1998        1997       1996
-------------------------------------------------------------------------------------
<S>                                         <C>           <C>        <C>  
Noninterest bearing deposits                $ 30,905       27,563     24,934
-------------------------------------------------------------------------------------
Interest-bearing deposits:
NOW accounts                                  41,454       38,781     35,805
Money market accounts                         46,066       41,033     37,255
Savings accounts                             105,717      108,578    124,868
Time deposits                                219,097      201,056    187,360 
-------------------------------------------------------------------------------------
Total interest-bearing deposits              412,334      389,448    385,288
-------------------------------------------------------------------------------------
Total deposits                              $443,239      417,011    410,222
-------------------------------------------------------------------------------------
</TABLE> 


<TABLE> 
<CAPTION> 
Table 9 -- MATURITIES OF TIME DEPOSITS - $100,000 AND OVER
-------------------------------------------------------------------
(dollars in thousands)                 December 31, 1998
-------------------------------------------------------------------
MATURITY                                      AMOUNT
-------------------------------------------------------------------
<S>                                         <C>  
Three months or less                        $ 36,590
Over three through six months                  6,834
Over six through twelve months                 7,891
Over twelve months                             5,070
-------------------------------------------------------------------
                                            $ 56,385
-------------------------------------------------------------------
</TABLE>

sales efforts designed to attract additional accounts and deposits. In addition,
enhanced cash management and commercial deposit products will be introduced at
Cayuga in 1999, and Homestead will pursue plans to relocate two of its branches
to take advantage of demographic changes in the Utica market. Management
believes that both of these initiatives could enhance the Company's ability to
increase deposits as a funding source of continued asset growth.

CAPITAL AND DIVIDENDS

     Total shareholders' equity at December 31, 1998 was $38.3 million, down
$687,000, or 1.8%, from the balance at the end of 1997. The decrease was due
primarily to the redemption in 1998 of the Company's outstanding preferred
stock. Common shareholders' equity increased $4.2 million, or 12.2%, from $34.2
million at December 31, 1997, to $38.3 million, or 100% of total equity, at
December 31, 1998. Equity per common share, referred to as book value, increased
11.7%, from $14.42 at year end 1997 to $16.11 at year end 1998. Other factors
contributing to the change in shareholders' equity during 1998 are shown in the
Consolidated Statement of Shareholders' Equity and Comprehensive Income
presented on page 28.

     Capital adequacy in the banking industry is evaluated primarily by the use
of ratios which measure capital against total assets as well as against total
assets that are weighted based on risk characteristics. At December 31, 1998,
Iroquois and each of the Banks exceeded all regulatory required minimum capital
ratios and met the definition of "well capitalized" as defined by applicable
regulation. On a consolidated basis at December 31, 1998, Iroquois had a total
capital to assets ratio of 7.00%, a tangible common equity to assets ratio of
6.67%, and a total capital to risk-weighted assets ratio of 11.7%. A more
comprehensive analysis of regulatory capital requirements is included in Note 9
of the accompanying consolidated financial statements.

     Iroquois paid total cash dividends of $1.2 million in 1998, of which
$187,000 was paid to preferred shareholders. Common shareholders received total
dividends of $.40 per share,

                                                                             17
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
-------------------------------------------------------------------------------
Management's Discussion and Analysis

representing a payout ratio to earnings per share of 20.4%, compared to 19.1% in
1997. Cash dividends have been paid on the Company's common stock for twelve
consecutive years. The Company intends to continue the practice of regular
payment of common stock dividends as long as its subsidiary Banks remain
profitable and in compliance with regulatory capital requirements.

     The Company emphasizes the capital adequacy of its Banks as an important
foundation for their individual growth plans, liquidity and projected capital
needs, as well as for meeting regulatory requirements. Internally generated
capital is the Company's primary strategy for capital growth for the Banks and
for the Company. Iroquois serves as the vehicle for access to capital markets
for its own needs, such as for the acquisition of new subsidiaries, and as a
source of funds, if necessary, to strengthen the capital position of its
subsidiaries.

     The Company strives to maintain optimal capital levels that are
commensurate with the risk profiles of its subsidiary Banks. The Company
regularly reviews its capital position and monitors adherence to regulatory
requirements.

LIQUIDITY

     Liquidity represents the Company's ability to generate cash or otherwise
obtain funds at reasonable rates to meet the demands of depositors, satisfy
commitments to borrowers, and support key business initiatives. Proper liquidity
management provides the necessary access to funds to satisfy cash flow
requirements. Liquidity risk represents the possibility that the Company would
be unable to generate cash or otherwise obtain funds at reasonable rates to meet
its obligations.

     In the ordinary course of business, Iroquois cash flows are generated from
net operating income, loan repayments, and the maturity or sale of other earning
assets. Liquidity management at the Banks is based on maintaining a strong base
of core customer deposits, an adequate level of short-term and available for
sale securities, and the availability of dependable borrowing sources.

     Funding is available to each Bank through their membership in the Federal
Home Loan Bank of New York ("FHLB"). Through the FHLB, the Banks can borrow up
to 25% of total assets at various terms and interest rates. At December 31,
1998, securities maturing in one year or less, excluding estimated payments from
amortizing securities, totaled $21.8 million, or 20.1% of the total securities
portfolio. Securities available for sale at December 31, 1998 totaled $61.4
million, or 11.2% of total assets.

     The consolidated statements of cash flows included in the consolidated
financial statements contained in this Annual Report identify Iroquois' cash
flows from operating, investing, and financing activities. During 1998 operating
activities generated cash flows of $8.1 million, while financing activities
provided $31.6 million. Investing activities, primarily net investments in loans
and securities, used $37.3 million, resulting in a net increase in cash and cash
equivalents of $2.5 million in 1998.

     While many factors, such as economic and competitive factors, customer
demand for loans and deposits, bank reputation and market share, affect the
Company's overall ability to effectively manage its liquidity, management
believes the Company has sufficient liquidity to meet its current obligations
and is not aware of any trends, events, or uncertainties that will have, or that
are reasonably likely to have, a material effect on the Company's liquidity,
capital resources, or operations.

MARKET RISK AND INTEREST RATE RISK MANAGEMENT

     Market risk is the risk of loss from adverse changes in market prices and
rates. The Company's market risk arises primarily from interest rate risk
inherent in its lending and deposit activities. Other types of market risk, such
as foreign currency exchange rate risk and commodity price risk, do not arise in
the normal course of the Company's business activities.

     Managing interest rate risk is of primary importance to Iroquois. The
Company's asset and liability management program includes a process for
identifying and measuring potential risks to earnings and to the market value of
equity due to changes in interest rates.

18
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
-------------------------------------------------------------------------------
Management's Discussion and Analysis


<TABLE>
<CAPTION>
 
TABLE 10 -- NET PORTFOLIO VALUE ANALYSIS
--------------------------------------------------------------------------------
(dollars in thousands)             At December 31, 1998
--------------------------------------------------------------------------------
     CHANGE IN INTEREST RATE           ESTIMATED            CHANGE IN NPV
          (BASIS POINTS)                  NPV             AMOUNT       %
--------------------------------------------------------------------------------
<S>                                <C>                    <C>         <C> 
             +200                       $45,271           $(12,663)   (21.9)%
             +100                        51,650             (6,304)   (10.9)
                0                        57,954                 --       --
             -100                        63,642              5,688      9.8
             -200                        67,784              9,830     17.0
--------------------------------------------------------------------------------
</TABLE>

Interest rate risk is measured and managed for each Bank and monitored from a
holding company perspective. The goal of interest rate risk analysis is to
minimize the potential loss in net interest income and net portfolio value that
could arise from changes in interest rates. Iroquois asset/liability management
strategies emphasize balancing the mix and repricing characteristics of its
loans, securities, deposits, and borrowings to ensure that exposure to interest
rate risk is limited within acceptable levels. Iroquois determines sensitivity
of earnings and capital to changes in interest rates by utilizing various tools.

     A simulation model is the primary tool used to assess the impact of changes
in interest rates on net interest income. Key assumptions used in the model
include prepayment speeds on loans and mortgage-backed securities, loan volumes
and pricing, customer preferences and sensitivity to changing rates, and
management's projected financial plans. These assumptions are compared to actual
results and revised as necessary. The Company's guidelines provide that net
interest income should not decrease by more than 5% when simulated against a
twelve-month rising or declining rate scenario reflecting a gradual change in
rates of up to 200 basis points. At December 31, 1998, based on simulation model
results, the Company was within these guidelines. Actual results may differ from
simulated results due to the inherent uncertainty of the assumptions, including
the timing, magnitude and frequency of rate changes, customer buying patterns,
economic conditions, and management strategies.

     The Company uses a net portfolio value ("NPV") analysis as another means of
measuring and monitoring its interest rate risk. NPV represents the difference
between the present value of the Company's liabilities and the present value of
the expected cash flows from its assets. Table 10 sets forth, at December 31,
1998, an analysis of the Company's interest rate risk as measured by the
estimated changes in NPV resulting from instantaneous and sustained parallel
shifts in the interest rate yield curve. The NPV analysis incorporates
assumptions regarding the projected prepayment speeds on loans and mortgage-
backed securities and estimated cash flows on deposits without a stated maturity
date. The assumptions are primarily based on the Company's historical prepayment
and/or runoff speeds of assets and liabilities when interest rates increase or
decrease by 200 basis points or greater. The Company's guidelines provide that a
Bank's NPV should not decrease more than 25% as a result of a sudden rate change
of plus or minus 200 basis points.

     Another tool used to measure interest rate sensitivity is the cumulative
gap analysis which is presented in Table 11. The cumulative gap represents the
net position of assets and liabilities subject to repricing in specified time
periods. Deposit accounts without specified maturity dates are modeled based on
historical run-off characteristics of these products in periods of rising rates.
At December 31, 1998, the one year cumulative gap position was $19.9 million
liability sensitive, or 3.6% of total assets, compared to a virtually neutral
one year position at year end 1997. While the one year gap position remains
within Company established risk guidelines, the Company has become slightly more
liability sensitive, principally due to the decrease in adjustable rate lending
given the current interest rate environment.

     Because the cumulative gap analysis is merely a snapshot at a particular
date and does not fully reflect that certain assets and liabilities may have
similar repricing periods but may in fact reprice at different times within that
period and at differing rate levels, management uses the interest rate
sensitivity gap only as a general indicator of the potential effects of interest
rate changes on net interest income. Management believes that the gap analysis
is a useful

                                                                              19
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
-------------------------------------------------------------------------------
Management's Discussion and Analysis
<TABLE>
<CAPTION>
 
TABLE 11 -- INTEREST RATE SENSITIVITY TABLE
---------------------------------------------------------------------------------------------------------------------------
                                                                At December 31, 1998
---------------------------------------------------------------------------------------------------------------------------
                                           0 - 3        4 - 12          1 - 5        Over 5
(DOLLARS IN THOUSANDS)                     MONTHS       MONTHS          YEARS        YEARS         TOTAL
---------------------------------------------------------------------------------------------------------------------------
<S>                                     <C>            <C>          <C>              <C>           <C> 
Interest-sensitive assets:
Mortgage loans:
 Residential                            $    23,061     54,703       112,135         64,856         254,755
 Commercial                                  10,156      8,339        19,532          1,470          39,497
Consumer and commercial loans                59,077     12,878        28,623          9,262         109,840
Securities                                    7,570     19,005        49,734          9,654          85,963
Mortgage-backed securities                    2,398      9,804         7,227          3,095          22,524
---------------------------------------------------------------------------------------------------------------------------
Total interest-sensitive assets         $   102,262    104,729       217,251         88,337         512,579
---------------------------------------------------------------------------------------------------------------------------
Interest-sensitive liabilities:
Deposits:
 Savings and NOW accounts                     9,100     17,719        53,489         66,863         147,171
 Money market accounts                        2,189      6,564        16,583         20,730          46,066
 Time deposits                               68,060    105,157        45,824             56         219,097
Borrowings                                    3,129     15,000        43,000            462          61,591
---------------------------------------------------------------------------------------------------------------------------
Total interest-sensitive liabilities    $    82,478    144,440       158,896         88,111         473,925
---------------------------------------------------------------------------------------------------------------------------
Interest rate sensitivity gap           $    19,784    (39,711)       58,355            226          38,654
Cumulative interest rate
 sensitive gap                          $    19,784    (19,927)       38,428         38,654
---------------------------------------------------------------------------------------------------------------------------
Cumulative gap to total assets:
 at December 31, 1998                           3.6%      (3.6)          7.0            7.0
 at December 31, 1997                           4.2%         0          12.2            8.0
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

tool only when used in conjunction with its simulation model, NPV analysis, and
other tools for analyzing and managing interest rate risk.

     The Company does not currently engage in trading activities or use
derivative instruments to control interest rate risk. Even though such
activities may be permitted with the approval of the Board of Directors, the
Company does not intend to engage in such activities in the immediate future.

IMPACT OF INFLATION

     The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles, which requires the measurement of
financial position and operating results in terms of historical dollars without
considering the changes in the relative purchasing power of money over time due
to inflation. The impact of inflation is reflected in the increased cost of the
Company's operations. Unlike industrial companies, nearly all of the assets and
liabilities of the Company are monetary in nature. As a result, interest rates
have a greater impact on the Company's performance than do the effects of
general levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent, as the price of goods and services.

YEAR 2000

     The Company's Year 2000 (or "Y2K") activities are continuing on schedule
under the framework of the FFIEC's Five Step program. Senior management and the
Company's Board of Directors are actively involved in managing efforts in
support of these activities, monitoring the Company's progress, and evaluating
risks of the process to the Company's strategic plan. The primary software
applications which support the Banks' checking, savings, and loan products have
already been updated and tested for Year 2000 compliance. Y2K-compliant versions
of these front-end software products are currently in use at the Banks.

STEP 1 AWARENESS PHASE

     The Company's Y2K Committee has been following a comprehensive reporting
and communication plan designed to increase awareness of the issues surrounding
the century

20
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
-------------------------------------------------------------------------------
Management's Discussion and Analysis

date change and report on the Company's progress in preparing for the Year 2000.
The communication plan includes ongoing progress reports to Senior Management,
the Company's Board of Directors, and Audit Committee. In addition, the Company
is presently taking steps to build awareness and increase the understanding of
its employees as well as its banking customers on the Company's readiness for
the Year 2000.

STEP 2 ASSESSMENT PHASE

     The Company has completed an inventory and assessment of its software,
hardware, and other systems applications (e.g. communications systems;
environmental systems; credit card; and ATM processing systems). As part of the
assessment phase, critical applications were identified. Critical applications
are those believed by the Company to be key to the accuracy of recording
customer banking transactions, to have a risk involving the safety of
individuals, or to affect the Company's revenues and/or liquidity.

     During the assessment phase, the Company also identified and prioritized
for further evaluation and testing, as appropriate, its exposure to third party
risks of noncompliance. Electronic data exchange service bureaus and business
customers with relationships in excess of $150,000 were identified. As part of
this assessment, the Company is collecting and analyzing information from third
parties regarding their Year 2000 readiness.

STEP 3 RENOVATION PHASE

     The renovation phase includes the installation of all necessary software
upgrades, the removal of non-compliant applications, the development of
application-specific contingency plans as necessary, and the testing of
currently compliant systems. The Company estimates that it has completed
approximately 80% of the renovation phase. Close monitoring of the progress of
its third party vendors, in particular, Fiserv Inc., the Company's data services
and item processing provider, is ongoing. Fiserv has advised the Company that it
anticipates its systems will be completely upgraded to Year 2000 compliance,
tested, and implemented no later than June 30, 1999.

     As of December 31, 1998, the Company had completed the identification of
systems requiring upgrades, had installed Y2K compliant versions as received,
and continues close monitoring of vendor progress to ensure timely delivery of
upgrades. A general contingency plan has been outlined. System-specific
contingency plans will be implemented for critical systems which fail their Y2K
test within 30 days of test, but no later than June 30, 1999. To date, the
Company has no reason to believe that its critical applications will not be Year
2000 compliant in all material respects.

STEP 4 VALIDATION PHASE

     During the validation phase, critical data flows both internally and with
third parties will be tested with both the sender and receiver simulating Year
2000 conditions. Testing is presently underway, both internally and with third
parties, including Fiserv, Inc. The validation phase is expected to be completed
by June 30, 1999.

STEP 5 IMPLEMENTATION PHASE

     The implementation phase will primarily occur during 1999. This phase will
focus on monitoring the progress of service providers and vendors as they
install fully renovated and tested Y2K compliant systems into the normal daily
operating environment. In addition, the Company has begun the process of
developing business resumption contingency plans for each of its key business
processes, and plans to complete and test them in 1999.

COSTS

     The Company presently expects to meet its Year 2000 compliance commitment
using existing resources and without incurring significant incremental expenses.
The Company has provided for the additional costs of the Year 2000 project,
primarily additional hardware, software, and service fees, in its operational
budget for information technology.

                                                                              21
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
-------------------------------------------------------------------------------
Management's Discussion and Analysis

RISK FACTORS

     Significant Year 2000 failures in the Company's systems or in the systems
of third parties (or third parties upon whom they depend) would have a material
adverse effect on the Company's financial condition and results of operation.
Although the Company believes that it has taken adequate measures to assure its
systems will be Year 2000 compliant, the Company does not have control of
external systems and conditions with which its systems interact, or by which its
systems are affected. In the event of external conditions relating to Year 2000,
it is possible that the Company could experience (i) a material increase in the
Company's credit losses due to Year 2000 problems for the Company's borrowers
and obligors and (ii) liquidity stress caused by disruption in financial
markets. The magnitude of such potential credit losses or disruption cannot be
determined at this time.

RECENT ACCOUNTING PRONOUNCEMENTS

     Effective January 1, 1998, the Company adopted the remaining provisions of
Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,"
which relates to the accounting for securities lending, repurchase agreements,
and other secured financing activities. These provisions, which were delayed for
implementation by SFAS No. 127, did not have a material impact on the Company.

     In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes comprehensive accounting and reporting requirements for derivative
instruments and hedging activities and requires companies to recognize all
derivatives as either assets or liabilities, with the instruments measured at
fair value. The accounting for gains and losses resulting from changes in fair
value of the derivative instrument, depends on the intended use of the
derivative and the type of risk being hedged. This statement is effective for
all fiscal quarters of fiscal years beginning after June 15, 1999. Initial
application of this statement should be as of the beginning of a company's
fiscal year, January 1, 2000 for Iroquois. Iroquois does not invest in
derivative instruments, therefore, the provisions of SFAS No. 133 are not
expected to have any effect on either the financial disclosures or the financial
condition of the Company. SFAS No. 133 also permits certain reclassifications of
securities among the trading, available for sale and held to maturity
classifications. The Company has no current intention to reclassify any
securities pursuant to SFAS No. 133.

22
<PAGE>
 
--------------------------------------------------------------------------------
                                               Consolidated Financial Statements
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Report of Management/Independent Auditors' Report

REPORT OF MANAGEMENT

     Management is responsible for preparation of the consolidated financial
statements and related financial information contained in all sections of this
annual report, including the determination of amounts that must necessarily be
based on judgments and estimates. It is the belief of management that the
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles appropriate in the circumstances and
that the financial information appearing throughout this annual report is
consistent with the consolidated financial statements.

     Management establishes and monitors the Company's system of internal
accounting controls in meeting its responsibility for reliable financial
statements. This system is designed to provide reasonable assurance that assets
are safeguarded and that transactions are executed in accordance with
management's authorization and are properly recorded.

     The Audit Committee of the Board of Directors, composed solely of outside
directors, meets periodically with the Company's management, internal auditors
and independent auditors, KPMG LLP, to review matters relating to the quality of
financial reporting, internal accounting control, and the nature, extent and
results of audit efforts. The internal auditors and independent auditors have
unlimited access to the Audit Committee to discuss all such matters.


/s/ Richard D. Callahan                             /s/ Marianne R. O'Connor

Richard D. Callahan                                     Marianne R. O'Connor
President and                                           Treasurer and
 Chief Executive Officer                                 Chief Financial Officer

INDEPENDENT AUDITORS' REPORT

     THE BOARD OF DIRECTORS AND SHAREHOLDERS IROQUOIS BANCORP, INC.:

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

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

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


KPMG LLP

Syracuse, New York
January 22, 1999

24
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Consolidated Balance Sheets

<TABLE> 
<CAPTION> 
------------------------------------------------------------------------------------------ 
                                                                       December 31,
------------------------------------------------------------------------------------------ 
(dollars in thousands,
except share data)                                                    1998          1997 
------------------------------------------------------------------------------------------ 
<S>                                                               <C>            <C>     
ASSETS                                                                                   
Cash and due from banks                                           $  9,571        12,778 
Federal funds sold and                                                                   
     interest-bearing deposits with                                                      
     other financial institutions                                    6,393           705 
Securities available for sale, at fair value                        61,431        51,944 
Securities held to maturity (fair value of                                               
     $47,717 in 1998 and $52,182 in 1997)                           47,056        51,676 
Loans                                                              404,092       373,269 
     Less allowance for loan losses                                  3,815         3,285 
------------------------------------------------------------------------------------------ 
     Loans, net                                                    400,277       369,984 
Premises and equipment, net                                          8,070         8,170 
Federal Home Loan Bank Stock, at cost                                4,079         3,629 
Accrued interest receivable                                          3,822         3,855 
Other assets                                                         6,721         7,037 
------------------------------------------------------------------------------------------ 
Total Assets                                                      $547,420       509,778 
------------------------------------------------------------------------------------------ 

LIABILITIES                                                                              
Savings and time deposits                                         $412,334       389,448 
Demand deposits                                                     30,905        27,563 
Borrowings                                                          61,591        50,164 
Accrued expenses and other liabilities                               4,248         3,574 
------------------------------------------------------------------------------------------ 
Total Liabilities                                                 $509,078       470,749 
------------------------------------------------------------------------------------------ 

SHAREHOLDERS' EQUITY                                                                     
Preferred Stock, $1.00 par value, 3,000,000 shares authorized:                           
     Series A-issued and outstanding:                                                   
     1998-none; 1997-29,999                                             --            30 
     Series B-issued and outstanding:                                                   
     1998-none; 1997-18,632                                             --            19 
Common Stock, $1.00 par value; 6,000,000                                                 
     shares authorized; 2,409,980 and 2,388,936                                          
     shares issued and outstanding in 1998 and                                           
     1997, respectively                                              2,410         2,389 
Additional paid-in capital                                           9,303        13,793 
Retained earnings                                                   26,557        22,868 
Accumulated other comprehensive income                                 490           213 
Unallocated shares of Stock Ownership Plan                            (418)         (283)
------------------------------------------------------------------------------------------ 
Total Shareholders' Equity                                        $ 38,342        39,029 
------------------------------------------------------------------------------------------ 
Total Liabilities and Shareholders' Equity                        $547,420       509,778  
------------------------------------------------------------------------------------------  
</TABLE>

See accompanying notes to consolidated financial statements.

                                                                              25
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Consolidated Statements of Income

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------
                                                               Year ended December 31,
--------------------------------------------------------------------------------------------
(dollars in thousands,
except share data)                                             1998        1997        1996 
--------------------------------------------------------------------------------------------  
<S>                                                         <C>          <C>         <C> 
Interest Income:                                                                            
Loans                                                       $32,401      30,579      29,603 
Securities                                                    6,421       6,606       5,838 
Other                                                           582         337         322 
--------------------------------------------------------------------------------------------  
                                                             39,404      37,522      35,763 
--------------------------------------------------------------------------------------------  
Interest Expense:                                                                           
Deposits                                                     16,152      15,457      14,759 
Borrowings                                                    3,067       1,760       1,593 
--------------------------------------------------------------------------------------------  
                                                             19,219      17,217      16,352 
--------------------------------------------------------------------------------------------  
Net Interest Income                                          20,185      20,305      19,411 

Provision for loan losses                                     1,470       1,520       1,334 
--------------------------------------------------------------------------------------------  
Net Interest Income after Provision                                                         
     for Loan Losses                                         18,715      18,785      18,077 
--------------------------------------------------------------------------------------------  
Non-Interest Income:                                                                        
Service charges                                               2,940       2,541       2,205 
Net gain(loss) on sales of                                                                  
     securities and loans                                       223          99      (1,021)
Other                                                           554         587         551 
--------------------------------------------------------------------------------------------  
Total Non-Interest Income                                     3,717       3,227       1,735 
--------------------------------------------------------------------------------------------  
Non-Interest Expense:                                                                       
Salaries and employee benefits                                7,564       7,328       6,697 
Occupancy and equipment                                       1,655       1,725       1,671 
Computer and product service fees                             1,676       1,328       1,045 
Promotion and marketing                                         461         356         379 
Other real estate expenses                                      345         333         388 
Deposit insurance                                                91          97         742 
Other                                                         3,087       2,954       2,664 
--------------------------------------------------------------------------------------------  
Total Non-Interest Expenses                                  14,879      14,121      13,586 
--------------------------------------------------------------------------------------------  
Income Before Income Taxes                                    7,553       7,891       6,226 
Income taxes                                                  2,711       2,994       2,447 
--------------------------------------------------------------------------------------------  
Net Income                                                    4,842       4,897       3,779 
--------------------------------------------------------------------------------------------  

Preferred stock dividend                                        187         441         451 
--------------------------------------------------------------------------------------------  
Net income applicable to common shares                      $ 4,655       4,456       3,328 
--------------------------------------------------------------------------------------------  

Net income per common share:                                                                
     Basic                                                  $  1.96        1.89        1.43 
     Diluted                                                   1.92        1.85        1.41  
--------------------------------------------------------------------------------------------  
</TABLE> 

See accompanying notes to consolidated financial statements.

26
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------- 
                                                                  Year ended December 31,
----------------------------------------------------------------------------------------------- 
(dollars in thousands)                                           1998       1997      1996
----------------------------------------------------------------------------------------------- 
<S>                                                            <C>        <C>       <C>
Cash flows from operating activities:
Net Income                                                     $  4,842     4,897     3,779
Adjustments to reconcile net income to net
     cash provided by operating activities:
Depreciation and amortization expense,
     provision for loan losses,
     deferred taxes and other                                     2,353     2,195     2,225
Net (gain)loss on sales of
     securities and loans                                          (223)      (99)    1,021
Increase in accrued interest
     receivable and other assets                                    (40)     (394)     (135)
Increase in accrued expenses
     and other liabilities                                        1,201       716       620
----------------------------------------------------------------------------------------------- 
Net cash provided by operating activities                         8,133     7,315     7,510
----------------------------------------------------------------------------------------------- 
Cash flows from investing activities:
Proceeds from sales of securities
     available for sale                                          11,668    10,637    10,038
Proceeds from maturities and redemptions of
     securities available for sale                                9,977     6,121     7,439
Proceeds from maturities and redemptions of
     securities held to maturity                                 15,925    12,732    11,704
Purchases of securities available for sale                      (30,437)  (23,669)  (23,240)
Purchases of securities held to maturity                        (11,459)  (10,896)  (20,470)
Loans made to customers net of principal
     payments received                                          (34,892)  (27,636)  (18,610)
Loans of acquired branches                                           --        --   (10,270)
Proceeds from sales of loans                                      4,090     2,835     8,461
Capital expenditures                                               (571)   (1,250)   (1,090)
Purchase of FHLB stock                                             (450)   (1,350)      (85)
Premium paid for deposits                                            --        --    (3,138)
Other - net                                                      (1,138)   (2,385)     (462)
----------------------------------------------------------------------------------------------- 
Net cash used by investing activities                           (37,287)  (34,861)  (39,723)
----------------------------------------------------------------------------------------------- 
Cash flows from financing activities:
Net increase(decrease) in savings
     accounts and demand deposits                                 8,187    (6,907)   (2,120)
Net increase(decrease) in time deposits                          18,041    13,696    (3,410)
Deposits of acquired branches                                        --        --    46,652
Net increase(decrease) in borrowings                             11,427    24,628    (9,714)
Proceeds from issuance of common stock                              285       366       338
Dividends paid                                                   (1,153)   (1,289)   (1,198)
Redemption of preferred stock                                    (4,863)     (140)      (50)
Stock purchased for ESOP                                           (289)       --        --
----------------------------------------------------------------------------------------------- 
Net cash provided by financing activities                        31,635    30,354    30,498
----------------------------------------------------------------------------------------------- 
Net increase(decrease) in cash and
     cash equivalents                                             2,481     2,808    (1,715)
Cash and cash equivalents at beginning of year                   13,483    10,675    12,390
----------------------------------------------------------------------------------------------- 
Cash and cash equivalents at end of year                       $ 15,964    13,483    10,675
----------------------------------------------------------------------------------------------- 
Supplemental disclosures of cash flow information:
Cash paid during the year for:
     Interest                                                  $ 19,036    17,071    16,280
     Income taxes                                                 2,145     2,082     2,134
Supplemental schedule of noncash
     investing activities:
Loans to facilitate the sale of other real estate                   405       422       530
Additions to other real estate                                    1,013       842     1,675
----------------------------------------------------------------------------------------------- 
</TABLE> 

See accompanying notes to consolidated financial statements

                                                                              27
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Consolidated Statements of Shareholders' Equity and Comprehensive Income

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------------
                                                                                                             Unallocated
                                                                                               Accumulated    Shares of
                                                                        Additional                Other         Stock
(dollars in thousands,                          Preferred      Common    Paid-In    Retained  Comprehensive   Ownership
except share data)                                Stock         Stock    Capital    Earnings      Income        Plans     Total
--------------------------------------------------------------------------------------------------------------------------------- 
<S>                                             <C>            <C>      <C>         <C>       <C>           <C>          <C> 
Balances at December 31, 1995                      $ 50         2,339     13,230     16,679         170        (622)     31,846
--------------------------------------------------------------------------------------------------------------------------------- 
Comprehensive Income:                                                                                        
Net Income                                           --            --         --      3,779          --          --       3,779
Change in net unrealized gain on                                                                             
 securities available for sale, net of taxes         --            --         --         --        (114)         --        (114)
                                                                                                                         -------
Total Comprehensive Income                                                                                                3,665
                                                                                                                         -------    
Allocation of Common stock                                                                                   
 under Stock Ownership Plans                         --            --         31         --          --         170         201
Preferred Stock Redemption                                                                                   
 (499 shares)                                        --            --        (50)        --          --          --         (50)
Stock Options Exercised                              --            10         45         --          --          --          55
Stock Issued - Dividend                                                                                       
 Reinvestment Plan                                   --            19        264         --          --          --         283
Cash dividends declared:                                                                                     
 Common stock                                        --            --         --       (747)         --          --        (747)
 Preferred stock                                     --            --         --       (451)         --          --        (451)
--------------------------------------------------------------------------------------------------------------------------------- 
Balances at December 31, 1996                      $ 50         2,368     13,520     19,260          56        (452)     34,802
--------------------------------------------------------------------------------------------------------------------------------- 
Comprehensive Income:                                                                                        
Net Income                                           --            --         --      4,897          --          --       4,897
Change in net unrealized gain                                                                                
 on securities available for sale,                                                                           
 net of taxes                                        --            --         --         --         157          --         157
                                                                                                                         -------
Total Comprehensive Income                                                                                                5,054
                                                                                                                         -------
Allocation of Common stock                                                                                   
 under Stock Ownership Plans                         --            --         67         --          --         169         236
Preferred Stock Redemption                                                                                   
 (1,408 shares)                                      (1)           --       (139)        --          --          --        (140)
Stock Options Exercised                              --             9         93         --          --          --         102
Stock Issued - Dividend                                                                                       
 Reinvestment Plan                                   --            12        252         --          --          --         264
Cash dividends declared:                                                                                     
 Common stock                                        --            --         --       (848)         --          --        (848)
 Preferred stock                                     --            --         --       (441)         --          --        (441)
--------------------------------------------------------------------------------------------------------------------------------- 
Balances at December 31, 1997                      $ 49         2,389     13,793     22,868         213        (283)     39,029
--------------------------------------------------------------------------------------------------------------------------------- 
Comprehensive Income:                                                                                        
Net Income                                           --            --         --      4,842          --          --       4,842
Change in net unrealized gain                                                                                
 on securities available for sale,                                                                           
 net of taxes                                        --            --         --         --         277          --         277
                                                                                                                         -------
Total Comprehensive Income                                                                                                5,119
                                                                                                                         -------
Allocation of Common stock                                                                                   
 under Stock Ownership Plan                          --            --         60         --          --         154         214
Preferred Stock Redemption                                                                                   
 (48,631 shares)                                    (49)           --     (4,814)        --          --          --      (4,863)
Stock Options Exercised                              --            21        264         --          --          --         285
Stock purchased for ESOP                             --            --         --         --                    (289)       (289)
Cash dividends declared:                                                                                     
 Common stock                                        --            --         --       (966)         --          --        (966)
 Preferred stock                                     --            --         --       (187)         --          --        (187)
--------------------------------------------------------------------------------------------------------------------------------- 
Balances at December 31, 1998                      $ --         2,410      9,303     26,557         490        (418)     38,342
--------------------------------------------------------------------------------------------------------------------------------- 
</TABLE> 

See accompanying notes to consolidated financial statements.

28
<PAGE>
 
IROQUOIS BANCORP. INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

(1)  Business

     Iroquois Bancorp, Inc. ("Iroquois"), a corporation organized under the laws
of New York, commenced operations in 1990. Iroquois, through its principal
banking subsidiaries, provides financial services primarily to individuals and
small- to medium- sized businesses in a six county area of upstate New York.
Iroquois and its subsidiary financial institutions are subject to the
regulations of certain Federal and state agencies and undergo periodic
examinations by those regulatory agencies. Effective January 1, 1997 Iroquois
became a bank holding company in connection with the change in charter of its
largest subsidiary, Cayuga Bank, to a state-chartered commercial bank.
Previously, Iroquois was a thrift holding company and that subsidiary a state-
chartered savings bank operating under the name Cayuga Savings Bank.

(2)  Summary of Significant Accounting Policies

PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the
accounts of Iroquois and its wholly-owned subsidiaries, Cayuga Bank and
subsidiaries ("Cayuga") and The Homestead Savings(FA) and subsidiary
("Homestead") collectively referred to herein as the "Company." All significant
intercompany accounts and transactions are eliminated in consolidation.

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

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

     Available for sale securities are recorded at fair value. Held to maturity
securities are recorded at amortized cost. Unrealized holding gains and losses,
net of the related tax effect, on available for sale securities are excluded
from earnings and are reported as a component of accumulated other comprehensive
income in shareholders' equity until realized. Transfers of securities between
categories are recorded at fair value at the date of transfer.

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

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

LOANS -- Loans are carried at current unpaid principal balance less applicable
unearned discounts and net deferred costs. The Company has the ability and
intent to hold its loans to maturity except for education loans which are sold
to a third party from time to time upon reaching fully funded status. Also, the
Company originates some residential fixed rate mortgages with terms exceeding 20
years with the intent to sell. At the date of origination, the loans so
designated and meeting secondary market guidelines are identified as held for
sale and carried at the lower of net cost or fair value on an aggregate basis.
The Company typically retains the servicing rights to mortgages sold.

                                                                              29
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

     Interest on loans is accrued and included in income at contractual rates
applied to principal outstanding. Accrual of interest on loans, including
impaired loans, is generally discontinued when loan payments are 90 days or more
past due or when, by judgment of management, collectibility becomes uncertain.
When a loan is placed on nonaccrual status, previously accrued and uncollected
interest is reversed against current period interest income. Subsequent
recognition of income occurs only to the extent payment is received. Nonaccrual
loans generally are restored to an accrual basis when principal and interest
payments become current or when the loan becomes well secured and is in the
process of collection.

     Loan origination fees and certain direct loan costs are deferred and
amortized generally over the contractual life of the related loans as an
adjustment of yield using the interest method. Amortization of loan fees is
discontinued when a loan is placed on nonaccrual status.

ALLOWANCE FOR LOAN LOSSES -- The allowance for loan losses is increased by the
provision for loan losses charged against income and is decreased by the charge-
off of loans, net of recoveries. Loans are charged off (including impaired
loans) once the probability of loss has been determined giving consideration to
the customer's financial condition, underlying collateral, and guarantees.

     The allowance for loan losses is based on management's evaluation of the
loan portfolio considering such factors as historical loan loss experience,
review of specific loans, estimated losses on impaired loans, current economic
conditions, and such other factors as management considers appropriate to
estimate losses inherent in the portfolio.

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

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

PREMISES AND EQUIPMENT -- Land is carried at cost; buildings, furniture and
equipment are carried at cost less accumulated depreciation. Depreciation is
computed on the straight-line method over the estimated useful lives of the
assets (15 to 50 years for buildings and 3 to 10 years for furniture, fixtures,
and equipment). Amortization of leasehold improvements is computed on the
straight-line method over the shorter of the lease term or the estimated useful
life of the improvements.

30
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

OTHER REAL ESTATE -- Real estate acquired through foreclosure or deed in lieu of
foreclosure is recorded at the lower of the unpaid loan balance on the property
at the date of transfer, or fair value less estimated costs to sell. Adjustments
to the carrying values of such properties that result from subsequent declines
in value are charged to operations in the period in which the declines occur.
Operating costs associated with the properties are charged to expense as
incurred.

INTANGIBLE ASSET -- Intangible asset represents the premium paid in connection
with the May 1996 acquisition of three branches from an unrelated bank. The
premium of $3,138,000, less accumulated amortization of $1,193,000, is being
amortized over the expected useful life of seven years on a straight-line basis.
The amortization period is monitored to determine if events and circumstances
require the estimated useful life to be reduced. Periodically, the Company
reviews the intangible asset for events or changes in circumstances that may
indicate the carrying amount of the asset is impaired.

TRUST DEPARTMENT -- Assets held in a fiduciary or agency capacity for customers
are not included in the accompanying consolidated balance sheets, since such
assets are not assets of the Company. Fee income is recognized on the accrual
method based on the fair value of assets administered.

RETIREMENT PLANS -- The Company sponsors various defined contribution retirement
plans under which the Company accrues contributions due under the terms of these
plans.

POSTRETIREMENT BENEFITS -- The Company provides health care and life insurance
benefits to retired employees. The estimated costs of providing benefits are
accrued over the years the employees render services necessary to earn those
benefits. The Company is amortizing the discounted present value of the
accumulated post-retirement benefit obligation at January 1, 1993 over a 20 year
transition period.

     On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 132, "Employers' Disclosures about Pension and Other
Postretirement Benefits." SFAS No. 132 revises employers' disclosures about
pension and other postretirement benefit plans. SFAS No. 132 does not change the
accounting for these plans.

STOCK-BASED COMPENSATION -- The Company continues to apply the intrinsic value-
based method of accounting prescribed by APB Opinion No. 25, "Accounting for
Stock Issued to Employees" in accounting for its stock-based compensation plans
and discloses in the footnotes to the financial statements pro forma net income
and earnings per share information as if the fair value based method had been
adopted.

INCOME TAXES -- The Company and its subsidiaries file a consolidated tax return.
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 and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which 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.

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

                                                                              31
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

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

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                             Years ended December 31,
--------------------------------------------------------------------------------
(dollars in thousands)                       1998     1997    1996
--------------------------------------------------------------------------------
<S>                                          <C>      <C>     <C>
Other comprehensive income, before tax:
 Net unrealized holding gain on securities    $ 665    353   (168)
 Reclassification adjustment for gains
    included in net income                     (202)   (93)   (22)
--------------------------------------------------------------------------------
Other comprehensive income, before tax          463    260   (190)
Income tax expense related to items of
    other comprehensive income                  186    103    (76)
--------------------------------------------------------------------------------
Other comprehensive income, net of tax        $ 277    157   (114)
--------------------------------------------------------------------------------
</TABLE>

SEGMENT REPORTING -- During 1998, the Company adopted SFAS No. 131 "Disclosures
about Segments of an Enterprise and Related Information." SFAS No. 131 requires
the Company to report financial and other information about key revenue-
producing segments of the Company for which such information is available and is
utilized by the chief operating decision maker. Specific information to be
reported for individual segments include profit and loss, certain revenue and
expense items, and total assets. A reconciliation of segment financial
information to amounts reported in the financial statements is also provided.
Adoption of SFAS No. 131 did not result in significant changes in the Company's
reporting.

     The Company's operations are solely in the financial service industry and
include the provision of traditional commercial banking services. The Company
operates solely in the geographical regions of Cayuga, Oswego, Oneida and
Madison Counties and surrounding areas in New York State. The Company has
identified separate operating segments, however, these segments did not meet the
quantitative thresholds for separate disclosure.

CASH AND CASH EQUIVALENTS -- For purposes of the Consolidated Statements of Cash
Flows, cash and cash equivalents include cash on hand and in banks, interest-
bearing deposits with other financial institutions and Federal funds sold.

FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK -- The Company does not engage
in the use of derivative financial instruments and currently the Company's only
financial instruments with off-balance sheet risk consist of commitments to
originate loans and commitments under unused lines of credit.

EARNINGS PER SHARE -- Basic earnings per share is calculated by dividing net
income available to common shareholders by the weighted average number of shares
outstanding during the year. Diluted earnings per share includes the maximum
dilutive effect of stock issuable upon conversion of stock options. Unallocated
shares held by the Company's Employee Stock Ownership Plan ("ESOP") are not
included in the weighted average number of shares outstanding.

(3)  Securities

     The amortized cost and fair value of securities available for sale and
securities held to maturity at December 31, 1998 and 1997 were as follows:

32
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------- 
                                               1998               1997
----------------------------------------------------------------------------------- 
                                         Amortized    Fair    Amortized      Fair
(dollars in thousands)                     Cost       Value     Cost         Value
-----------------------------------------------------------------------------------
<S>                                      <C>          <C>     <C>           <C> 
Securities available for sale:                                                   
U.S. Government & agencies obligations    $40,172     40,734     42,187     42,537
States and municipal obligations            6,959      7,090        231        232
Corporate bonds                             3,362      3,471      1,507      1,517
Mortgage-backed securities                  7,120      7,179      4,664      4,675
Other                                       3,000      2,957      3,000      2,983
----------------------------------------------------------------------------------
                                          $60,613     61,431     51,589     51,944
----------------------------------------------------------------------------------
Securities held to maturity:                                                     
U.S. Government & agencies obligations    $    --         --         25         25
States and municipal obligations            5,818      5,903      3,729      3,795
Corporate bonds                            25,893     26,190     27,717     27,887
Mortgage-backed securities                 15,345     15,624     20,205     20,475
----------------------------------------------------------------------------------
                                          $47,056     47,717     51,676     52,182
----------------------------------------------------------------------------------
</TABLE> 

     Securities with an amortized cost of $48,447,000 (fair value of
$49,505,000) at December 31, 1998 were pledged to secure public deposits,
borrowings, and for other purposes. Gross unrealized gains and gross unrealized
losses on the securities portfolio at December 31, 1998 and 1997 were as
follows:

<TABLE> 
<CAPTION> 
-----------------------------------------------------------------------------------------
                                                  1998                       1997
----------------------------------------------------------------------------------------- 
                                          Unrealized  Unrealized   Unrealized  Unrealized
 (dollars in thousands)                     Gains       Losses       Gains      Losses
-----------------------------------------------------------------------------------------
<S>                                       <C>         <C>          <C>         <C>    
Securities available for sale:
U.S. Government & agencies obligations         $ 624          62         421       71
States and municipal obligations                 134           3           1       --
Corporate bonds                                  111           2          10       --
Mortgage-backed securities                        68           9          12        1
Other                                             --          43          --       17
----------------------------------------------------------------------------------------- 
                                               $ 937         119         444       89
----------------------------------------------------------------------------------------- 
Securities held to maturity:
States and municipal obligations               $  85          --          66       --
Corporate bonds                                  298           1         172        2
Mortgage-backed securities                       327          48         348       78
----------------------------------------------------------------------------------------- 
                                               $ 710          49         586       80
----------------------------------------------------------------------------------------- 
</TABLE> 

Maturities of debt securities classified as available for sale and held to
maturity at December 31, 1998 were as follows:

<TABLE> 
<CAPTION> 
------------------------------------------------------------------------------
                                             Amortized           Fair
(dollars in thousands)                        Cost               Value
------------------------------------------------------------------------------
<S>                                          <C>                 <C>   
Securities available for sale:
Maturing within one year                     $10,025             10,022
Maturing after one but within five years      31,267             31,876
Maturing after five but within ten years       6,958              7,081
Maturing after ten years.                      5,243              5,273
------------------------------------------------------------------------------
                                              53,493             54,252
Mortgage-backed securities                     7,120              7,179
------------------------------------------------------------------------------
                                             $60,613             61,431
------------------------------------------------------------------------------
Securities held to maturity:
Maturing within one year                     $10,871             10,926
Maturing after one but within five years      18,916             19,193
Maturing after five but within ten years       1,559              1,609
Maturing after ten years                         365                365
------------------------------------------------------------------------------
                                              31,711             32,093
Mortgage-backed securities                    15,345             15,624
------------------------------------------------------------------------------
                                             $47,056             47,717
------------------------------------------------------------------------------
</TABLE>
                                                                              
                                                                              33
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

     Proceeds from sales of available for sale securities were $11,668,000 in
1998, $10,637,000 in 1997, and $10,038,000 in 1996. The gross realized gains and
gross realized losses on those sales were $202,000 and $0 in 1998, $105,000 and
$12,000 in 1997, and $33,000 and $11,000 in 1996, respectively.

(4)  LOANS

     Loans at December 31, 1998 and 1997 were as follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
(dollars in thousands)                        1998       1997
--------------------------------------------------------------------------------
<S>                                         <C>        <C>
Loans secured by first
 mortgages on real estate:
 Residential (1-4 Family):
  Conventional                              $252,319   212,680
  VA insured                                     929     1,201
  FHA insured                                    858     1,089
 Commercial                                   39,496    41,678
--------------------------------------------------------------------------------
                                             293,602   256,648
--------------------------------------------------------------------------------
Other loans:
  Consumer loans                              44,826    44,881
  Home equity lines of credit                 26,221    26,877
  Education loans                                436     1,905
  Commercial business loans                   37,573    41,920
--------------------------------------------------------------------------------
                                             109,056   115,583
--------------------------------------------------------------------------------
Total Loans                                  402,658   372,231
Unearned discount and net deferred costs       1,434     1,038
Allowance for loan losses                     (3,815)   (3,285)
--------------------------------------------------------------------------------
                                            $400,277   369,984
--------------------------------------------------------------------------------
</TABLE>

     The Company serviced mortgage loans for others aggregating approximately
$12,300,000, and $11,246,000 at December 31, 1998 and 1997, respectively. During
1996, the Company sold $4,666,000 in commercial mortgages to a third party and
realized a loss of $1,050,000.

     Transactions in the allowance for loan losses for the years ended December
31, 1998, 1997 and 1996 were as follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                      Years ended December 31,
--------------------------------------------------------------------------------
(dollars in thousands)              1998          1997       1996
--------------------------------------------------------------------------------
<S>                                 <C>           <C>        <C>
Balance at January 1                $ 3,285       3,389      3,380
Provision for loan losses             1,470       1,520      1,334
Charge-offs                          (1,061)     (1,808)    (1,406)
Recoveries                              121         184         81
--------------------------------------------------------------------------------
Balance at December 31              $ 3,815       3,285      3,389
--------------------------------------------------------------------------------
</TABLE>

     Impaired loans were $2,951,000 and $2,632,000 at December 31, 1998 and
1997, respectively. At December 31, 1998, impaired loans included $1,175,000 of
loans for which the related allowance for loan losses was $554,000. At December
31, 1997, impaired loans included $202,000 of loans for which the related
allowance for loan losses was $125,000. The average recorded investment in
impaired loans was $3,063,000, $2,256,000, and $2,416,000 for the years ended
December 31, 1998, 1997 and 1996, respectively. The effect on interest income
for impaired loans was not material to the accompanying consolidated financial
statements for the years ended December 31, 1998, 1997, and 1996.

     Loans on nonaccrual status amounted to $5,255,000 at December 31, 1998, and
$5,902,000 at December 31, 1997, including the impaired loans described above.
The effect of nonaccrual loans on interest income for the years ended December
31, 1998, 1997, and 1996 is not material to the accompanying consolidated
financial statements. Other real estate owned amounted to $665,000 at December
31, 1998 and $565,000 at December 31, 1997, and is included in other assets in
the accompanying consolidated balance sheets.

34
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

     A summary of the changes in outstanding loans to members of the board of
directors and officers of the Company, or their interests, follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
(dollars in thousands)                                 1998       1997
--------------------------------------------------------------------------------
<S>                                                  <C>          <C>
Balance of loans outstanding at beginning of year    $ 4,334      5,216
New loans and increase in existing loans                 551      1,089
Loan principal repayments                             (3,132)    (1,971)
--------------------------------------------------------------------------------
Balance at end of year:                              $ 1,753      4,334
--------------------------------------------------------------------------------
</TABLE>

     These loans were made on substantially the same terms, including interest
rate and collateral, as those prevailing at the time for comparable transactions
with unrelated parties.

(5)  PREMISES AND EQUIPMENT

     A summary of premises and equipment at December 31, 1998 and 1997 follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
                                       December 31, 1998                     December 31, 1997
--------------------------------------------------------------------------------------------------------
                                          Accumulated                          Accumulated
                                          Depreciation                         Depreciation
(dollars in thousands)        Cost       & Amortization        Net     Cost   & Amortization      Net
--------------------------------------------------------------------------------------------------------
<S>                           <C>        <C>                <C>        <C>     <C>               <C>
Land                           $ 1,008         --            1,008      1,008       --           1,008
Bank premises                    8,308      2,593            5,715      8,108     2,350          5,758
Furniture, fixtures
 & equipment                     5,301      3,954            1,347      4,930     3,526          1,404
--------------------------------------------------------------------------------------------------------
Total                          $14,617      6,547            8,070     14,046     5,876          8,170
--------------------------------------------------------------------------------------------------------
</TABLE>

     Depreciation and amortization expense amounted to $671,000, $673,000, and
$598,000 for the years ended December 31, 1998, 1997, and 1996, respectively.

(6)  Savings and Time Deposits

A summary of savings and time deposits at December 31, 1998 and 1997 follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
                                                                                1998           1997
--------------------------------------------------------------------------------------------------------
(dollars in thousands)                                                          Amount         Amount
--------------------------------------------------------------------------------------------------------
<S>                                                                             <C>            <C>
Savings accounts                                                                $105,717       108,578
Time deposits                                                                    219,097       201,056
Money market accounts                                                             46,066        41,033
Interest checking                                                                 41,454        38,781
--------------------------------------------------------------------------------------------------------
                                                                                $ 412,334      389,448
--------------------------------------------------------------------------------------------------------
</TABLE> 

     Contractual maturities of time deposits at December 31, 1998 were as 
follows:

<TABLE> 
<CAPTION> 
--------------------------------------------------------------------------------------------------------
                                                                                   1998
--------------------------------------------------------------------------------------------------------
(dollars in thousands)                                                           Amount         %
--------------------------------------------------------------------------------------------------------
<S>                                                                              <C>         <C> 
Under 12 months                                                                  $173,358     79.1
12 months to 24 months                                                             30,675     14.0
24 months to 36 months                                                              5,188      2.4
36 months to 48 months                                                              7,303      3.3
48 months to 60 months                                                              2,516      1.2
Thereafter                                                                             57       --
--------------------------------------------------------------------------------------------------------
                                                                                 $219,097    100.0%
--------------------------------------------------------------------------------------------------------
</TABLE>

     Time deposits issued in amounts of $100,000 or more were approximately
$56,000,000 and $41,000,000 at December 31, 1998 and 1997, respectively.
Interest expense by depositor account type for the years ended December 31,
1998, 1997, and 1996 was as follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
(dollars in thousands)                                      1998          1997        1996
--------------------------------------------------------------------------------------------------------
<S>                                                         <C>          <C>          <C>
Savings accounts                                            $ 2,650       2,911       3,347
Time deposits                                                11,417      10,591       9,852
Money market accounts                                         1,653       1,446       1,166
Interest checking                                               432         509         394
--------------------------------------------------------------------------------------------------------
                                                            $16,152      15,457      14,759
--------------------------------------------------------------------------------------------------------
</TABLE>
                                                                             35
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

     Interest expense on time deposits of $100,000 or more amounted to
$2,749,000, $2,272,000, and $999,000, for the years ended December 31, 1998,
1997, and 1996, respectively.

(7)  BORROWINGS

     Borrowings consisted of the following at December 31, 1998 and 1997:

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------
(dollars in thousands)                                      1998             1997
------------------------------------------------------------------------------------------
<S>                                                         <C>              <C>
Federal Home Loan Bank Line of Credit                       $    --          13,400
Federal Home Loan Bank Term Advances                         61,462          36,477
Employee Stock Ownership Plan Notes                             129             287
------------------------------------------------------------------------------------------
                                                            $61,591          50,164
------------------------------------------------------------------------------------------
</TABLE>

LINE OF CREDIT AND TERM ADVANCES

     The Company maintains a $29,300,000 overnight line of credit with the
Federal Home Loan Bank of New York (FHLB). Advances are payable on demand and
bear interest at the federal funds rate plus 1/8%. The Company has access to the
FHLB's Term Advance Program and can borrow up to 25% of total assets at various
terms and interest rates. Term advances mature $18,000,000 in 1999, $19,000,000
in 2000, $16,000,000 in 2001, $2,000,000 in 2002, $6,000,000 in 2003, and
$462,000 in 2014 at interest rates ranging from 4.91% to 7.47%. Under the terms
of a blanket collateral agreement with the Federal Home Loan Bank of New York,
these outstanding balances are collateralized by certain qualifying assets not
otherwise pledged (primarily first mortgage loans).

     Information related to the Federal Home Loan Bank Line of Credit for the
years ended December 31, 1998 and 1997 follows:

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------
(dollars in thousands)                                           1998          1997
------------------------------------------------------------------------------------------
<S>                                                             <C>           <C>
Outstanding balance at end of year                              $    --       13,400
Average interest rate                                                --         6.13%
Maximum outstanding at any month end                            $21,600       23,300
Average amount outstanding during year                            6,786       10,132
Average interest rate during year                                  5.71%        5.78%
------------------------------------------------------------------------------------------
</TABLE> 

EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) NOTES

     The ESOP Notes consist of borrowings by the Company's ESOP from a third
party lender. Proceeds of the Notes were used to acquire common stock of the
Company. These Notes are guaranteed by the Company and are secured by
unallocated shares of the Company's stock held by the ESOP. Payment of these
Notes is derived from the Company's contributions to the plan. (Note 15)

     At December 31, 1998, the ESOP Notes consist of one loan payable in annual
principal payments of $43,000 plus interest at the Federal funds rate plus 250
basis points through 2001. During 1998, an ESOP note with an outstanding balance
of $115,000 at December 31, 1997 matured and was paid in full.

(8)  INCOME TAXES

     Total income taxes for the years ended December 31, 1998, 1997, and 1996
were allocated as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------
(dollars in thousands)                             1998          1997    1996
----------------------------------------------------------------------------------
<S>                                               <C>            <C>    <C>
Income before income taxes,                       $2,711         2,994  2,447
Change in Shareholders' Equity, for unrealized
 gain(loss) on securities                            186           103    (76)
----------------------------------------------------------------------------------
                                                  $2,897         3,097  2,371
----------------------------------------------------------------------------------
</TABLE>


36
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

     For the years ended December 31, 1998, 1997, and 1996, income tax expense
(benefit) attributable to income before income taxes consisted of:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------
(dollars in thousands)             1998      1997      1996
---------------------------------------------------------------------------------
<S>                                <C>       <C>      <C>
Current:
 State                             $  256      389      578
 Federal                            2,804    2,324    1,934
---------------------------------------------------------------------------------
                                    3,060    2,713    2,512
---------------------------------------------------------------------------------
Deferred:
 State                                 78       59      (16)
 Federal                             (427)     222      (49)
                                     (349)     281      (65)
--------------------------------------------------------------------------------- 
                                   $2,711    2,994    2,447
---------------------------------------------------------------------------------
</TABLE>

     Income tax expense attributable to income before income taxes differed from
the amounts computed by applying the U.S. federal statutory income tax rate to
pretax income as a result of the following:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------
(dollars in thousands)                  1998      1997     1996
---------------------------------------------------------------------------------
<S>                                    <C>        <C>      <C>
Tax expense at statutory rate          $2,568     2,683    2,117
State taxes, net of Federal benefit       220       296      371
Other                                     (77)       15      (41)
---------------------------------------------------------------------------------
Actual income tax expense              $2,711     2,994    2,447
---------------------------------------------------------------------------------
</TABLE>

     The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1998 and 1997 are:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------
(dollars in thousands)                               1998      1997
---------------------------------------------------------------------------------
<S>                                                  <C>       <C>
Deferred tax assets:
 Intangible assets                                   $  254      158
 Financial statement allowance for loan losses        1,524    1,264
 Postretirement benefits other than pension             177      147
 Other                                                  224      232
---------------------------------------------------------------------------------
Total gross deferred tax assets                      $2,179    1,801
---------------------------------------------------------------------------------
Deferred tax liabilities:
 Bond discount                                       $   87      116
 Other                                                   41       73
 Net unrealized gain on securities
  available for sale                                    328      142
 Undistributed earnings of subsidiary                   355      340
 Tax loan loss reserve in excess of base
  year reserve                                          289      214
---------------------------------------------------------------------------------
Total gross deferred liabilities                      1,100      885
---------------------------------------------------------------------------------
Net deferred tax asset                               $1,079      916
---------------------------------------------------------------------------------
</TABLE>

     Realization of deferred tax assets is dependent upon the generation of
future taxable income or the existence of sufficient taxable income within the
carryback period. A valuation allowance is provided when it is more likely than
not that some portion of the deferred tax assets will not be realized. In
assessing the need for a valuation allowance, management considers the scheduled
reversal of the deferred tax liabilities, the level of historical taxable
income, and projected future taxable income over the periods in which the
temporary differences comprising the deferred tax assets will be deductible.
Based on its assessment, management determined that no valuation allowance is
necessary.

     Included in retained earnings at December 31, 1998 is approximately
$2,038,000 representing aggregate provisions for loan losses taken under the
Internal Revenue Code. Use of these reserves to pay dividends in excess of
earnings and profits or to redeem stock, or if the institution fails to qualify
as a bank for Federal income tax purposes would result in taxable income to the
Company. However, it is not contemplated that the reserves will be used in a
manner that will create tax liabilities.

                                                                              37
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements


9)   Regulatory Capital Matters

     The Company and its subsidiary financial institutions are subject to
various regulatory capital requirements administered by the federal banking
agencies which regulate them. Failure to meet minimum capital requirements can
initiate certain mandatory--and possibly additional discretionary--actions by
regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, Iroquois, Cayuga, and
Homestead must meet specific capital guidelines that involve quantitative
measures of assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.

     Quantitative measures established by regulation to ensure capital adequacy
require that each of the entities maintain minimum amounts and ratios (set forth
in the table below) of total and Tier I capital (as defined in the regulations)
to risk-weighted assets (as defined). Management believes, as of December 31,
1998, that Iroquois, Cayuga, and Homestead meet all capital adequacy
requirements to which each is subject.

     The most recent notifications from the Federal Reserve Bank of New York
(FRB), the Federal Deposit Insurance Corporation (FDIC), and the Office of
Thrift Supervision (OTS) categorized Iroquois, Cayuga, and Homestead,
respectively, as well capitalized under regulatory guidelines. To be categorized
as well capitalized, Iroquois, Cayuga, and Homestead must maintain the minimum
ratios as set forth in the table. There were no conditions or events since that
notification that management believes have changed the category of the
institutions.

     The Company's actual capital amounts and ratios as of December 31, 1998,
and 1997 are presented in the following table:

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------- 
                                                                            As of December 31, 1998:
------------------------------------------------------------------------------------------------------------------------------- 
                                                                                                        To Be Well
                                                                                                     Capitalized Under
                                                                                   For Capital           Regulatory
                                                              Actual            Adequacy Purposes        Provisions
(dollars in thousands)                                 Amount        Ratio       Amount     Ratio     Amount     Ratio
------------------------------------------------------------------------------------------------------------------------------- 
<S>                                                    <C>           <C>        <C>         <C>      <C>         <C>
Total Capital (to Risk Weighted Assets):
------------------------------------------------------------------------------------------------------------------------------- 
Consolidated                                           $40,212       11.65%      27,609      *8.0     34,511     *10.0    
Cayuga                                                  32,120       11.59       22,077      *8.0     27,596     *10.0 
Homestead                                                7,278       11.12        5,237      *8.0      6,546     *10.0 
                                                                                                                       
Tier 1 Capital (to Risk Weighted Assets):                                                                              
------------------------------------------------------------------------------------------------------------------------------- 
Consolidated                                           $36,397       10.55%      13,804      *4.0     20,708      *6.0 
Cayuga                                                  28,526       10.34       11,039      *4.0     16,558      *6.0 
Homestead                                                7,057       10.78        2,618      *4.0      3,928      *6.0 
                                                                                                                       
Tier 1 Capital (to Average Assets):                                                                                    
------------------------------------------------------------------------------------------------------------------------------- 
Consolidated                                           $36,397        6.70%      21,730      *4.0        N/A        -- 
Cayuga                                                  28,526        6.82       16,729      *4.0     20,911      *5.0 
Homestead                                                7,057        6.36        4,438      *4.0      5,547      *5.0 
                                                                                                                  
Tangible Capital (to Average Assets):                                                                                  
------------------------------------------------------------------------------------------------------------------------------- 
Consolidated                                               N/A          --          N/A        --        N/A        -- 
Cayuga                                                     N/A          --          N/A        --        N/A        -- 
Homestead                                              $ 7,057        6.36%       1,664      *1.5        N/A        --
------------------------------------------------------------------------------------------------------------------------------- 
</TABLE>
  
N/A- Not Applicable

* GREATER THAN OR EQUAL TO

38
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------- 
                                                                         As of December 31, 1997:
-------------------------------------------------------------------------------------------------------------------------- 
                                                                                                      To Be Well
                                                                                                   Capitalized Under
                                                                                   For Capital         Regulatory
                                                              Actual            Adequacy Purposes      Provisions
-------------------------------------------------------------------------------------------------------------------------- 
(dollars in thousands)                                 Amount        Ratio      Amount      Ratio    Amount    Ratio
--------------------------------------------------------------------------------------------------------------------------
<S>                                                    <C>           <C>        <C>         <C>    <C>         <C> 
Total Capital (to Risk Weighted Assets):
--------------------------------------------------------------------------------------------------------------------------
Consolidated                                           $39,697       12.14%     26,164      *8.0        N/A       --      
Cayuga                                                  31,720       11.90      21,317      *8.0     26,646    *10.0      
Homestead                                                6,800       11.07       4,913      *8.0      6,141    *10.0      
                                                                                                               
Tier 1 Capital (to Risk Weighted Assets):                                                                                 
--------------------------------------------------------------------------------------------------------------------------
Consolidated                                           $36,412       11.13%     13,082      *4.0        N/A       --      
Cayuga                                                  28,671       10.76      10,658      *4.0     15,987     *6.0      
Homestead                                                6,564       10.69       2,457      *4.0      3,685     *6.0      
                                                                                                                
Tier 1 Capital (to Average Assets):                                                                                       
--------------------------------------------------------------------------------------------------------------------------
Consolidated                                           $36,412        7.29%     27,480      *4.0        N/A       --      
Cayuga                                                  28,671        7.48      15,327      *4.0     19,158     *5.0      
Homestead                                                6,564        6.16       4,261      *4.0      5,326     *5.0      
                                                                                                                
Tangible Capital (to Average Assets):                                                                                     
--------------------------------------------------------------------------------------------------------------------------
Consolidated                                               N/A          --         N/A        --        N/A       --      
Cayuga                                                     N/A          --         N/A        --        N/A       --      
Homestead                                              $ 6,564        6.16%      1,598      *1.5        N/A       --
--------------------------------------------------------------------------------------------------------------------------
</TABLE> 
      
N/A- Not Applicable

* GREATER THAN OR EQUAL TO

(10)  Shareholders' Equity

Preferred Stock, Series A -- In April 1998, the Company completed the redemption
of its Series A Floating Rate Cumulative Preferred Stock, which resulted in the
redemption during 1998 of 29,999 shares at a cost of $2,999,900. The Company
paid dividends per share on its Series A Preferred Stock of $2.38, $9.44, and
$9.38 for the years ended December 31, 1998, 1997, and 1996, respectively.

Preferred Stock, Series B -- In October 1998, the Company completed the
redemption of its Series B Floating Rate Cumulative Preferred Stock, which
resulted in the redemption during 1998 of 18,632 shares at a cost of $1,863,200.
The Company paid dividends per share on its Series B Preferred Stock of $6.38,
$8.44, and $8.38 for the years ended December 31, 1998, 1997, and 1996,
respectively.

     The Company's ability to pay dividends is primarily dependent upon the
ability of its subsidiary banks to pay dividends to the Company. The payment of
dividends by the Banks is subject to being in compliance with minimum regulatory
capital requirements. In addition, regulatory approval is generally required
prior to either Bank declaring dividends in an amount in excess of net income
for that year plus net income retained in the preceding two years.

     The Company paid dividends per share on its common stock of $ .40, $ .36,
and $ .32 for the years ended December 31, 1998, 1997, and 1996, respectively.

                                                                              39
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
 
(11) Earnings per Share

     Basic and diluted earnings per share for the years ended December 31, 1998,
1997, and 1996 were computed as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
                                                                 For Years Ended December 31,
----------------------------------------------------------------------------------------------------------
(dollars in thousands, except share data)                      1998          1997           1996          
<S>                                                         <C>            <C>            <C>             
----------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE                                                                                  
Earnings available for common shares:                                                                     
Earnings from operations                                    $    4,842         4,897          3,779       
Cash dividends on preferred stock                                  187           441            451       
----------------------------------------------------------------------------------------------------------
Net earnings available for common shareholders              $    4,655         4,456          3,328       
----------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding                   2,378,049     2,355,285      2,324,847      
---------------------------------------------------------------------------------------------------------- 
Basic earnings per share                                    $     1.96          1.89           1.43       
----------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE                                                                                
Net earnings available for common shares and                                                              
 common stock equivalent shares deemed to                                                                 
 have a dilutive effect                                     $    4,655         4,456          3,328       
----------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding                   2,378,049     2,355,285      2,324,847       
Effect of dilutive securities:                                                                            
Stock options                                                   42,754        65,101         28,627       
----------------------------------------------------------------------------------------------------------
Total                                                        2,420,803     2,420,386      2,353,474       
----------------------------------------------------------------------------------------------------------
Diluted earnings per share                                  $     1.92          1.85           1.41       
---------------------------------------------------------------------------------------------------------- 
</TABLE>

(12) Retirement Plans

     The Company's retirement plans cover substantially all of its full-time
employees who have been employed by the Company for more than one year. The
Company has a noncontributory defined contribution retirement plan and a 401(k)
plan. Contributions to the retirement plan are based on the participant's age
and compensation, generally 2.5% of each covered employee's wages. Contributions
to the 401(k) plan amount to 50% of participant contributions up to 6% of
employee compensation. Expense for these plans for the years ended December 31,
1998, 1997, and 1996 was $301,000, $246,000, and $193,000, respectively.

(13) Other Postretirement Benefit Plans

     The Company sponsors a defined contribution Postretirement Medical Spending
Account Plan that provides funds for medical expenditures for retired full time
employees who meet minimum age and service requirements. In addition, the
Company sponsors a life insurance benefit of $10,000 for retired full time
employees meeting minimum age and service requirements.

40
<PAGE>
 

IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

     The following table presents the plan's funded status reconciled with
amounts recognized in the Company's consolidated balance sheet at December 31,
1998, 1997, and 1996:

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------
(dollars in thousands)                                          1998                           1997 
-------------------------------------------------------------------------------------------------------------
<S>                                                            <C>                             <C>      
CHANGE IN BENEFIT OBLIGATION                                                                        
Benefit obligation, at beginning of year                       $   875                          812 
Service cost                                                        13                           13  
Interest cost                                                       66                           62  
Participant contributions                                           14                           11 
Actuarial loss                                                     131                           35  
Benefits paid                                                      (59)                         (58) 
-------------------------------------------------------------------------------------------------------------
Benefit obligation, at end of year                             $ 1,040                          875 
-------------------------------------------------------------------------------------------------------------
CHANGE IN PLAN ASSETS                                                                               
Fair value of assets, at beginning of year                     $    --                           -- 
Employer contributions                                              45                           47 
Participant contributions                                           14                           11 
Benefits paid                                                      (59)                         (58)
-------------------------------------------------------------------------------------------------------------
Fair value of assets, at end of year                           $    --                           -- 
-------------------------------------------------------------------------------------------------------------
FUNDED STATUS                                                                                       
Benefit obligation                                             $(1,040)                        (875)
Unrecognized transition obligation                                 604                          647 
Unrecognized net actuarial (gain)/loss                              19                         (112)
-------------------------------------------------------------------------------------------------------------
Accrued benefit cost                                           $  (417)                        (340) 
-------------------------------------------------------------------------------------------------------------

<CAPTION> 
-------------------------------------------------------------------------------------------------------------
(dollars in thousands)                                          1998            1997           1996
-------------------------------------------------------------------------------------------------------------
<S>                                                            <C>              <C>            <C> 
COMPONENTS OF NET PERIODIC COST
Service cost                                                   $    13            13             16
Interest cost                                                       66            62             57
Amortization of unrecognized
 transition obligation                                              43            41             40
-------------------------------------------------------------------------------------------------------------
Net periodic cost                                              $   122           116            113
-------------------------------------------------------------------------------------------------------------
</TABLE>

     For measurement purposes, a nine percent annual rate of increase in the per
capita cost of covered health care benefits was assumed for 1999. The rate was
assumed to decrease gradually to five percent for 2007 and remain at that level
thereafter.

     The postretirement benefit obligation was determined using a discount rate
of 6.5% for 1998 and 7.5% for 1997. A one-percentage-point increase or decrease
in assumed health care cost trend rates does not have a material effect on the
obligation.

(14) Stock Option Plan

     Under the 1988 Plan which terminated in 1998, 55,600 shares of authorized
but unissued common stock has been reserved for the granting of options to key
employees. Options were granted at the market price of shares at the date of
grant, adjusted when applicable for the effect of changes in capitalization.
Vesting of options is determined by the Company's Stock Option Committee at the
time of grant and expire not later than ten years after the date of grant. All
options available under the Plan were granted prior to its expiration in 1998.

     The terms, conditions and provisions of the 1996 Plan are substantially the
same as those of the 1988 Plan. Under the 1996 Plan, 230,000 shares of
authorized but unissued common stock were reserved for future issuance. At
December 31, 1998, there were 149,700 options available for grant under this
Plan.

     Options outstanding at December 31, 1998 were at prices ranging from $8.80
to $25.65 per share.

                                                                              41
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements


The following is a summary of the changes in options outstanding:

<TABLE> 
<CAPTION> 
------------------------------------------------------------------------------------------------------------------------------------
                                                    1998                          1997                      1996
------------------------------------------------------------------------------------------------------------------------------------
                                                          Weighted                       Weighted                 Weighted
                                              #         Average Price        #         Average Price      #      Average Price
------------------------------------------------------------------------------------------------------------------------------------
<S>                                        <C>          <C>                <C>         <C>             <C>       <C>
Options outstanding, January 1             133,944         $13.39          122,450         12.62        96,000       10.76    
Granted                                     23,200          25.65           26,900         17.20        39,900       15.35    
Exercised                                  (21,044)         11.32           (8,606)        11.77        (9,850)       5.59    
Expired                                     (2,900)         21.86           (6,800)        16.57        (3,600)      12.68    
------------------------------------------------------------------------------------------------------------------------------------
Options outstanding, December 31           133,200          15.67          133,944         13.39       122,450       12.62    
------------------------------------------------------------------------------------------------------------------------------------
Options exercisable, December 31            90,500          12.92           73,944         11.23        86,150       11.35    
------------------------------------------------------------------------------------------------------------------------------------
Shares available for future grants         149,700             --          173,600            --       190,100          --    
------------------------------------------------------------------------------------------------------------------------------------
</TABLE> 

     The following summarizes outstanding and exercisable options at December
31, 1998:

<TABLE> 
<CAPTION> 
------------------------------------------------------------------------------------------------------------------------------------
                                                         Options Outstanding                    Options Exercisable
------------------------------------------------------------------------------------------------------------------------------------
                                                          Weighted Average   Weighted                        Weighted
Range of                               Number                 Remaining       Average          Number         Average
Exercise Prices                      Outstanding         Contractual Life  Exercise Price   Exercisable    Exercise Price
------------------------------------------------------------------------------------------------------------------------------------
<S>                                  <C>                 <C>               <C>              <C>            <C>   
$ 8.80 - 12.68                         56,700                5.5 years        $  11.48         56,700         $  11.48            
$15.35 - 17.20                         54,900                4.4 years        $  16.06         33,800         $  15.35            
$25.65 - 25.65                         21,600                6.1 years        $  25.65             --               --            
------------------------------------------------------------------------------------------------------------------------------------
                                      133,200                                                  90,500            
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

     Had compensation cost been determined based on the fair value at the grant
dates for awards under the plans, consistent with the method of SFAS No. 123,
the Company's net income and earnings per share would have been reduced to the
pro forma amounts indicated below: 

<TABLE> 
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except share data)                                1998      1997       1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                     <C>        <C>        <C>                 
Net Income:
 As reported                                                            $4,842     4,897      3,779  
 Pro forma                                                               4,768     4,836      3,738  
------------------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share:                                                                          
 As reported                                                              1.92      1.85       1.41  
 Pro forma                                                                1.89      1.82       1.40   
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

     The per share weighted average fair value of stock options granted during
1998, 1997, and 1996 of $7.45, $5.43, and $5.83 on the date of grant was
determined using the Black-Scholes option-pricing model with the following
weighted average assumptions:

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                           1998           1997              1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                     <C>              <C>              <C>
Expected dividend yield                                                    1.6%              1.6              2.0
Risk free interest rate                                                    5.4%              6.2              6.6
Expected life                                                           5 years          5 years          5 years
Volatility                                                                26.7%             27.5             39.9 
------------------------------------------------------------------------------------------------------------------------------------

</TABLE>

(15)  EMPLOYEE STOCK OWNERSHIP PLAN

      The Company has a noncontributory Employee Stock Ownership Plan (ESOP)
covering substantially all employees. The number of shares allocable to Plan
participants is determined by the Board of Directors. Allocations to individual
participant accounts is based on participant compensation.

      In connection with establishing the ESOP, the ESOP borrowed $1,147,000 in
1988 and utilized a Company contribution of $70,000 to acquire 188,260 shares of
the Company's common stock. At December 31, 1998 all of these shares have been
allocated. Interest incurred by the ESOP on debt applicable to such shares was
$4,000, $16,000, and $24,000 in 1998, 1997, and 1996, respectively. The Company
contributed and expensed $115,000, $104,000, and $105,000 during 1998, 1997, and
1996, respectively, with respect to such shares. 

42
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

     The Company accounts for shares purchased subsequent to December 31, 1992
in accordance with Statement of Position 93-6. Accordingly, as shares are
released from collateral, the Company reports compensation expense equal to the
current market price of the shares and the shares become outstanding for
earnings per share computations. In 1994, the ESOP borrowed $302,000 and used
the proceeds to purchase 34,188 shares of the Company's common stock. Interest
incurred by the ESOP on debt applicable to such shares was $14,000, $15,000, and
$21,000 in 1998, 1997, and 1996, respectively. In 1998, the ESOP borrowed
$289,000 from the Company to purchase an additional 15,000 shares of the
Company's common stock.

     ESOP compensation expense applicable to shares purchased subsequent to 1992
was $103,000, $111,000, and $74,000 in 1998, 1997, and 1996, respectively.
Through December 31, 1998, a total of 19,536 of the 49,188 shares purchased
after 1992 had been released to participants. The fair value at December 31,
1998 of unreleased ESOP shares purchased subsequent to 1992 was $623,000.

(16) COMMITMENTS AND CONTINGENCIES

     In the normal course of business, various commitments and contingent
liabilities are outstanding, such as standby letters of credit and commitments
to extend credit that are not reflected in the consolidated financial
statements. Financial instruments with off-balance sheet risk involve elements
of credit risk, interest rate risk, liquidity risk, and market risk. Management
does not anticipate any significant losses as a result of these transactions.

     Commitments to originate mortgages and other loans were approximately
$12,592,000 and $10,994,000 at December 31, 1998 and 1997, respectively.
Commitments under unused lines of credit were approximately $42,326,000 and
$44,008,000 at December 31, 1998 and 1997, respectively. The majority of these
commitments carry a variable rate of interest.

     Primarily all of the Company's loans are to borrowers in the New York
counties of Cayuga and Oneida and their surrounding areas. The ability and
willingness of borrowers to repay their loans is dependent on the overall
economic health of the Company's market area, current real estate values, and
the general economy. A majority of the Company's loans are secured by real
estate collateral.

     The Company leases certain property and equipment under operating lease
arrangements. Rent expense under these arrangements amounted to $32,000 in 1998,
$75,000 in 1997, and $117,000 in 1996. Real estate taxes, insurance,
maintenance, and other operating expenses associated with leased property are
generally paid by the Company.

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

(17) FAIR VALUES OF FINANCIAL INSTRUMENTS
     The following methods and assumptions were used to estimate the fair value
of each class of financial instruments:

CASH AND CASH EQUIVALENTS
     For these short-term instruments that generally mature in ninety days or
less, the carrying value approximates fair value.

SECURITIES
     Fair values for securities are based on quoted market prices or dealer
quotes, where available. Where quoted market prices are not available, fair
values are based on quoted market prices of comparable instruments. 

                                                                              43
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements

LOANS
     For variable-rate loans that reprice frequently and have no significant
credit risk, fair values are based on carrying values. Fair values for fixed-
rate residential mortgage loans are based on quoted market prices of similar
loans sold in the secondary market, adjusted for differences in loan
characteristics. The fair values for other loans are estimated through
discounted cash flow analysis using interest rates currently being offered for
loans with similar terms and credit quality.

FHLB STOCK
     The carrying value of this instrument, which is redeemable at par,
approximates fair value.

DEPOSITS
     The fair values disclosed for demand deposits, savings accounts, and money
market accounts are, by definition, equal to the amounts payable on demand at
the reporting date (i.e. their carrying values). The fair value of fixed
maturity deposits is estimated using a discounted cash flow approach that
applies interest rates currently being offered on time deposits to a schedule of
aggregated expected monthly maturities.

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

BORROWINGS
     The fair value of the term advances from the Federal Home Loan Bank is
estimated using discounted cash flow analysis based on the Company's current
incremental borrowing rate for similar borrowing arrangements.

COMMITMENTS TO EXTEND CREDIT
     The fair value of commitments to extend credit are based on fees currently
charged to enter into similar agreements, the counterparty's credit standing and
discounted cash flow analysis. The fair value of these commitments to extend
credit approximates the recorded amounts of the related fees and is not material
at December 31, 1998 and 1997.

     The estimated fair values of the Company's financial instruments as of
December 31, 1998 and 1997 were as follows (dollars in thousands):

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------
                                           1998                  1997
-----------------------------------------------------------------------------------
                                   Carrying    Fair       Carrying   Fair
(dollars in thousands)              Amount    Value/1/      Amount   Value/1/
-----------------------------------------------------------------------------------
<S>                               <C>        <C>          <C>       <C>
Financial Assets:
 Cash and cash equivalents.       $ 15,964    15,964       13,483    13,483 
 Securities                        108,487   109,148      103,620   104,126 
 Loans, net                        400,277   419,829      369,984   385,859 
 FHLB stock                          4,079     4,079        3,629     3,629 
-----------------------------------------------------------------------------------
Financial Liabilities:                                                      
 Deposits:                                                                  
  Demand accounts, savings, and                                             
   money market accounts          $224,142   224,142      215,955   215,955 
  Time Deposits                    219,097   220,175      201,056   202,134 
 Borrowings                         61,591    62,235       50,164    52,130  
-----------------------------------------------------------------------------------
</TABLE>

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

44
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Notes to Consolidated Financial Statements


(18) Parent Company Only Financial Statements

     The following presents the financial position of the parent company as of
December 31, 1998 and 1997 and the results of its operations and cash flows for
the years ended December 31, 1998, 1997, and 1996:

<TABLE>
<CAPTION>
CONDENSED BALANCE SHEETS
-------------------------------------------------------------------------------------------------
                                                                   December 31, 
-------------------------------------------------------------------------------------------------
(dollars in thousands)                                    1998                      1997
-------------------------------------------------------------------------------------------------
<S>                                                     <C>          <C>           <C> 
Assets
Cash and Due from Banks                                 $   563                     1,277
Other assets                                                311                       117
Investment in subsidiaries                               38,018                    37,843
-------------------------------------------------------------------------------------------------
                                                        $38,892                    39,237        
-------------------------------------------------------------------------------------------------             
Liabilities and Shareholders' Equity                                                   
Other liabilities                                       $   132                        36    
Borrowings                                                  418                       172 
Shareholders' equity                                     38,342                    39,029  
-------------------------------------------------------------------------------------------------
                                                        $38,892                    39,237        
-------------------------------------------------------------------------------------------------                           
CONDENSED STATEMENTS OF INCOME
-------------------------------------------------------------------------------------------------
                                                               Year ended December 31,
-------------------------------------------------------------------------------------------------
(dollars in thousands)                                     1998        1997          1996   
-------------------------------------------------------------------------------------------------
Dividends from subsidiaries                             $ 5,044       1,250         1,200   
Other income from subsidiaries                              706         594           632   
-------------------------------------------------------------------------------------------------
Total income                                              5,750       1,844         1,832   
Operating expenses                                          810         635           632   
Interest expense                                             18          15            21   
-------------------------------------------------------------------------------------------------
Total expenses                                              828         650           653   
-------------------------------------------------------------------------------------------------
Income before income taxes and equity in                                                    
 undistributed income of subsidiaries                     4,922       1,194         1,179   
Income tax benefit                                           23          --            --   
Equity in undistributed income of subsidiaries             (103)      3,703         2,600   
-------------------------------------------------------------------------------------------------
Net Income                                              $ 4,842       4,897         3,779   
-------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS                                                          
-------------------------------------------------------------------------------------------------
                                                               Year ended December 31, 
-------------------------------------------------------------------------------------------------
(dollars in thousands)                                     1998        1997          1996   
-------------------------------------------------------------------------------------------------
Operating activities:                                                                       
 Net Income                                             $ 4,842       4,897         3,779   
 Adjustments to reconcile net income to net cash                                            
  provided(used) by operating activities:                                                   
 Equity in undistributed income of subsidiaries             103      (3,703)       (2,600)  
 (Increase)decrease in other assets                        (194)         73           (48)  
 Increase(decrease) in other liabilities                                                    
  and due to  subsidiaries                                   96          22          (162)  
-------------------------------------------------------------------------------------------------
Net cash provided by operating activities                 4,847       1,289           969   
-------------------------------------------------------------------------------------------------
Financing activities:                                                                       
 Proceeds from issuance of common stock                     285         366           338   
 Stock plan distributions                                   213         236           211   
 Cash dividends paid to shareholders                     (1,153)     (1,289)       (1,198)  
 Redemption of preferred stock                           (4,863)       (140)          (50)  
 Stock purchase for ESOP                                   (289)         --            --   
 Increase (decrease) in borrowings                          246         (43)          (86)  
-------------------------------------------------------------------------------------------------
Net cash used by financing activities                    (5,561)       (870)         (795)  
-------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents       (714)        419           174   
Cash and cash equivalents at beginning of year            1,277         858           684   
-------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year                $   563       1,277           858    
-------------------------------------------------------------------------------------------------
</TABLE>

                                                                              45
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Quarterly Summarized Financial Information (Unaudited)

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------- 
(dollars in thousands, except share data)    1998                                 1997
--------------------------------------------------------------------------------------------------------- 
<S>                         <C>       <C>    <C>    <C>     <C>     <C>    <C>    <C>    <C>    <C>
By Quarter                       1        2      3       4   Year       1      2      3      4   Year
--------------------------------------------------------------------------------------------------------- 
Interest income             $9,647    9,785  9,945  10,027  39,404  9,112  9,323  9,476  9,611  37,522
Interest expense             4,591    4,795  4,915   4,918  19,219  4,046  4,218  4,406  4,547  17,217
--------------------------------------------------------------------------------------------------------- 
Net interest income          5,056    4,990  5,030   5,109  20,185  5,066  5,105  5,070  5,064  20,305
Provision for
 loan losses                   360      360    387     363   1,470    373    372    373    402   1,520
--------------------------------------------------------------------------------------------------------- 
                             4,696    4,630  4,643   4,746  18,715  4,693  4,733  4,697  4,662  18,785
Noninterest income             815      929    969   1,004   3,717    724    849    845    809   3,227
Noninterest expense          3,596    3,626  3,676   3,981  14,879  3,429  3,491  3,594  3,607  14,121
--------------------------------------------------------------------------------------------------------- 
Income before
 income taxes                1,915    1,933  1,936   1,769   7,553  1,988  2,091  1,948  1,864   7,891
Income taxes                   697      697    705     612   2,711    759    793    724    718   2,994
--------------------------------------------------------------------------------------------------------- 
Net income                   1,218    1,236  1,231   1,157   4,842  1,229  1,298  1,224  1,146   4,897
Preferred stock
 dividend                      111       38     38      --     187    108    111    111    111     441
---------------------------------------------------------------------------------------------------------  
Net income
 attributable to
 common shares              $1,107    1,198  1,193   1,157   4,655  1,121  1,187  1,113  1,035   4,456
--------------------------------------------------------------------------------------------------------- 
Net income per
 common share:
Basic                       $  .47      .50    .50     .49    1.96    .48    .50    .47    .44    1.89
Diluted                        .45      .49    .49     .48    1.92    .47    .49    .46    .43    1.85
--------------------------------------------------------------------------------------------------------- 
</TABLE>

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


Common Stock Price and Dividend Information (Unaudited)

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------- 
                                       1998                                              1997
<S>              <C>        <C>        <C>       <C>       <C>       <C>      <C>       <C>       <C>       <C>           
By Quarter         1          2          3         4        Year       1        2         3         4       Year          
Stock price                                                                                                       
 High             27         26 1/2     25        21        27        21 1/2   21 3/4    27 1/2    28 1/4    28 1/4         
 Low              24 1/4     24         19 1/2    17 3/4    17 3/4    16 1/4   20        20 1/2    24 1/4    16 1/4         
----------------------------------------------------------------------------------------------------------------------- 
Dividends        .10        .10        .10       .10       .40       .08      .08       .10       .10       .36          
</TABLE>

     The common stock of the Company is presently traded on the Nasdaq Stock
Market under the symbol "IROQ." The above table indicates the high and low
closing prices as reported in the Nasdaq National Market listings for the
Iroquois Bancorp, Inc. common stock, and dividend information for each quarter
in the last two calendar years. The prices may represent interdealer
transaction, without retail markups, markdowns, or commissions. The number of
registered shareholders of Iroquois Bancorp, Inc. stock as of December 31, 1998,
was 1,302.

46
<PAGE>
 
IROQUOIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
Directors and Officers/Corporate Data

<TABLE> 
<CAPTION> 
IROQUOIS                                                      CAYUGA                             THE HOMESTEAD                      
BANCORP, INC.                                                 BANK                               SAVINGS (FA)                       
<S>                          <C>                              <C>                                <C> 
DIRECTORS:                   OFFICERS:                        DIRECTORS:                         DIRECTORS:                         

JOSEPH P. GANEY              RICHARD D. CALLAHAN              JOSEPH P. GANEY, CHAIRMAN          ANNETTE M. DIMON                   
Chairman                     President &                      JOHN BISGROVE, JR.                 DAVID A. ENGELBERT                 
                             Chief Executive Officer          RICHARD D. CALLAHAN                RICHARD R. GRIFFITH                
BRIAN D. BAIRD                                                CAROL I. CONTIGUGLIA               PATRICK J. HART                    
Attorney, Kavinoky & Cook    MARIANNE R. O'CONNOR             PETER J. EMERSON                   WILLIAM E. JAKES                   
                             CPA, Treasurer &                 DR. ARTHUR A. KARPINSKI            HENRY D. MOREHOUSE                 
JOHN BISGROVE, JR.           Chief Financial Officer          MARTHA S. MACKAY                   RICHARD J. NOTEBAERT, JR.          
President & Owner of                                          LAWRENCE H. POOLE, PH.D.           EDWARD D. PETERSON                 
Sunrise Farms                RICHARD J. NOTEBAERT, JR.        FREDERICK N. RICHARDSON                                               
                             Vice President                   LEWIS E. SPRINGER, II              OFFICES:                           
RICHARD D. CALLAHAN          President & Chief Executive      DONALD E. STAPLES                                                     
President &                  Officer, The Homestead                                              MAIN OFFICE                        
Chief Executive Officer      Savings (FA)                     OFFICES:                           283 Genesee Street                 
                                                                                                 Utica, NY  13501                   
PETER J. EMERSON             HENRY M. O'REILLY                MAIN OFFICE                        (315) 797-1350                     
Director, Fred L. Emerson    Director of Internal Audit       115 Genesee Street                                                    
Foundation, Inc.                                              Auburn, NY  13021                  SOUTH UTICA OFFICE                 
                             W. ANTHONY SHAY, JR.             (315) 252-9521                     1930 Genesee Street                
DR. ARTHUR A. KARPINSKI      Vice President-Operations                                           Utica, NY  13502                   
Retired Periodontist                                          GRANT AVENUE OFFICE                                                   
                                                              Auburn, NY  13021                  ROME OFFICE                        
HENRY D. MOREHOUSE                                                                               Freedom Mall                       
Owner, Morehouse                                              LOOP ROAD OFFICE                   Rome, NY  13440                    
Appliances                                                    Auburn, NY  13021                                                     
                                                                                                 WATERVILLE OFFICE                  
EDWARD D. PETERSON                                            WEST GENESEE STREET OFFICE         129 Main Street                    
Retired Manager, Human                                        355 Genesee Street                 Waterville, NY  13480              
Resources, General Electric                                   Auburn, NY  13021                                                     
Aerospace Operations Dept.;                                                                      CLINTON OFFICE                     
Management Consultant                                         WEEDSPORT OFFICE                   Homestead Plaza                    
                                                              9015 North Seneca Street           Clinton, NY  13323                 
LEWIS E. SPRINGER, II                                         Weedsport, NY  13166                                                  
Executive,                                                                                       OLD FORGE-LOAN CENTER              
Creative Electric, Inc.                                       MORAVIA OFFICE                     Green Sleeves Common               
Andersen Laboratories, Inc.                                   31-33 Main Street                  Professional Building              
and Sawgrass Electronics                                      Moravia, NY  13118                 Old Forge, NY  13420               
Group, Inc.                                                                                                                         
                                                              LACONA OFFICE                      LAKE PLACID - LOAN CENTER          
                                                              1897 Harwood Drive                 Crestview Plaza                    
                                                              Lacona, NY  13083                  Saranac Ave                        
                                                                                                 Lake Placid, NY  12946 
                                                              
CORPORATE DATA                                                
                                                              
CORPORATE OFFICES            REQUEST FOR FINANCIAL            COUNSEL                            AUTOMATIC DIVIDEND               
                             INFORMATION                                                         REINVESTMENT PLAN                
Iroquois Bancorp, Inc.                                        Harris Beach & Wilcox, LLP                                          
115 Genesee Street           Shareholders and others          The Granite Building               A convenient, no-cost means      
Auburn, New York 13021       seeking information about        130 East Main Street               for Iroquois Bancorp, Inc.       
(315) 252-9521               Iroquois Bancorp, Inc.,          Rochester, NY  14604               shareholders to increase         
                             including copies of the                                             their holdings is available      
ANNUAL MEETING               annual and quarterly reports,    INDEPENDENT AUDITORS               through the Automatic Dividend   
                             as well as Form 10-K, as                                            Reinvestment Plan. This plan is  
The annual meeting of        filed with the Securities        KPMG LLP                           administered by American Stock   
Iroquois Bancorp, Inc. will  Exchange Commission, are         113 South Salina Street            Transfer & Trust Co. acting as   
be held at 10:00 a.m.,       invited to contact:              Syracuse, NY  13202                your Agent.                      
Thursday, April 29, 1999,                                                                                                         
at the Holiday Inn,          Marianne R. O'Connor             MARKET MAKERS                      Quarterly dividends and optional 
75 North Street, Auburn,     Chief Financial Officer          (as of year-end)                   additional cash investments may  
New York 13021.              (315) 252-9521                                                      be used to purchase additional   
                                                              F. J. Morrissey & Co., Inc.        shares.                          
                             Transfer Agent & Registrar:      Sandler O'Neill & Partners                                          
                             American Stock Transfer &                                           For further information contact: 
                             Trust Co.                                                           American Stock                   
                             40 Wall Street                                                      Transfer & Trust Co.             
                             New York, NY  10005                                                 40 Wall Street                   
                             (800) 937-5449                                                      New York, NY  10005              
                                                                                                 (800) 987-5449
</TABLE> 
                                  
                                                                              47
<PAGE>
 
     IROQUOIS BANCORP, INC. AND SUBSIDIARIES
     ---------------------------------------------------------------------------
     Notes

48
<PAGE>
 
       Iroquois Bancorp, Inc. 115 Genesee Street, Auburn, New York 13021