<PAGE>
 
CONFIDENTIAL, FOR USE OF THE COMMISSION ONLY
 
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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549
                               ----------------
                                   FORM 10-K
(Mark One)
 
[X] Annual Report Pursuant to Section 13 or 15(d)
    of the Securities Exchange Act of 1934 (Fee Required)
    For the Fiscal Year Ended December 31, 1998
 
                        or
 
[  ] Transition Report Pursuant to Section 13 or
     15(d) of the Securities Exchange Act of 1934 (No Fee Required)
     for the transition period from              to
 
                         Commission File Number 0-7974
 
                            CHITTENDEN CORPORATION
             (Exact name of Registrant as specified in its charter)
 
<TABLE>
<S>                                            <C>
                   Vermont                                       03-0228404
          (State of Incorporation)                   (IRS Employer Identification No.)
            Two Burlington Square
             Burlington, Vermont                                   05401
  (Address of Principal Executive Offices)                       (Zip Code)
</TABLE>
                  Registrant's telephone number: 802-658-4000
          Securities registered pursuant to Section 12(b) of the Act:
                         $1.00 Par Value Common Stock
                               (Title of Class)
          Securities registered pursuant to Section 12(g) of the Act:
                                     NONE
 
  Indicate by check mark whether the registrant: (1) has filed all reports to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [  ]
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
 
  The aggregate market value of the Registrant's common stock held by non-
affiliates of the Registrant, computed by reference to the last reported sale
price on the NYSE on February 26, 1999, was $390,822,108.
 
  At February 26, 1999, there were 14,211,713 shares of the Registrant's
common stock issued and outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
The following documents, in whole or in part, are specifically incorporated by
reference in the indicated Part of this Annual Report on Form 10-K:
 
1. Joint Proxy Statement/Prospectus for 1999 Annual Meeting of Registrant's
   Stockholders: Part III, Items 10, 11, 12, 13.
 
  This Form 10-K contains certain statements that may be considered forward-
looking statements within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. The Company's actual results could differ materially from those
projected in the forward-looking statements as a result of, among other
factors, changes in general, national or regional economic conditions, changes
in loan default and charge-off rates, reductions in deposit levels
necessitating increased borrowing to fund loans and investments, changes in
interest rates, and changes in the assumptions used in making such forward-
looking statements.
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                                    PART I
 
ITEM 1 BUSINESS
 
  Chittenden Corporation (the "Company" or "CC"), a Vermont corporation
organized in 1971, is a registered bank holding company under the Bank Holding
Company Act of 1956, as amended. At December 31, 1998, the Company had total
consolidated assets of $2,122,019,000. The Company is the holding company
parent and owns 100% of the outstanding common stock of Chittenden Trust
Company ("CTC"), Flagship Bank and Trust Company ("FBT"), The Bank of Western
Massachusetts ("BWM") (collectively "The Banks") and Chittenden Connecticut
Corporation ("CCC"), a non-bank mortgage company.
 
  Through its subsidiaries, the Company offers a variety of lending services,
with loans and leases totaling $1,400,103,000 at December 31, 1998. The
largest loan category is commercial loans, including those secured by
commercial real estate, and others made to a variety of businesses, including
retail concerns, small manufacturing businesses, larger corporations, other
commercial banks, and to political subdivisions in the U.S. Commercial loans
amounted to 50% of the total loans outstanding at December 31, 1998.
 
  Loans secured by residential properties, including closed-ended home equity
loans comprised 27% of total loans outstanding at December 31, 1998. The
Company underwrites substantially all of its residential mortgages based upon
secondary market standards and sells substantially all of its fixed-rate
residential mortgage loans on a servicing-retained basis. Variable or
adjustable rate mortgage loans are typically held in portfolio. Revolving home
equity loans as a separate group amounted to 5% of loans at December 31, 1998.
These loans are generally underwritten based upon the same standards as first
mortgages. The remaining real estate loans, which are 2% of total loans
outstanding at December 31, 1998, are construction loans secured by
residential and commercial land under development. Consumer loans outstanding
at December 31, 1998 were 21% of total loans. Indirect installment loans and
auto leases comprise 17%, while the remaining loans consist of direct
installment and revolving credit.
 
  The Company's lending activities are conducted primarily in Vermont and
Massachusetts, with additional activity related to nearby market areas in
Quebec, New York, New Hampshire, Maine and Connecticut. In addition to the
portfolio diversification described above, the loans are diversified by
borrowers and industry groups. In making commercial loans, the Banks
occasionally solicit the participation of other banks and other financial
investors. The Company, through its subsidiaries, also occasionally
participates in loans originated by other banks. Certain of the Company's
commercial loans are made under programs administered by the Vermont
Industrial Development Authority, the U.S. Small Business Administration, the
U.S. Farmers Home Administration or other local government agencies within the
Company's market. Loan terms include repayment guarantees by the agency
involved in varying amounts up to 90% of the original loan.
 
  The company evaluates the adequacy of the allowance for loan losses based
upon historical loss experience, industry statistics, and economic conditions.
The evaluation is based upon the results of the Company's ongoing loan rating
process which assesses individual credits in the commercial, commercial real
estate, and construction portfolios as either: pass, assets especially
mentioned, substandard, doubtful, or loss. Credits in the residential real
estate and consumer portfolios are not individually rated, but may be assigned
to a category when information known to management indicates that such
classification is appropriate. Management applies the allowance percentages it
considers appropriate to the balances in each rating category within each loan
portfolio. These percentages are based on the Company's historical loss
experience, industry trends, and the impact of economic conditions on the
Company's borrowers and are periodically adjusted as necessary when changes in
these factors warrant. Specific allowances are also determined for all loans
considered to be impaired in accordance with Statement of Financial Accounting
Standard Number 114. See "Allowance for Possible Loan Losses" below.
 
  The Banks offer a wide range of banking services, including the acceptance
of demand, savings, and time deposits. As of December 31, 1998, total
interest-bearing deposits and noninterest-bearing demand deposits amounted to
$1,569,575,000 and $321,179,000, respectively. The Banks also provide personal
trust services,
 
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<PAGE>
 
including services as executor, trustee, administrator, custodian and
guardian. Corporate trust services are also provided, including services as
trustee for pension and profit sharing plans. Asset management services are
provided with both personal and corporate trust services. Trust assets under
administration totaled $3.2 billion at December 31, 1998.
 
  The Company offers data processing services consisting primarily of payroll
and automated clearing house for several outside clients. Financial and
investment counseling is provided to municipalities and school districts
within the Company's service area, as well as central depository, lending,
payroll, and other banking services for such customers. The Banks offer a
variety of other services including safe deposit facilities, MasterCard and
VISA credit card services, credit card processing, certain non-deposit
investment products through the brokerage services of Chittenden Securities,
Inc, and various insurance related products through The Pomerleau Agency.
Chittenden Securities and The Pomerleau Agency are subsidiaries of Chittenden
Bank.
 
  The Company's principal executive offices are located at Two Burlington
Square, Burlington, Vermont 05401; telephone number: 802-658-4000.
 
Chittenden Trust Company
 
  CTC was chartered by the Vermont Legislature as a commercial bank in 1904.
It is the second largest bank in Vermont, based on total assets of
$1,538,357,000 and total deposits of $1,332,130,000 at December 31, 1998.
CTC's principal offices are in Burlington, Vermont and it has 35 additional
locations in Vermont. There are five free standing automated teller machines
("ATM's") at other locations. (See Item 2, "Properties"). The trade name
"Chittenden Bank" is used at all locations.
 
  On May 31, 1997, CTC acquired certain assets and assumed certain liabilities
of The Pomerleau Agency. The Pomerleau Agency offers various insurance related
products including: personal, commercial and life/health policies, as well as
specialized coverages and a consulting and risk management service.
 
  In October 1998, CTC established a registered broker/dealer, Chittenden
Securities, Inc., as a subsidiary. Chittenden Securities, Inc. is a full
service broker-dealer registered with the Securities and Exchange Commission
(SEC) and is a member of both the National Association of Securities Dealers,
Inc. (NASD) and the Securities Investor Protection Corporation (SIPC).
 
The Bank of Western Massachusetts
 
  BWM was chartered by the Commonwealth of Massachusetts as a commercial bank
in 1986. At December 31, 1998, BWM had total assets of $287,988,000 and total
deposits of $247,581,000. BWM's principal offices are in Springfield,
Massachusetts and it has four additional locations in the greater Springfield,
Massachusetts area.
 
Flagship Bank and Trust Company
 
  FBT was chartered by the Commonwealth of Massachusetts as a commercial bank
in 1986. At December 31, 1998, FBT had total assets of $346,993,000 and total
deposits of $320,987,000. FBT's principal offices are in Worcester,
Massachusetts and it has five additional locations in the greater Worcester,
Massachusetts area.
 
Chittenden Connecticut Corporation
 
  CCC was chartered by the State of Vermont, as a mortgage company in 1996 and
its principal offices are in Burlington, Vermont. CCC has additional offices
in Brattleboro, Vermont, Southbury, Connecticut and Lexington, Massachusetts
(See Item 2, "Properties"). CCC's primary business is the origination of
conforming residential real estate mortgage loans for resale to the secondary
market. CCC originates these loans for resale through correspondent
relationships with credit unions and through other mortgage brokers in the
state of
 
                                       2
<PAGE>
 
Connecticut who receive loan applications. These applications are underwritten
by CTC in Vermont based upon secondary market standards and then sold. In
addition, CCC uses brokers that are directly employed by and working through
various financial institutions in Connecticut.
 
Recent Developments
 
  On December 16, 1998, Chittenden announced that a definitive merger
agreement had been signed under which the Company would acquire Vermont
Financial Services Corporation (VFSC) for stock. Vermont Financial Services
Corporation is the parent company of Vermont National Bank, headquartered in
Brattleboro, VT, and United Bank, headquartered in Greenfield, Massachusetts,
and had consolidated assets of $2.1 billion at December 31, 1998 (See Note 2,
"Acquisitions" in Notes to Consolidated Financial Statements). The
transaction, which is structured to qualify as a pooling of interests for
accounting purposes, is subject to the approval of shareholders of Chittenden
and Vermont Financial, as well as to the receipt of federal and state
regulatory board approvals. Subject to the foregoing conditions, the
transaction is expected to close during the second quarter of 1999.
 
  The transaction is structured as a tax-free exchange of 1.07 shares of
Chittenden common stock for each share of VFSC common stock outstanding. At
the Company's closing stock price of $33 on December 14, 1998, the transaction
would be valued at approximately $454 million. In connection with the
transaction, the Company expects to record a one-time pre-tax charge of
between $35 to $45 million in acquisition-related costs, including severance
payments and integration of duplicative systems.
 
  Concurrent with the execution of the agreement on December 16, 1998, the
Company entered into a Stock Option Agreement with VFSC pursuant to which VFSC
granted the Company the option to purchase, under certain circumstances, up to
2,577,073 shares (or approximately 19.9 percent) of its outstanding common
stock for $22 per share.
 
Economy
 
  The New England economy showed signs of continued expansion, but at a slower
pace in 1998 than in 1997. Retail sales were mixed, while housing permits and
new construction contracts remained strong. New England unemployment levels
remained at steady lows, however, regional job growth has shown the effects of
slower global and national economic growth. The ability and willingness of the
Company's borrowers to honor their repayment commitments are impacted by many
factors, including the prevailing market interest rates and the level of
overall economic activity within the borrowers' geographic area.
 
Competition
 
  There is vigorous competition in the Company's marketplace for all aspects
of banking and related financial service activities presently engaged in by
the Company and its subsidiaries. In the retail financial services market,
competitors include other banks, credit unions, finance companies, thrift
institutions and, increasingly, brokerage firms, insurance companies, and
mortgage loan companies. Money market deposit accounts and short-term
flexible-maturity certificates of deposit offered by the Banks compete with
investment account offerings of brokerage firms and with new products offered
by insurance companies. The Company also competes for personal and commercial
trust business with investment advisory firms, mutual funds, and insurance
companies.
 
  CTC competes with Vermont banks and metropolitan banks based in southern New
England and New York to provide commercial banking services to businesses.
Many of these out-of-state banks have greater financial resources than those
of Vermont banks and are actively seeking financial relationships with
promising Vermont enterprises. BWM and FBT compete with other financial
institutions in their respective markets of Springfield and Worcester,
Massachusetts.
 
                                       3
<PAGE>
 
  BWM and FBT also operate in areas in which competition among financial
institutions is continuously increasing. BWM has focused on meeting the needs
of the smaller and medium-sized businesses and professionals in its market
area, while FBT has taken a balanced approach in serving the needs of both
smaller and medium-sized businesses, as well as retail consumers in its
market.
 
Supervision and Regulation
 
  The Company and its banking subsidiaries (CTC, BWM and FBT) are subject to
extensive regulation under federal and state banking laws and regulations. The
following discussion of certain of the material elements of the regulatory
framework applicable to banks and bank holding companies is not intended to be
complete and is qualified in its entirety by the text of the relevant state
and federal statutes and regulations. A change in the applicable laws or
regulations may have a material effect on the business of the Company and/or
its banking subsidiaries.
 
 Regulation of the Company
 
  General. As a corporation incorporated under Vermont law, the Company is
subject to regulation by the Secretary of the State of Vermont and the rights
of its stockholders are governed by Vermont corporate law. As a bank holding
company, the Company is subject to supervision and regulation by the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board") under
the Bank Holding Company Act of 1956, as amended (the "BHC Act"). Under the
BHC Act, bank holding companies generally may not acquire ownership or control
of more than 5% of any class of voting shares or substantially all of the
assets of any company, including a bank, without the prior approval of the
Federal Reserve Board. In addition, bank holding companies are generally
prohibited under the BHC Act from engaging in non-banking activities, subject
to certain exceptions. As a bank holding company, the Company's activities are
limited generally to the business of banking and activities determined by the
Federal Reserve Board to be so closely related to banking as to be a proper
incident thereto. The Federal Reserve Board has authority to issue cease and
desist orders to terminate or prevent unsafe or unsound banking practices or
violations of laws or regulations and to assess civil money penalties against
bank holding companies and their non-bank subsidiaries, officers, directors
and other institution-affiliated parties, and to remove officers, directors
and other institution-affiliated parties.
 
  Interstate Acquisitions. Prior to September 29, 1995, under the BHC Act a
bank holding company was permitted to acquire a bank in another state only if
the law of the state in which the bank to be acquired was located specifically
authorized such acquisition of an in-state bank by an out-of-state bank
holding company. As described below under "Capital Requirements and FDICIA--
Interstate Banking and Branching", the BHC Act was amended, effective
September 29, 1995, to remove this prohibition. Even prior to this amendment
to the BHC Act, previously enacted state legislation substantially lessened
prior legislative restrictions on geographic expansion by bank holding
companies from and into Massachusetts and Vermont. For example, under
nationwide reciprocal interstate banking legislation adopted by both states
which became effective in 1990, bank holding companies whose subsidiaries'
banking operations were principally conducted in any state outside
Massachusetts or Vermont were authorized to acquire Massachusetts or Vermont
banking organizations, provided that such companies' home states afforded
Massachusetts or Vermont banking organizations reciprocal rights to acquire
banks in such states.
 
  Dividends. The Federal Reserve Board has authority to prohibit bank holding
companies from paying dividends if such payment is deemed to be an unsafe or
unsound practice. The Federal Reserve Board has indicated generally that it
may be an unsafe and an unsound practice for bank holding companies to pay
dividends unless the bank holding company's net income over the preceding year
is sufficient to fund the dividends and the expected rate of earnings
retention is consistent with the organization's capital needs, asset quality,
and overall financial condition. The Company's ability to pay dividends is
dependent upon the flow of dividend income to it from its banking
subsidiaries, which may be affected or limited by regulatory restrictions
imposed by federal or state bank regulatory agencies. See "--Regulation of
CTC, BWM and FBT--Dividends."
 
                                       4
<PAGE>
 
  Certain Transactions by Bank Holding Companies with their Affiliates. There
are various legal restrictions on the extent to which bank holding companies
and their non-bank subsidiaries may borrow, obtain credit from or otherwise
engage in "covered transactions" with their insured depository institution
subsidiaries. Such borrowings and other covered transactions by an insured
depository institution subsidiary (and its subsidiaries) with its non-
depository institution affiliates are limited to the following amounts: (a) in
the case of any one such affiliate, the aggregate amount of covered
transactions of the insured depository institution and its subsidiaries cannot
exceed 10% of the capital stock and surplus of the insured depository
institution; and (b) in the case of all affiliates, the aggregate amount of
covered transactions of the insured depository institution and its
subsidiaries cannot exceed 20% of the capital stock and surplus of the insured
depository institution. "Covered transactions" are defined by statute for
these purposes to include a loan or extension of credit to an affiliate, a
purchase of or investment in securities issued by an affiliate, a purchase of
assets from an affiliate unless exempted by the Federal Reserve Board, the
acceptance of securities issued by an affiliate as collateral for a loan or
extension of credit to any person or company, or the issuance of a guarantee,
acceptance or letter of credit on behalf of an affiliate. Covered transactions
are also subject to certain collateral security requirements. Other types of
transactions between a bank and a bank holding company must be on market terms
and not otherwise unduly favorable to the holding company or an affiliate
thereof. Further, a bank holding company and its subsidiaries are prohibited
from engaging in certain tying arrangements in connection with any extension
of credit, lease or sale of property of any kind, or furnishing of any
service.
 
  Holding Company Support of Subsidiary Banks. Under Federal Reserve Board
policy, the Company is expected to act as a source of financial strength to
its subsidiary banks and to commit resources to support such subsidiaries.
This support of its subsidiary banks may be required at times when, absent
such Federal Reserve Board policy, the Company might not otherwise be inclined
to provide it. In addition, any capital loans by a bank holding company to any
of its subsidiary banks are subordinate in right of payment to deposits and
certain other indebtedness of such subsidiary banks. In the event of a bank
holding company's bankruptcy, any commitment by the bank holding company to a
federal bank regulatory agency to maintain capital of a subsidiary bank will
be assumed by the bankruptcy trustee and entitled to a priority of payment.
 
  Liability of Commonly Controlled Depository Institutions. Under the Federal
Deposit Insurance Act, as amended ("FDI Act"), an FDIC-insured depository
institution, such as CTC, BWM or FBT, can be held liable for any loss incurred
by, or reasonably expected to be incurred by, the FDIC after August 9, 1989 in
connection with (i) the "default" of a commonly controlled FDIC-insured
depository institution, or (ii) any assistance provided by the FDIC to any
commonly controlled depository institution in "danger of default." For these
purposes, the term "default" is defined generally as the appointment of a
conservator or receiver and "in danger of default" is defined generally as the
existence of certain conditions indicating that a default is likely to occur
without Federal regulatory assistance.
 
 Regulation of CTC, BWM and FBT
 
  General. As FDIC-insured state-chartered banks, CTC, BWM and FBT are subject
to supervision of and regulation by the Commissioner of Banking, Insurance,
Securities and Health Care Administration of the State of Vermont, in the case
of CTC, and the Commissioner of Banks of the Commonwealth of Massachusetts in
the case of BWM and FBT (individually, a Commissioner and collectively, the
"Commissioners") and, for all three banks, by the FDIC. This supervision and
regulation is for the protection of depositors, the BIF (as hereinafter
defined), and consumers, and is not for the protection of the Company's
stockholders. The prior approval of the FDIC and the relevant Commissioner is
required for CTC, BWM or FBT to establish or relocate an additional branch
office, assume deposits, or engage in any merger, consolidation or purchase or
sale of all or substantially all of the assets of any bank or savings
association.
 
  Examinations and Supervision. The FDIC and the Commissioners regularly
examine the condition and the operations of CTC, BWM and FBT, including (but
not limited to) their capital adequacy, reserves, loans, investments,
earnings, liquidity, compliance with laws and regulations, record of
performance under the
 
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<PAGE>
 
Community Reinvestment Act and management practices. In addition, CTC, BWM and
FBT are required to furnish quarterly and annual reports of income and
condition to the FDIC and periodic reports to the Commissioners. The
enforcement authority of the FDIC includes the power to impose civil money
penalties, terminate insurance coverage, remove officers and directors and
issue cease-and-desist orders to prevent unsafe or unsound practices or
violations of laws or regulations. In addition, under recent federal banking
legislation, the FDIC has authority to impose additional restrictions and
requirements with respect to banks that do not satisfy applicable regulatory
capital requirements. See "--Capital Requirements and FDICIA--Prompt
Corrective Action" below.
 
  Dividends. The principal source of the Company's revenue is dividends from
the Banks. Payments of dividends by the Banks are subject to certain Vermont
and Massachusetts banking law restrictions. Payment of dividends by CTC is
subject to Vermont banking law restrictions which require that, except when
surplus and paid-in capital together amount to 10% or more of deposits and
other liabilities (not including surplus, paid-in capital, capital notes and
debentures, and funds held in a fiduciary capacity), at least one-tenth of its
net profits must be set aside annually and added to surplus. Payment of
dividends by BWM and FBT is subject to Massachusetts banking law restrictions
which require that the capital stock and surplus account of the bank must
amount, in the aggregate, to at least 10% of the bank's deposit liability or
there shall be transferred from net profits to the surplus account (1) the
amount required to increase the surplus account so that it, together with the
capital stock, will amount to at least 10% of deposit liability or (2) the
amount required to increase the surplus account so that it shall amount to 50%
of the common stock, and thereafter, the amount , not exceeding 50% of net
profits, required to increase the surplus account so that it shall amount to
100% of capital stock.
 
  The FDIC has authority to prevent CTC, BWM and FBT from paying dividends if
such payment would constitute an unsafe or unsound banking practice or reduce
the respective bank's capital below safe and sound levels. In addition,
federal legislation prohibits FDIC-insured depository institutions from paying
dividends or making capital distributions that would cause the institution to
fail to meet minimum capital requirements. See "Capital Requirements and
FDICIA--Prompt Corrective Action" below.
 
  Affiliate Transactions. As noted above, banks are subject to restrictions
imposed by federal law on extensions of credit to, purchases of assets from,
and certain other transactions with, affiliates, and on investments in stock
or other securities issued by affiliates. Such restrictions prevent CTC, BWM
and FBT from making loans to affiliates unless the loans are secured by
collateral in specified amounts and have terms at least as favorable to the
bank as the terms of comparable transactions between the bank and non-
affiliates. Further, federal and applicable state laws significantly restrict
extensions of credit by CTC, BWM and FBT to directors, executive officers and
principal stockholders and related interests of such persons.
 
  Deposit Insurance. CTC's, BWM's and FBT's deposits are insured by the Bank
Insurance Fund ("BIF") of the FDIC to the legal maximum of $100,000 for each
insured depositor. The FDI Act provides that the FDIC shall set deposit
insurance assessment rates on a semi-annual basis at a level sufficient to
increase the ratio of BIF reserves to BIF-insured deposits to at least 1.25%
over a 15-year period commencing in 1991, and to maintain that ratio. Although
the established framework of risk-based insurance assessments accomplished
this increase in May 1995, and the FDIC has made a substantial reduction in
the assessment rate schedule, the BIF insurance assessments may be increased
in the future if necessary to maintain BIF reserves at the required level. In
addition, legislation enacted in 1996 to recapitalize the Savings Association
Insurance Fund ("SAIF"), which insures the deposits of savings associations
and certain savings banks, resulted in increased BIF assessments. See "Capital
Requirements and FDICIA--Risk-Based Deposit Insurance and FICO Assessments"
below.
 
  Federal Reserve Board Policies. The monetary policies and regulations of the
Federal Reserve Board have had a significant effect on the operating results
of banks in the past and are expected to continue to do so in the future.
Federal Reserve Board Policies affect the levels of bank earnings on loans and
investments and the levels of interest paid on bank deposits through the
Federal Reserve System's open-market operations in United States government
securities, regulation of the discount rate on bank borrowings from Federal
Reserve Banks and regulation of non-earning reserve requirements applicable to
bank deposit account balances.
 
                                       6
<PAGE>
 
  Consumer Protection Regulation; Bank Secrecy Act. Other aspects of the
lending and deposit businesses of CTC, BWM and FBT that are subject to
regulation by the FDIC and the Commissioners include disclosure requirements
with respect to interest, payment and other terms of consumer and residential
mortgage loans and disclosure of interest and fees and other terms of, and the
availability of, funds for withdrawal from consumer deposit accounts. In
addition, CTC, BWM and FBT are subject to federal and state laws and
regulations prohibiting certain forms of discrimination in credit
transactions, and imposing certain record keeping, reporting and disclosure
requirements with respect to residential mortgage loan applications. In
addition, CTC, BWM and FBT are subject to federal laws establishing certain
record keeping, customer identification, and reporting requirements with
respect to certain large cash transactions, sales of travelers checks or other
monetary instruments and the international transportation of cash or monetary
instruments.
 
  CRA Regulations. The Community Reinvestment Act ("CRA") requires lenders to
identify the communities served by the institution's offices and to identify
the types of credit the institution is prepared to extend within such
communities. The FDIC conducts examinations of insured institutions' CRA
compliance and rates such institutions as "Outstanding", "Satisfactory",
"Needs to Improve" and "Substantial Noncompliance". As of their last CRA
examinations, CTC, BWM and FBT received a rating of "Outstanding". Failure of
an institution to receive at least a "Satisfactory" rating could inhibit such
institution's undertaking certain activities, including acquisitions of other
financial institutions, which require regulatory approval based, in part, on
CRA compliance considerations. The Federal Reserve Board must take into
account the record of performance of banks in meeting the credit needs of the
entire community served, including low and moderate income neighborhoods.
 
  As a result of certain amendments in 1996, current CRA regulations rely more
than the former CRA regulations upon objective criteria of the performance of
institutions under three key assessment tests: a lending test, a service test
and an investment test. CTC, BWM and FBT are committed to meeting the existing
or anticipated credit needs of their entire communities, including low and
moderate-income neighborhoods, consistent with safe and sound operations.
 
 Capital Requirements and FDICIA
 
  General. The FDIC has established guidelines with respect to the maintenance
of appropriate levels of capital by FDIC-insured banks. The Federal Reserve
Board has established substantially identical guidelines with respect to the
maintenance of appropriate levels of capital, on a consolidated basis, by bank
holding companies. If a banking organization's capital levels fall below the
minimum requirements established by such guidelines, a bank or bank holding
company will be expected to develop and implement a plan acceptable to the
FDIC or the Federal Reserve Board, respectively, to achieve adequate levels of
capital within a reasonable period, and may be denied approval to acquire or
establish additional banks or non-bank businesses, merge with other
institutions or open branch facilities until such capital levels are achieved.
Federal legislation requires federal bank regulators to take "prompt
corrective action" with respect to insured depository institutions that fail
to satisfy minimum capital requirements and imposes significant restrictions
on such institutions. See "Prompt Corrective Action" below.
 
  Leverage Capital Ratio. The regulations of the FDIC require FDIC-insured
banks to maintain a minimum "Leverage Capital Ratio" or "Tier 1 Capital" (as
defined in the Risk-Based Capital Guidelines discussed in the following
paragraphs) to Total Assets of 3.0%. The regulations of the FDIC state that
only banks with the highest federal bank regulatory examination rating will be
permitted to operate at or near such minimum level of capital. All other banks
are expected to maintain an additional margin of capital, equal to at least 1%
to 2% of Total Assets, above the minimum ratio. Any bank experiencing or
anticipating significant growth is expected to maintain capital well above the
minimum levels. The Federal Reserve Board's guidelines impose substantially
similar leverage capital requirements on bank holding companies on a
consolidated basis.
 
  Risk-Based Capital Requirements. The regulations of the FDIC also require
FDIC-insured banks to maintain minimum capital levels measured as a percentage
of such banks' risk-adjusted assets. A bank's qualifying total capital ("Total
Capital") for this purpose may include two components--"Core" (Tier 1)
 
                                       7
<PAGE>
 
Capital and "Supplementary" (Tier 2) Capital. Core Capital consists primarily
of common stockholders' equity, which generally includes common stock, related
surplus and retained earnings, certain non-cumulative perpetual preferred
stock and related surplus, and minority interests in the equity accounts of
consolidated subsidiaries, and (subject to certain limitations) mortgage
servicing rights and purchased credit card relationships, less all other
intangible assets (primarily goodwill). Supplementary Capital elements
include, subject to certain limitations, a portion of the allowance for losses
on loans and leases, perpetual preferred stock that does not qualify for
inclusion in Tier 1 capital, long-term preferred stock with an original
maturity of at least 20 years and related surplus, certain forms of perpetual
debt and mandatory convertible securities, and certain forms of subordinated
debt and intermediate-term preferred stock.
 
  The risk-based capital rules of the FDIC and the Federal Reserve Board
assign a bank's balance sheet assets and the credit equivalent amounts of the
bank's off-balance sheet obligations to one of four risk categories, weighted
at 0%, 20%, 50% or 100%, respectively. Applying these risk-weights to each
category of the bank's balance sheet assets and to the credit equivalent
amounts of the bank's off-balance sheet obligations and summing the totals
results in the amount of the bank's total Risk-Adjusted Assets for purposes of
the risk-based capital requirements. Risk-Adjusted Assets can either exceed or
be less than reported balance sheet assets, depending on the risk profile of
the banking organization. Risk-Adjusted Assets for institutions such as CTC,
BWM and FBT will generally be less than reported balance sheet assets because
its retail banking activities include proportionally more residential mortgage
loans with a lower risk weighing and relatively smaller off-balance sheet
obligations.
 
  The risk-based capital regulations require all banks to maintain a minimum
ratio of Total Capital to Risk-Adjusted Assets of 8.0%, of which at least one-
half (4.0%) must be Core (Tier 1) Capital. For the purpose of calculating
these ratios: (i) a banking organization's Supplementary Capital eligible for
inclusion in Total Capital is limited to no more than 100% of Core Capital;
and (ii) the aggregate amount of certain types of Supplementary Capital
eligible for inclusion in Total Capital is further limited. For example, the
regulations limit the portion of the allowance for loan losses eligible for
inclusion in Total Capital to 1.25% of Risk-Adjusted Assets. The Federal
Reserve Board has established substantially identical risk-based capital
requirements, which are applied to bank holding companies on a consolidated
basis. The risk-based capital regulations provide explicitly for consideration
of interest rate risk in the FDIC's overall evaluation of a bank's capital
adequacy to ensure that banks effectively measure and monitor their interest
rate risk, and that they maintain capital adequate for that risk. A bank
deemed by the FDIC to have excessive interest rate risk exposure may be
required by the FDIC to maintain additional capital (that is, capital in
excess of the minimum ratios discussed above). CTC, BWM and FBT believe that
this provision will not have a material adverse effect on them.
 
  At December 31, 1998, the Company's consolidated Total and Tier 1 Risk-Based
Capital Ratios were 11.18% and 9.90%, respectively, and its Leverage Capital
Ratio was 7.37%. Based on the above figures and accompanying discussion, CC
exceeds all regulatory capital requirements and is considered well
capitalized.
 
  Prompt Corrective Action. Among other things, the Federal Deposit Insurance
Corporation Improvement Act ("FDICIA") requires the federal banking regulators
to take "prompt corrective action" with respect to, and imposes significant
restrictions on, any bank that fails to satisfy its applicable minimum capital
requirements. FDICIA establishes five capital categories consisting of "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." Under applicable
regulations, a bank that has a Total Risk-Based Capital Ratio of 10.0% or
greater, a Tier 1 Risk-Based Capital Ratio of 6.0% or greater and a Leverage
Capital Ratio of 5.0% or greater, and is not subject to any written agreement,
order, capital directive or prompt corrective action directive to meet and
maintain a specific capital level for any capital measure is deemed to be
"well capitalized." A bank that has a Total Risk-Based Capital Ratio of 8.0%
or greater, a Tier 1 Risk-Based Capital Ratio of 4.0% or greater and a
Leverage Capital Ratio of 4.0% or greater and does not meet the definition of
a well capitalized bank is considered to be "adequately capitalized." A bank
that has a Total Risk-Based Capital Ratio of less than 8.0% or has a Tier 1
Risk-Based Capital Ratio that is less than 4.0% or generally a Leverage
Capital Ratio of less than 4.0% is considered
 
                                       8
<PAGE>
 
"undercapitalized." A bank that has a Total Risk-Based Capital Ratio of less
than 6.0%, or a Tier 1 Risk-Based Capital Ratio that is less than 3.0% or a
Leverage Capital Ratio that is less than 3.0% is considered to be
"significantly undercapitalized," and a bank that has a ratio of tangible
equity to total assets equal to or less than 2% is deemed to be "critically
undercapitalized." A bank may be deemed to be in a capital category lower than
is indicated by its actual capital position if it is determined to be in an
unsafe or unsound condition or receives an unsatisfactory examination rating.
FDICIA generally prohibits a bank from making capital distributions (including
payment of dividends) or paying management fees to controlling stockholders or
their affiliates if, after such payment, the bank would be undercapitalized.
 
  Under FDICIA and the applicable implementing regulations, an
undercapitalized bank will be (i) subject to increased monitoring by the FDIC;
(ii) required to submit to the FDIC an acceptable capital restoration plan
(guaranteed, subject to certain limits, by the bank's holding company) within
45 days; (iii) subject to strict asset growth limitations; and (iv) required
to obtain prior regulatory approval for certain acquisitions, transactions not
in the ordinary course of business, and entry into new lines of business. In
addition to the foregoing, the FDIC may issue a "prompt corrective action
directive" to any undercapitalized institution. Such a directive may require
sale or re-capitalization of the bank, impose additional restrictions on
transactions between the bank and its affiliates, limit interest rates paid by
the bank on deposits, limit asset growth and other activities, require
divestiture of subsidiaries, require replacement of directors and officers,
and restrict capital distributions by the bank's parent holding company.
 
  In addition to the foregoing, a significantly undercapitalized institution
may not award bonuses or increases in compensation to its senior executive
officers until it has submitted an acceptable capital restoration plan and
received approval from the FDIC.
 
  Not later than 90 days after an institution becomes critically
undercapitalized, the appropriate federal banking agency for the institution
must appoint a receiver or, with the concurrence of the FDIC, a conservator,
unless the agency, with the concurrence of the FDIC, determines that the
purposes of the prompt corrective action provisions would be better served by
another course of action. FDICIA requires that any alternative determination
be "documented" and reassessed on a periodic basis. Notwithstanding the
foregoing, a receiver must be appointed after 270 days unless the appropriate
federal banking agency and the FDIC certify that the institution is viable and
not expected to fail.
 
  Risk-Based Deposit Insurance and FICO Assessments. The FDIC has adopted a
rule establishing a risk-based system which assigns an institution to one of
three capital categories consisting of (1) well capitalized, (2) adequately
capitalized, or (3) undercapitalized, and one of three supervisory categories.
An institution's assessment rate depends on the capital category and
supervisory category to which it is assigned. Under this rule there are nine
assessment risk classifications (i.e. combinations of capital categories and
supervisory subgroups within each capital group). An institution's deposit
insurance assessment rate is determined by assigning the institution to a
capital category and a supervisory subgroup to determine which one of the nine
risk classification categories is applicable. The FDIC is authorized to raise
the assessment rates in certain circumstances. If the FDIC determines to
increase the assessment rates for all institutions, institutions in all risk
categories could be affected. The FDIC has exercised this authority several
times in the past and may raise BIF insurance premiums again in the future. If
such action is taken by the FDIC, it could have an adverse effect on the
earnings of CTC, BWM and FBT, the extent of which is not currently
quantifiable. The risk classification to which an institution is assigned by
the FDIC is confidential and may not be disclosed.
 
  Assessment rates in 1998 ranged from 0% of domestic deposits for an
institution in the lowest risk category (i.e., well-capitalized and healthy
from a supervisory standpoint) to 0.27% of domestic deposits for institutions
in the highest risk category (i.e., undercapitalized and unhealthy from a
supervisory standpoint), for the first semiannual period of 1998. During 1998,
assessment rates also included a minimum annual assessment of $2,000 per
institution. CTC, BWM and FBT qualified for, and paid in 1998, the minimum
annual assessment under this rate schedule.
 
                                       9
<PAGE>
 
  The Deposit Insurance Funds Act of 1996 eliminates the minimum assessment
and authorizes the Financing Corporation (FICO) to levy assessments on BIF-
assessable deposits and stipulates that the rate must equal one-fifth the FICO
assessment rate that is applied to deposits assessable by the SAIF. The actual
assessment rates for FICO were determined by deposit data from the September
30, 1997, Call Reports. Based on the 1996 Act, the Banks paid assessments
totaling $234,000 or 1.2 cents per $100 of deposits in 1998.
 
  Brokered Deposits and Pass-Through Deposit Insurance Limitations. Under
FDICIA, a bank cannot accept brokered deposits unless it either (i) is "Well
Capitalized" or (ii) is "Adequately Capitalized" and has received a written
waiver from the FDIC. For this purpose, "Well Capitalized" and "Adequately
Capitalized" have the same definitions as in the Prompt Corrective Action
regulations. See "--Prompt Corrective Action" above. Banks that are not in the
"Well Capitalized" category are subject to certain limits on the rates of
interest they may offer on any deposits (whether or not obtained through a
third-party deposit broker). Pass-through insurance coverage is not available
for deposits of certain employee benefit plans in banks that do not satisfy
the requirements for acceptance of brokered deposits, except that pass-through
insurance coverage will be provided for employee benefit plan deposits in
institutions which at the time of acceptance of the deposit meet all
applicable regulatory capital requirements and send written notice to their
depositors that their funds are eligible for pass-through deposit insurance.
Although eligible to do so, CTC, BWM and FBT have not accepted brokered
deposits.
 
  Conservatorship and Receivership Amendments. FDICIA authorizes the FDIC to
appoint itself conservator or receiver for a state-chartered bank under
certain circumstances and expands the grounds for appointment of a conservator
or receiver for an insured depository institution to include (i) consent to
such action by the board of directors of the institution; (ii) cessation of
the institution's status as an insured depository institution; (iii) the
institution is undercapitalized and has no reasonable prospect of becoming
adequately capitalized, or fails to become adequately capitalized when
required to do so, or fails to timely submit an acceptable capital plan, or
materially fails to implement an acceptable capital plan; and (iv) the
institution is critically undercapitalized or otherwise has substantially
insufficient capital. FDICIA provides that an institution's directors shall
not be liable to its stockholders or creditors for acquiescing in or
consenting to the appointment of the FDIC as receiver or conservator for, or
as a supervisor in the acquisition of, the institution.
 
  Real Estate Lending Standards. FDICIA requires the federal bank regulatory
agencies to adopt uniform real estate lending standards. The FDIC has adopted
implementing regulations, which establish supervisory limitations on Loan-to-
Value ("LTV") ratios in real estate loans by FDIC-insured banks. The
regulations require FDIC-insured banks to establish LTV ratio limitations
within or below the prescribed uniform range of supervisory limits.
 
  Standards for Safety and Soundness. FDICIA requires the federal bank
regulatory agencies to prescribe, by regulation, standards for all insured
depository institutions and depository institution holding companies relating
to: (i) internal controls, information systems and internal audit systems;
(ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk
exposure; (v) asset growth; and (vi) compensation, fees and benefits. The
compensation standards would prohibit employment contracts, compensation or
benefit arrangements, stock option plans, fee arrangements or other
compensatory arrangements that would provide "excessive" compensation, fees or
benefits, or that could lead to material financial loss. In addition, the
federal bank regulatory agencies are required by FDICIA to prescribe standards
specifying; (i) maximum classified assets to capital ratios; (ii) minimum
earnings sufficient to absorb losses without impairing capital; and (iii) to
the extent feasible, a minimum ratio of market value to book value for
publicly-traded shares of depository institutions and depository institution
holding companies. The FDIC has issued regulations implementing certain of
these provisions.
 
  Activities and Investments of Insured State Banks. FDICIA provides that
FDIC-insured state banks such as CTC, BWM and FBT may not engage as a
principal, directly or through a subsidiary, in any activity that is not
permissible for a national bank unless the FDIC determines that the activity
does not pose a significant risk
 
                                      10
<PAGE>
 
to the BIF, and the bank is in compliance with its applicable capital
standards. In addition, an insured state bank may not acquire or retain,
directly or through a subsidiary, any equity investment of a type, or in an
amount, that is not permissible for a national bank.
 
  Subject to certain limited exceptions, the foregoing provisions of FDICIA
prohibit insured state banks such as CTC, BWM and FBT or any subsidiary of
such insured state banks from retaining or acquiring equity investments.
However, under an exception in the statute, an insured state bank that (i) is
located in a state such as Vermont or Massachusetts which authorized, as of
September 30, 1991, state banks to invest in common or preferred stock listed
on a national securities exchange ("listed stock") or shares of an investment
company registered under the Investment Company Act of 1940 ("registered
shares") and (ii) during the period beginning September 30, 1990 and ending on
November 26, 1991 made or maintained investments in listed stocks and
registered shares, may retain whatever listed stock or registered shares it
lawfully acquired or held prior to December 19, 1991 and may continue to
acquire listed stock or registered shares which may not exceed, taken together
in the aggregate, 100% of the bank's Tier 1 Capital. In order to acquire or
retain any listed stock or registered shares under this exception, the bank
must file a one-time notice with the FDIC containing specified information,
and the FDIC must determine that acquiring or retaining the listed stock or
registered shares will not pose a significant risk to the BIF. Any such
approval may be subject to whatever conditions or restrictions the FDIC
determines to be necessary or appropriate and will terminate with respect to
further acquisitions of listed stock or registered shares if the bank or its
holding company experiences a change in control and in certain other
circumstances. CTC filed the one-time notice with the FDIC and the FDIC did
not object.
 
  Consumer Protection Provisions. FDICIA also includes provisions requiring
advance notice to regulators and customers for any proposed branch closing and
authorizing (subject to future appropriation of the necessary funds) reduced
insurance assessments for institutions offering "lifeline" banking accounts or
engaged in lending in distressed communities. FDICIA also includes provisions
requiring depository institutions to make additional and uniform disclosures
to depositors with respect to the rates of interest, fees and other terms
applicable to consumer deposit accounts.
 
  Depositor Priority Statute. The FDI Act provides that, in the liquidation or
other resolution by any receiver of a bank insured by the FDIC, the claims of
depositors have priority over the general claims of other creditors. Hence, in
the event of the liquidation or other resolution of a banking subsidiary of
the Company, the general claims of the Company as creditor of such banking
subsidiary would be subordinate to the claims of the depositors of such
banking subsidiary, even if the claims of CC were not by their terms so
subordinated. In addition, this statute may, in certain circumstances,
increase the costs to banks of obtaining funds through non-deposit
liabilities.
 
  Interstate Banking and Branching. The Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 ("Riegle-Neal Act") provides that an
adequately capitalized and managed bank holding company may (with Federal
Reserve Board approval) acquire control of banks outside its principal state
of operations, without regard to whether such acquisitions are permissible
under state law. States may, however, limit the eligibility of banks to be
acquired by an out-of-state bank holding company to banks in existence for a
minimum period of time (not in excess of five years). No bank holding company
may make an acquisition outside its principal state of operations which would
result in it controlling more than 10% of the total amount of deposits of all
insured depository institutions in the United States, or 30% or more of the
total deposits of insured depository institutions in any state (unless such
limit is waived, or a more restrictive or permissible limit is established, by
a particular state). In addition, since June 1, 1997, banks may branch across
state lines either by merging with banks in other states or by establishing
new branches in other states. The provision relating to establishing new
branches in another state requires a state's specific approval. Effective in
1996, the Vermont and Massachusetts legislatures adopted legislation to
accelerate the effective date of interstate branching through mergers (that
is, to "opt-in early"). The Company is unable to predict the ultimate impact
of this interstate banking legislation on it or its competitors.
 
                                      11
<PAGE>
 
  The United States Congress has periodically considered and adopted
legislation which has resulted in and could result in further regulation or
deregulation of both banks and other financial institutions. Such legislation
could place the Company, CTC, BWM, FBT or CCC in more direct competition with
other financial institutions, including mutual funds, securities brokerage
firms and investment banking firms. No assurance can be given as to whether
any additional legislation will be enacted or as to the effect of such
legislation on the business of the Company or its subsidiaries.
 
Employees
 
  At December 31, 1998, the Company and its subsidiaries employed 1,046
persons, with a full-time equivalency of 985 employees. The Company enjoys
good relations with its employees. A variety of employee benefits, including
health, group life and disability income replacement insurance, a funded, non-
contributory pension plan, and an incentive savings and profit sharing plan,
are available to qualifying officers and employees.
 
ITEM 2 PROPERTIES
 
  The Company's principal banking subsidiary, CTC, operates banking facilities
in 36 locations in Vermont. The offices of the Company are located in an owned
facility at Two Burlington Square in Burlington, Vermont. BWM's principal
offices are in Springfield, Massachusetts and it has four additional locations
in the greater Springfield, Massachusetts area. FBT's principal offices are in
Worcester, Massachusetts and it has five additional locations in the greater
Worcester, Massachusetts area. CCC operates two mortgage company facilities in
Connecticut and Massachusetts. Except for the CTC property, all of the
properties mentioned above are leased. The offices of CTC, BWM, FBT and CCC
are in good physical condition with modern equipment and facilities considered
adequate to meet the banking needs of customers in the communities serviced.
 
ITEM 3 LEGAL PROCEEDINGS
 
  A number of legal claims against the Company arising in the normal course of
business were outstanding at December 31, 1998. Management, after reviewing
these claims with legal counsel, is of the opinion that these matters, when
resolved, will not have a material effect on the consolidated financial
statements.
 
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  None
 
                                      12
<PAGE>
 
                                    PART II
 
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
  The $1 par value common stock of Chittenden Corporation has been publicly
traded since November 14, 1974. As of February 26, 1999, there were 2,877
holders of record of the Company's common stock.
 
  As of February 18, 1998, the Corporation's stock initiated trading on the
NYSE under the symbol "CHZ". Prior to that date, the Corporation's stock
traded on the NASDAQ, under the symbol "CNDN". The following table sets forth
the range of the high and low sales prices for the Corporation's common stock,
and the dividends declared, for each quarterly period within the past two
years:
 
<TABLE>
<CAPTION>
                                                                     Dividends
      Quarter ended                                     High   Low     Paid
      -------------                                    ------ ------ ---------
      <S>                                              <C>    <C>    <C>
      1998
      March 31........................................ $39.00 $32.00  $0.176
      June 30.........................................  40.00  32.75   0.200
      September 30....................................  36.88  27.13   0.200
      December 31.....................................  33.38  25.44   0.200
      1997
      March 31........................................  24.00  18.50   0.160
      June 30.........................................  27.60  21.50   0.176
      September 30....................................  31.70  25.60   0.176
      December 31.....................................  36.00  30.40   0.776(1)
</TABLE>
--------
(1) Dividends paid during the fourth quarter of 1997 included a special cash
dividend of $0.60 per share.
 
For a discussion of dividend restrictions on the Corporation's common stock,
see "Dividends" under the caption Regulation on page 6 of this report.
 
                                      13
<PAGE>
 
ITEM 6 SELECTED FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                        Years Ended December 31,
                         ----------------------------------------------------------
                            1998        1997        1996        1995        1994
                         ----------  ----------  ----------  ----------  ----------
                           (in thousands, except share and per share amounts)
<S>                      <C>         <C>         <C>         <C>         <C>
Statements of income:
 Interest income........ $  151,511  $  150,029  $  142,558  $  135,074  $  101,383
 Interest expense.......     60,508      59,500      58,599      56,772      36,088
                         ----------  ----------  ----------  ----------  ----------
 Net interest income....     91,003      90,529      83,959      78,302      65,295
 Provision for possible
  loan losses...........      5,100       4,050       4,183       5,000       5,500
 Net interest income
  after provision for
  possible loan losses..     85,903      86,479      79,776      73,302      59,795
 Noninterest income.....     32,402      28,200      24,806      22,069      19,352
 Noninterest expense....     71,767      69,947      64,409      61,584      51,393
                         ----------  ----------  ----------  ----------  ----------
 Income before
  provision for income
  taxes.................     46,538      44,732      40,173      33,787      27,754
 Provision for income
  taxes.................     15,873      15,326      13,452      11,656       9,717
                         ----------  ----------  ----------  ----------  ----------
 Net income............. $   30,665  $   29,406  $   26,721  $   22,131  $   18,037
                         ==========  ==========  ==========  ==========  ==========
Total assets at year-
 end.................... $2,122,019  $1,977,150  $1,988,746  $1,794,704  $1,461,419
Common shares
 outstanding at year-
 end.................... 14,182,307  14,421,585  15,345,265  14,972,359  13,581,631
 
Balance sheets--average
 daily balances:
 Total assets........... $2,007,413  $1,934,333  $1,841,944  $1,687,803  $1,436,462
 Loans, net of
  allowance.............  1,391,811   1,363,394   1,307,725   1,202,591   1,001,356
 Investment securities
  and interest-bearing
  cash equivalents......    469,764     417,767     385,111     348,028     328,296
 Total deposits.........  1,775,244   1,695,953   1,627,834   1,486,500   1,268,338
 Total stockholders'
  equity................    167,618     167,568     162,823     138,641     115,442
Per common share:
 Basic Earnings......... $     2.14  $     1.99  $     1.75  $     1.50  $     1.28
 Diluted Earnings.......       2.09        1.94        1.72        1.47        1.26
 Cash dividends
  declared..............       0.78        1.29        0.57        0.32        0.22
 Book value.............      12.35       11.25       11.37       10.28        8.34
Weighted average common
 shares outstanding..... 14,303,053  14,812,208  15,228,820  14,763,133  14,087,763
Weighted average common
 and common equivalent
 shares outstanding..... 14,682,636  15,166,557  15,543,741  15,105,914  14,341,166
Selected financial
 percentages:
 Return on average
  stockholders' equity..      18.29%      17.55%      16.41%      15.96%      15.62%
 Return on average
  total assets..........       1.53        1.52        1.45        1.31        1.25
 Net yield on earning
  assets................       4.94        5.11        4.99        5.08        4.95
 Interest rate spread...       4.13        4.31        4.23        4.34        4.37
 Net charge-offs as a
  percent of average
  loans.................       0.52        0.39        0.29        0.28        0.49
 Nonperforming assets
  ratio (1).............       0.75        0.56        0.99        1.19        1.03
 Allowance for possible
  loan losses as a
  percent
  of year-end loans.....       1.72        1.89        2.07        2.20        2.09
 Year-end leverage
  capital ratio.........       7.37        7.43        8.58        8.05        8.10
 Risk-based capital
  ratios:
   Tier 1...............       9.90        9.86       11.71       11.16       11.40
   Total................      11.18       11.17       13.06       12.53       12.76
 Average stockholders'
  equity to average
  assets................       8.35        8.66        8.84        8.21        8.03
 Common stock dividend
  payout ratio (2)......      36.40       64.25       32.73       21.71       17.38
</TABLE>
--------
(1) The sum of nonperforming assets (nonaccrual loans, restructured loans, and
    other real estate owned) divided by the sum of total loans and other real
    estate owned
(2) Common stock cash dividends declared divided by net income; dividends
    declared during 1997 included a special cash dividend of $0.60 per share.
 
                                       14
<PAGE>
 
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
       OF OPERATIONS
 
 For the Years Ended December 31, 1998, 1997, and 1996
 
Overview
 
  The following discussion and analysis of financial condition and results of
operations of the Company and its subsidiaries should be read in conjunction
with reference to the consolidated financial statements and notes thereto and
selected statistical information appearing elsewhere in this report.
 
  On May 31, 1997, CTC acquired certain assets and assumed certain liabilities
of The Pomerleau Agency, Inc. This transaction has been accounted for as a
purchase and, accordingly, all results of operations subsequent to the
transaction have been included in the consolidated statements of income.
 
  Chittenden recorded net income of $30.7 million or basic earnings per share
of $2.14 and diluted earnings per share of $2.09 for the year ended December
31, 1998. This compares to net income of $29.4 million and basic earnings per
share of $1.99 and diluted earnings per share of $1.94 for 1997 and net income
of $26.7 million, basic earnings per share of $1.75 and diluted earnings per
share of $1.72 in 1996. For 1998, return on average equity was 18.29% and the
return on average assets was 1.53%. These compare to returns on average equity
of 17.55% and 16.41% and returns on average assets of 1.52% and 1.45% for 1997
and 1996, respectively. The progressively higher levels of return on equity
reflect the impact of the share repurchase plan that was commenced in the
first quarter of 1997, as well as the higher level of earnings during 1997 and
1998. The repurchase plan was rescinded prior to the announcement of the
agreement to acquire VFSC, see "Capital Resources", below.
 
  Total assets increased from $1.977 billion in 1997 to $2.122 billion in
1998. The increase in assets was primarily attributable to increases in
deposit levels from $1.76 billion at December 31, 1997 to $1.89 billion at
December 31, 1998. Core deposits increased by $135.6 million to $1.77 billion
in 1998. These additional funds were invested primarily in investment
securities available for sale, which increased $140.4 million from year end
1997. While the overall balance of the loan portfolio remained substantially
unchanged, the mix of loans has continued to change, reflecting the shift in
the Company's strategy toward commercial and consumer lending.
 
  The $1.3 million increase in net income from 1998 to 1997 was primarily
attributable to increases in revenues from noninterest sources, which totaled
$32.4 million for 1998, up from $28.2 million for 1997. Investment management
income increased significantly, up $1.1 million or 19%, to $6.7 million, due
to increased business and generally favorable market conditions throughout the
year. Gains on sales of mortgage loans increased to $4.8 million in 1998,
compared to $2.5 million in 1997 due to increased market activity caused by a
decrease in interest rates. Commissions from insurance sales, which commenced
with the May 1997 acquisition of the Pomerleau Agency, were $2.9 million in
1998, an increase of $1.6 million from the seven months of income following
the acquisition in 1997. Credit card and merchant servicing income declined
$1.2 million to $3.6 million in 1998 as a result of the Company's ongoing
evaluation of the risk profile of its commercial credit card processing base.
Mortgage servicing income declined by $407,000 in 1998 as a result of
decreases in average service fees and increased amortization expense related
to originated mortgage-servicing rights.
 
  Noninterest expense totaled $71.8 million in 1998, up $1.8 million from the
1997 level. Noninterest expenses related to The Pomerleau Agency were $2.4
million in 1998 compared with $1.4 million in 1997. Excluding the expenses
related to the insurance agency, total noninterest expenses were approximately
1% higher in 1998 than 1997.
 
  The $2.7 million increase in earnings from 1996 to 1997 was due to several
factors. Net interest income on a tax equivalent basis increased $6.5 million
to $92.4 million due to the higher level of average earning assets and an
increase in the net yield from 4.99% to 5.11%. Revenues from noninterest
sources were $28.2 million, up $3.4 million. This increase was partially
attributable to commission income from the Pomerleau Agency, accompanied by
increases in several other categories. Other increases were seen in net credit
card and merchant
 
                                      15
<PAGE>
 
servicing income, which increased $576,000 to $4.8 million, investment
management income, which increased $707,000 to $5.6 million, and service
charges on deposit accounts, which increased $692,000 to $7.0 million. Total
noninterest expenses increased $5.5 million to $69.9 million for 1997.
Noninterest expenses of The Pomerleau Agency represented $1.4 million of the
increase in 1997.
 
 Financial Condition
 
Loans
 
  Chittenden's gross loan portfolio at December 31, 1998 totaled $1.400
billion, which remained substantially unchanged from year end 1997. However,
the overall proportions of commercial-related and consumer types of loans
continued to increase in 1998. This offset reduced balances in residential
real estate loans caused by higher prepayments on adjustable rate loans, which
resulted from reductions in market rates relating to economic slowdowns in
several parts of the world. The total real estate portfolio, including home
equity credit lines, decreased $61.5 million or 7.8% from year-end 1997.
Growth in consumer loans including automobile leasing, was $53.2 million or
22% from year-end 1997. Non-real estate commercial loans increased by $9.3
million or 2.5% from the previous year. Commercial real estate loans increased
$17.5 million or 5.6% from 1997. The classification of the Company's loan
portfolio is based on underlying collateral. At December 31, 1998, commercial
loans secured by non-real estate business assets totaled $374.1 million or 27%
of total loans, up from the $364.9 million posted at year-end 1997. Commercial
real estate loans, representing 24% of the portfolio, stood at $332.0 million
at year-end 1998, up from $314.5 million at December 31, 1997. Construction
loans amounted to $24.3 million at December 31, 1998, up slightly from $21.9
million the year before.
 
  Residential real estate loans stood at $375.0 million at year-end 1998, down
from $456.5 million at December 31, 1997. Reflecting the shift in the
Company's strategy to commercial and consumer lending, as well as the higher
prepayments on residential loans, this category represented 27% of the
portfolio at year-end 1998, compared to 33% at year-end 1997. Residential
mortgages originated during 1998 totaled $491.2 million, compared to $219.3
million during 1997, due to heavy volumes of fixed rate residential loans
caused by declining market rates. The Company underwrites substantially all of
its residential mortgages to secondary market standards. Because the Company
continued to follow its policy of selling substantially all of its fixed-rate
residential mortgage production on a servicing-retained non-recourse basis,
secondary market sales of mortgage loans totaled $442.1 million in 1998,
compared to $182.4 million in 1997.
 
  Included in the real estate portfolio are home equity credit lines, which
totaled $67.4 million at December 31, 1998, compared to $80.5 million the
previous year. The unused portion of these lines totaled $81.6 million at
December 31, 1998, compared to $79.8 million at year-end 1997.
 
  The portfolio of residential mortgages serviced for investors totaled $1.105
billion at December 31, 1998, compared to $1.024 billion at year-end 1997.
These assets are owned by investors other than Chittenden and therefore are
not included in the consolidated balance sheets of the Company. Of the loans
serviced, the Company originated $994.3 million and the balance consisted of
loans whose mortgage-servicing rights were purchased by the company.
 
  Consumer loans increased significantly in 1998, ending the year at $294.6
million, compared with $241.4 million at year-end 1997. This increase reflects
the Company's continued development of the indirect auto lending and leasing
market, and its emphasis on responding to the marketplace through the
continued expansion of dealer relationships within its existing deposit
franchise area, as well as into the franchise areas of the subsidiary banks
located in Massachusetts. The Company underwrites all of its indirect
automotive loans, maintaining substantially the same credit standards as for
car loans originated in its branch offices. The Company does not originate any
subprime loans. Indirect installment lending through auto dealers was up $30.0
million from year-end 1997 to $132.7 million at the end of 1998. The Company
also offers auto leases through its dealer base. This product is underwritten
and priced similarly to indirect installment auto loans. Lease financing
receivables outstanding at December 31, 1998 were $107.1 million, up from
$72.6 million a year earlier. The Company has residual insurance through
outside insurance companies which substantially eliminates the risk
 
                                      16
<PAGE>
 
associated with the residual values of its leased vehicle portfolio. Contrary
to the trend in indirect lending and leasing, direct installment and credit
card balances at December 31, 1998 stood at $32.7 million and $22.1 million,
respectively, compared with $43.3 million and $22.8 million at the end of
1997. Unused portions of credit card lines totaled $72.2 million at the end of
1998, up from $68.1 million one year earlier.
 
  The Company's lending activities are conducted in market areas focused in
Vermont and western and central Massachusetts, with additional activity
related to nearby trading areas in Quebec, New York, New Hampshire, Maine, and
Connecticut. In addition to the portfolio diversification described above, the
loans are widely diversified by borrowers and industry groups.The following
table shows the composition of the loan portfolio for the five years ended
December 31, 1998:
 
<TABLE>
<CAPTION>
                                              December 31,
                         ----------------------------------------------------------
                            1998        1997        1996        1995        1994
                         ----------  ----------  ----------  ----------  ----------
                                             (in thousands)
<S>                      <C>         <C>         <C>         <C>         <C>
Commercial.............. $  374,139  $  364,864  $  320,885  $  291,496  $  188,568
Real estate:
  Residential...........    307,598     375,967     406,850     388,705     372,344
  Commercial............    332,018     314,477     304,530     305,941     258,023
  Construction..........     24,340      21,900      25,084      25,796      18,813
Home equity.............     67,359      80,491      84,390      78,668      76,457
Consumer................    187,592     168,877     161,811     147,627     143,250
Lease financing.........    107,057      72,562      41,117      12,420         --
                         ----------  ----------  ----------  ----------  ----------
Total gross loans.......  1,400,103   1,399,138   1,344,667   1,250,653   1,057,455
Allowance for possible
 loan losses............    (24,510)    (26,721)    (28,096)    (27,818)    (22,163)
                         ----------  ----------  ----------  ----------  ----------
Net loans............... $1,375,593  $1,372,417  $1,316,571  $1,222,835  $1,035,292
                         ==========  ==========  ==========  ==========  ==========
Mortgage loans held for
 sale................... $   25,974  $   16,433  $    9,870  $   14,692  $    2,870
</TABLE>
 
Nonperforming Assets
 
  Loans on which the accrual of interest has been discontinued are designated
as nonaccrual loans. Management classifies loans, except consumer and
residential loans, as nonaccrual loans when they become 90 days past due as to
principal or interest, unless they are adequately secured and are in the
process of collection. In addition, loans that have not met this delinquency
test may be placed on nonaccrual at management's discretion. Consumer and
residential loans are included when management considers it to be appropriate,
based upon evidence of collectibility, the value of any underlying collateral,
and other general criteria. Nonaccrual loans with a related guarantee by a
governmental agency are reflected net of those guarantees in nonperforming
statistics. Generally, a loan remains on nonaccrual status until the factors
which indicated doubtful collectibility no longer exist or the loan is
determined to be uncollectible and is charged off against the allowance for
possible loan losses.
 
  A loan is classified as a restructured loan when the interest rate is
reduced and/or other terms are modified because of the inability of the
borrower to service debt at current market rates and terms. Other real estate
owned ("OREO") is real estate that has been formally acquired through
foreclosure.
 
                                      17
<PAGE>
 
  The following table shows the composition of nonperforming assets and loans
past due 90 days or more and still accruing for the five years ended December
31, 1998:
 
<TABLE>
<CAPTION>
                                                 December 31,
                                    -------------------------------------------
                                     1998     1997     1996     1995     1994
                                    -------  -------  -------  -------  -------
                                                (in thousands)
<S>                                 <C>      <C>      <C>      <C>      <C>
Loans on nonaccrual...............  $10,011  $ 6,481  $10,601  $ 9,939  $ 8,289
Troubled debt restructurings .....      --       767      638    2,502      515
Other real estate owned...........      694      747    2,251    2,652    2,141
                                    -------  -------  -------  -------  -------
Total nonperforming assets........  $10,705  $ 7,995  $13,490  $15,093  $10,945
                                    =======  =======  =======  =======  =======
Loans past due 90 days or more and
 still accruing...................  $ 2,267  $ 2,838  $   966  $ 1,054  $ 1,134
Percentage of nonperforming assets
 to total
 loans and other real estate
 owned............................     0.75%    0.56%    0.99%    1.19%    1.03%
Nonperforming assets to total
 assets...........................     0.50     0.40     0.68     0.84     0.75
Allowance for possible loan losses
 to nonperforming
 loans, excluding OREO............   244.83   368.67   249.99   223.60   251.74
</TABLE>
 
  Nonaccrual loans consisted of approximately 175 loans, which were
diversified across a range of industries, sectors, and geography. The largest
nonaccrual loan had a balance of approximately $2.4 million at year-end 1998,
and resulted from a fraud committed by a commercial borrower against the
Company. This loan was partially charged off during the year and management
believes the remaining $2.4 million balance in nonaccrual is collectible.
 
Allowance for possible loan losses
 
  The allowance for possible loan losses is based on management's estimate of
the amount required to reflect the risks in the loan portfolio, based on
circumstances and conditions known or anticipated at each reporting date. In
addition to evaluating the collectibility of specific loans when determining
the adequacy of the allowance for possible loan losses, management also takes
into consideration other factors such as changes in the mix and volume of the
loan portfolio, historic loss experience, the amount of delinquencies and
loans adversely classified, and economic trends. The adequacy of the allowance
for possible loan losses is assessed by an allocation process whereby specific
loss allocations are made against adversely classified loans, and general loss
allocations are made against segments of the loan portfolio which have similar
attributes. As previously mentioned, the mix of the Company's loan portfolio
has changed during the past three years. This, along with the Company's
historical loss experience, industry trends, and the impact of the local and
regional economy on the Company's borrowers, were considered by management in
determining the adequacy of the allowance for possible loan losses.
 
                                      18
<PAGE>
 
  The following table summarizes the activity in the Company's allowance for
possible loan losses for the five years ended December 31, 1998:
 
<TABLE>
<CAPTION>
                                               December 31,
                          ----------------------------------------------------------
                             1998        1997        1996        1995        1994
                          ----------  ----------  ----------  ----------  ----------
                                              (in thousands)
<S>                       <C>         <C>         <C>         <C>         <C>
Balance of allowance for
 possible loan losses at
 beginning of year......  $   26,721  $   28,096  $   27,818  $   22,163  $   21,672
BWM allowance acquired..         --          --          --        4,135         --
Provision charged to
 expense................       5,100       4,050       4,183       5,000       5,500
                          ----------  ----------  ----------  ----------  ----------
Balance of allowance for
 possible loan losses
 after provision........      31,821      32,146      32,001      31,298      27,172
                          ----------  ----------  ----------  ----------  ----------
Loans charged off:
  Commercial............       4,973       3,903       1,770       1,353       1,085
  Real estate:
    Residential.........         564         780         966       1,525         878
    Commercial..........         343         675         791       1,596       3,160
    Construction........         101         204         185         --            4
  Home equity...........          67         158         167         108          51
  Consumer..............       3,411       2,517       2,230       1,900       1,061
                          ----------  ----------  ----------  ----------  ----------
    Total loans charged
     off................       9,459       8,237       6,109       6,482       6,239
                          ----------  ----------  ----------  ----------  ----------
Recoveries of loans
 previously charged off:
  Commercial............         936         859         822       1,161         555
  Real estate:
    Residential.........          49         118         188          57          99
    Commercial..........         111       1,168         546       1,130         158
    Construction........           5          12          91         --          --
  Home equity...........           4          49           8         --           29
  Consumer..............       1,043         606         549         654         389
                          ----------  ----------  ----------  ----------  ----------
    Total recoveries....       2,148       2,812       2,204       3,002       1,230
                          ----------  ----------  ----------  ----------  ----------
Net loans charged off...       7,311       5,425       3,905       3,480       5,009
                          ----------  ----------  ----------  ----------  ----------
Balance of allowance for
 possible loan losses at
 year end...............  $   24,510  $   26,721  $   28,096  $   27,818  $   22,163
                          ==========  ==========  ==========  ==========  ==========
Amount of loans
 outstanding at end of
 year...................  $1,426,078  $1,415,571  $1,354,537  $1,265,345  $1,060,325
Average amount of loans
 outstanding............   1,418,530   1,391,234   1,336,185   1,228,948   1,023,399
Ratio of net charge-offs
 during year to average
 loans outstanding......        0.52%       0.39%       0.29%       0.28%       0.49%
Allowance as a percent
 of loans outstanding at
 end of year............        1.72        1.89        2.07        2.20        2.09
</TABLE>
 
  At December 31, 1998, the allowance for possible loan losses was $24.5
million, or 1.72% of total loans, compared with $26.7 million, or 1.89% of
loans one year ago. The coverage ratio, or allowance for possible loan losses
to nonperforming loans, stood at 245% at year-end 1998, compared with 369% at
the end of 1997.
 
  The provision for possible loan losses totaled $5.1 million in 1998,
compared to $4.1 million in 1997, and $4.2 million in 1996. The provision was
increased during 1998 in anticipation of the return to higher charge off
levels from the lows experienced in 1995 and 1996.
 
  Commercial charge-offs for 1998 include a $2.4 million charge which resulted
from the previously mentioned fraud committed by a commercial borrower against
the Company. Commercial charge-offs for 1997 include a $1.9 million charge
related to CTC's commercial customer credit card processing business. This
charge
 
                                      19
<PAGE>
 
related to a future services company, which had contracted with, and accepted
deposits from customers, prior to discontinuing operations. This company was
obligated to provide services to its customers upon the payment of a second
amount. At the time this company discontinued operations, CTC chose to honor
these obligations, leading to the charge-off of the resulting $1.9 million
overdraft. During the past two years the company has assessed its commercial
customer credit card processing base and has taken steps to mitigate the risk
of similar charge-offs in the future.
 
  The following table summarizes the allocation of the allowance for possible
loan losses for the five years ended December 31, 1998:
 
<TABLE>
<CAPTION>
                                                                      December 31,
                   -----------------------------------------------------------------------------------------------------
                            1998                   1997                   1996                   1995
                   ---------------------- ---------------------- ---------------------- ----------------------
                    Amount       Loan      Amount       Loan      Amount       Loan      Amount       Loan      Amount
                   Allocated Distribution Allocated Distribution Allocated Distribution Allocated Distribution Allocated
                   --------- ------------ --------- ------------ --------- ------------ --------- ------------ ---------
                                                                     (in thousands)
<S>                <C>       <C>          <C>       <C>          <C>       <C>          <C>       <C>          <C>
Commercial.......   $ 4,991       24%      $ 5,075       26%      $ 4,494       24%      $ 3,901       23%      $ 2,417
Real estate:
 Residential.....     1,262       22         1,275       27         1,395       30         1,452       31           764
 Commercial......     5,534       24         6,143       23         5,960       23         6,024       25         5,692
 Construction....       334        1           455        1           500        2           439        2           770
Home equity......       241        5           318        6           317        6           291        6           268
Consumer and
 leasing.........     4,696       24         4,093       17         3,149       15         1,754       13         1,916
Other............     7,452      --          9,362      --         12,281      --         13,957      --         10,336
                    -------      ---       -------      ---       -------      ---       -------      ---       -------
                    $24,510      100%      $26,721      100%      $28,096      100%      $27,818      100%      $22,163
                    =======      ===       =======      ===       =======      ===       =======      ===       =======
<CAPTION>
                  1994
                   ------------
                       Loan
                   Distribution
                   ------------
<S>                <C>
Commercial.......       18%
Real estate:
 Residential.....       35
 Commercial......       24
 Construction....        2
Home equity......        7
Consumer and
 leasing.........       14
Other............      --
                   ------------
                       100%
                   ============
</TABLE>
 
  Over the last five years, the percentage of the allowance for loan losses
allocated to commercial and consumer (including leasing) loans has increased
from 18% and 14%, respectively, to 24% and 24%, respectively. Over the same
period, the percentage of the allowance for loan losses allocated to the
residential real estate portfolio has declined from 35% to 22%. The shifts in
these allocations reflect the trends in the overall mix of the Company's
portfolio (described above in "Overview" and "Loans") to increased levels of
commercial and consumer (including leasing) loans. As noted in the
Nonperforming Assets table above, the overall level of the allowance for loan
losses at December 31, 1998 is very consistent with levels in prior years when
viewed as a percentage of nonperforming loans, excluding OREO. The only
exception is the percentage at December 31, 1997, which was higher than the
other year-ends because of the unusually low level of nonperforming assets at
that date. The other category is the allowance considered necessary by
management based on its assessment of historical loss experience, industry
trends, and the impact of the local and regional economy on the Company's
borrowers that may not have been captured in the specific risk
classifications.
 
  Notwithstanding the foregoing analytical allocations, the entire allowance
for possible loan losses is available to absorb charge-offs in any category of
loans. (See "Provision for Possible Loan Losses.")
 
Investment Securities
 
  The investment portfolio is used to meet liquidity demands, mitigate
interest rate sensitivity, invest excess liquidity, and generate interest
income. At December 31, 1998, the Company held investments available for sale
totaling $503.7 million. This compares with investments of $363.3 million
available for sale at December 31, 1997. During 1997, in order to improve the
liquidity of the investment portfolio, investments previously classified as
held to maturity, with an amortized cost and market value of $6.8 million,
were sold. In addition, the remaining held for investment portfolio, with an
amortized cost of $21.9 million and unrealized loss of $385,000, was
transferred to available for sale in accordance with Statement of Financial
Accounting Standards No. 115. At December 31, 1998, unrealized gains (net of
taxes) of $3,811,000 resulted from marking the available for sale portfolio to
market value. This compares with unrealized gains (net of taxes) of $1,675,000
at December 31, 1997. These amounts are reflected as an increase in
stockholders' equity from the change in other comprehensive income.
 
                                      20
<PAGE>
 
  The following tables show the composition of the Company's investment
portfolio, at December 31, 1998, 1997, 1996 and 1995:
 
<TABLE>
<CAPTION>
                                                   1998     1997     1996     1995
                                                 -------- -------- -------- --------
Securities available for sale (at market value)             (in thousands)
<S>                                              <C>      <C>      <C>      <C>
  U.S. Treasury securities...................... $ 12,830 $ 23,334 $109,471 $ 81,625
  U.S. government agency obligations............  260,442  138,203   76,707   60,448
  Obligations of states and political
   subdivisions.................................      344      314       --   44,853
  Mortgage-backed securities....................   66,072   91,438   51,604   49,187
  Corporate bonds and notes.....................  129,356   90,812   65,190   30,072
  Government bond mutual funds..................    9,000    9,050   10,103   10,605
  Money market preferred .......................   25,513   10,007   16,138      231
  Other debt securities.........................      142      121      --       --
                                                 -------- -------- -------- --------
    Total Securities available for sale.........  503,699  363,279  329,213  277,021
                                                 -------- -------- -------- --------
Securities held for investment (at amortized
 cost)
  U.S. government agency obligation.............      --       --  $    198 $    298
  Obligations of states and political
   subdivisions.................................      --       --       490    5,119
  Mortgage-backed securities....................      --       --    34,761   37,747
  Corporate bonds and notes.....................      --       --        25      --
                                                 -------- -------- -------- --------
  Other debt securities.........................      --       --       106      --
                                                 -------- -------- -------- --------
    Total Securities held for investment........      --       --    35,580   43,164
                                                 -------- -------- -------- --------
      Total Investment Securities............... $503,699 $363,279 $364,793 $320,185
                                                 ======== ======== ======== ========
</TABLE>
 
  The following table shows the maturity distribution of the amortized cost of
the Company's investment securities and weighted average yields of such
securities on a fully taxable equivalent basis, at December 31, 1998, with
comparative totals for 1997. Expected maturities may differ from contractual
maturities because borrowers may have the right to call or prepay obligations:
 
<TABLE>
<CAPTION>
                                            After One       After Five
                              Within        But Within      But Within        After         No Fixed
                             One Year       Five Years       Ten Years      Ten Years       Maturity         Total
                          --------------  --------------   -------------   ------------   ------------   --------------
                           Amount  Yield   Amount  Yield   Amount  Yield   Amount Yield   Amount Yield    Amount  Yield
                          -------- -----  -------- -----   ------- -----   ------ -----   ------ -----   -------- -----
Securities available for
sale                                                         (in thousands)
<S>                       <C>      <C>    <C>      <C>     <C>     <C>     <C>    <C>     <C>    <C>     <C>      <C>
 US Treasury securities.  $ 12,718 6.52%  $    --    -- %  $   --    -- %  $  --    -- %  $  --    -- %  $ 12,718 6.52%
 US government agency
  obligations...........   104,876 5.18    149,531 6.36      3,000 7.82       --   --        --   --      257,407 5.90
 Obligations of states
  and political
  subdivisions..........         3 8.67        206 5.97         60 8.67        73 8.67       --   --          342 6.60
 Mortgage-backed
  securities (1)........    23,392 6.42     40,489 6.63      1,130 6.62       171 5.68       --   --       65,182 6.55
 Corporate bonds and
  notes.................    11,539 6.36    115,300 6.45         25 7.00       --   --        --   --      126,864 6.44
 Government bond mutual
  funds.................       --   --         --   --         --   --        --   --      9,526 6.37       9,526 6.37
 Money market preferred.    25,500 5.86        --   --         --   --        --   --          4  --       25,504 5.86
 Other debt securities..       --   --          80 6.09         62 8.36       --   --        --   --          142 7.08
                          -------- ----   -------- ----    ------- ----    ------ ----    ------ ----    -------- ----
Total available for
 sale...................   178,028 5.61    305,606 6.43      4,277 7.52       244 6.58     9,530 6.37     497,685 6.14
                          -------- ----   -------- ----    ------- ----    ------ ----    ------ ----    -------- ----
Comparative totals for
 1997...................  $ 54,115 6.35%  $265,305 6.55%   $29,566 7.05%   $2,158 7.26%   $9,526 6.91%   $360,670 6.57%
</TABLE>
--------
(1) Maturities of mortgage-backed securities are based on contractual payments
    and estimated mortgage loan prepayments.
 
                                      21
<PAGE>
 
Deposits
 
  During 1998, total deposits averaged $1.775 billion, up from $1.696 billion
in 1997. Noninterest-bearing demand deposits averaged $301 million, up from
$279 million in 1997. Average savings deposits increased $65 million, to $952
million for 1998. This category includes non-contractual interest bearing
deposit products, such as savings, money market, and N.O.W. accounts. During
1998, time accounts (retirement and certificates of deposit) averaged $523
million, decreasing slightly compared to $530 million in 1997. The Company has
a number of institutional customers within its franchise whose investment
needs are frequently met by purchasing certificates of deposit over $100,000.
Depositors in this category tend to seek bids regularly, and the Company
raises or lowers the interest rates it offers depending on its liquidity needs
and on its investment opportunities.
 
  The following table shows average balances of the Company's deposits for the
periods indicated:
 
<TABLE>
<CAPTION>
                                             Years Ended December 31,
                                    -------------------------------------------
                                       1998       1997       1996       1995
                                    ---------- ---------- ---------- ----------
                                                  (in thousands)
<S>                                 <C>        <C>        <C>        <C>
Demand deposits.................... $  300,727 $  279,034 $  251,276 $  223,800
Savings deposits...................    951,657    886,516    832,677    760,029
Certificates of deposit less than
 $100,000 and other time deposits..    403,801    413,036    430,501    388,276
Certificates of deposit $100,000
 and over..........................    119,059    117,367    113,380    114,395
                                    ---------- ---------- ---------- ----------
  Total deposits................... $1,775,244 $1,695,953 $1,627,834 $1,486,500
                                    ========== ========== ========== ==========
</TABLE>
 
  The Company's ending balances of outstanding certificates of deposit and
other time deposits in denominations of $100,000 and over had maturities as
follows:
 
<TABLE>
<CAPTION>
                                                      Years Ended December 31,
                                                     --------------------------
                                                       1998     1997     1996
                                                     -------- -------- --------
                                                           (in thousands)
<S>                                                  <C>      <C>      <C>
Three months or less................................ $ 86,410 $ 82,886 $ 73,043
Over three months to six months.....................   22,039   20,935   15,421
Over six months to twelve months....................   19,114   24,957   15,831
Over twelve months..................................    9,332   10,698    8,303
                                                     -------- -------- --------
                                                     $136,895 $139,476 $112,598
                                                     ======== ======== ========
</TABLE>
 
Borrowings
 
  During 1998, short-term borrowings averaged $34.0 million, down from the
$38.1 million posted in 1997. This funding consists of treasury, tax and loan
deposits, securities sold under agreements to repurchase, Federal Home Loan
Bank (FHLB) borrowings, and federal funds purchased. Treasury borrowings
averaged $20.8 million for 1998 compared with $22.4 million during 1997.
Treasury funding is attractive to the Company because the rate of interest
paid on borrowings floats at 25 basis points below the federal funds rate,
there are no reserve requirements, and there are no FDIC insurance costs.
Repurchase agreements averaged $10.1 million for 1998, down slightly from
$10.6 million in 1997. These borrowings have neither reserve requirements nor
FDIC insurance costs.
 
Capital Resources
 
  The Company's capital forms the foundation for maintaining investor
confidence as well as for developing programs for growth and new activities.
Because of the Company's profitability over the past several years, total
capital increased from $111.7 million at December 31, 1993 to $162.3 million
at December 31, 1997. During 1997, the Company adopted measures to maintain a
capital level consistent with the needs for its activities. The quarterly
dividend rate was increased from $0.18 to $0.20 per share in the second
quarter of 1998. An additional
 
                                      22
<PAGE>
 
special $0.60 per share dividend was declared in October 1997 to maintain
capital at a level consistent with the Company's requirements at that time.
Additionally, a share repurchase plan was implemented, in which up to
1,250,000 shares could be repurchased during 1997 and 1998. During 1998, the
repurchase plan was expanded to allow an additional 500,000 shares to be
repurchased during 1998 and 1999. However, the repurchase plan was rescinded
prior to the announcement of the agreement to merge with Vermont Financial
Services Corporation in a transaction to be accounted for as a pooling of
interests.
 
  At December 31, 1998, capital stood at $175.1 million, an increase of $12.8
million from $162.3 million at December 31, 1997. Repurchases of 298,000
shares of the Company's common stock totaling $10.0 million and dividend
payments totaling $11.2 million reduced the capital position during 1998. The
reductions in capital were offset by earnings of $30.7 million, $1.2 million
in proceeds from common stock issued in connection with benefit plans and an
increase in the net unrealized gain on securities available for sale of $2.1
million.
 
  The capital position decreased during 1997 by $12.1 million. Repurchases of
1,043,000 shares of the Company's stock totaling $26.0 million, normal
quarterly dividend payments totaling $10.2 million and a special dividend of
$8.7 million reduced the capital position during 1997. These reductions were
partially offset by earnings of $29.4 million and $1.4 million of common stock
issued in connection with benefit plans and a change in the net unrealized
gain on securities available for sale of $1.9 million.
 
  Both the Board of Governors of the Federal Reserve System (the "FRB") and
the Federal Deposit Insurance Corporation (the "FDIC") have defined leverage
capital requirements. At December 31, 1998, the Company's leverage capital
ratio (which is calculated pursuant to the FRB's regulations) was 7.37%,
CTC's, BWM's, and FBT's leverage capital ratios (which are calculated pursuant
to the FDIC's regulations) were 6.89%, 7.57% and 6.33%, respectively. The
ratios in 1997 were 7.43% for the Company, 7.05% for CTC, 7.31% for BWM, and
6.65% for FBT.
 
  Additionally, the FRB and the FDIC have a risk-based capital standard. Under
this measure of capital, banks are required to hold more capital against
certain assets perceived as more-risky, such as commercial loans, than against
other assets perceived as less-risky, such as residential mortgage loans and
U.S. Treasury securities. Further, off-balance sheet items such as unfunded
loan commitments and standby letters of credit, are included for the purposes
of determining risk-weighted assets. Commercial banking organizations are
required to have total capital equal to 8% of risk-weighted assets, and Tier 1
capital -- consisting of common stock and certain types of preferred stock --
 equal to at least 4% of risk-weighted assets. Tier 2 capital, included in
total capital, includes the allowance for possible loan losses up to a maximum
of 1.25% of risk-weighted assets. At December 31, 1998, the Company's risk-
based capital ratio was 11.18% and its Tier 1 capital, consisting entirely of
common stock, was 9.90% of risk-weighted assets. This compares with year-end
1997 ratios of 11.17% and 9.86%, respectively.
 
  FDIC regulations pertaining to capital adequacy, which apply to the Banks,
require a minimum 3% leverage capital ratio for those institutions with the
most favorable composite regulatory examination rating. In addition, a 4% Tier
1 risk-based capital ratio, and an 8% total risk-based capital ratio are
required for a bank to be considered adequately capitalized. Leverage, Tier 1
risk-based, and total risk-based capital ratios exceeding 5%, 6%, and 10%,
respectively, qualify a bank for the "well-capitalized" designation. At
December 31, 1998, CTC's leverage capital ratio was 6.89%, its Tier 1 risk-
based capital ratio was 9.22%, and its total risk-based capital ratio was
10.49%; BWM's ratios were 7.57%, 8.64%, and 10.00%, respectively; FBT's ratios
were 6.33%, 9.49%, and 10.58%, respectively. These ratios placed the Banks in
the FDIC's highest capital category of "well capitalized". Capital ratios in
excess of minimum requirements indicate capacity to take advantage of
profitable and credit-worthy opportunities as well as the potential to respond
to unforeseen adverse conditions.
 
 
                                      23
<PAGE>
 
  The following table presents capital components and ratios of the Company at
December 31, 1998, 1997, 1996, and 1995:
 
<TABLE>
<CAPTION>
                                                December 31,
                                 ----------------------------------------------
                                    1998        1997        1996        1995
                                 ----------  ----------  ----------  ----------
                                               (in thousands)
<S>                              <C>         <C>         <C>         <C>
Leverage
Stockholders' equity............ $  158,500  $  146,434  $  163,513  $  141,453
Total average assets (1)........  2,149,352   1,969,822   1,906,114   1,757,002
Leverage capital ratio..........       7.37%       7.43%       8.58%       8.05%
Risk-based
Capital components:
  Tier 1........................ $  158,500  $  146,434  $  163,513  $  141,453
  Tier 2........................     20,008      18,570      17,449      15,873
                                 ----------  ----------  ----------  ----------
    Total....................... $  178,508  $  165,004  $  180,962  $  157,326
                                 ==========  ==========  ==========  ==========
Risk-weighted assets:
  On-balance sheet.............. $1,526,333  $1,407,074  $1,331,203  $1,216,807
  Off-balance sheet.............     86,807      92,441      75,308      62,347
                                 ----------  ----------  ----------  ----------
                                 $1,613,140  $1,499,515  $1,406,511  $1,279,154
                                 ==========  ==========  ==========  ==========
Ratios:
  Tier 1........................       9.90%       9.86%      11.71%      11.16%
  Total (including Tier 2)......      11.18       11.17       13.06       12.53
</TABLE>
--------
(1) Total average assets for the most recent quarter.
 
Liquidity and Rate Sensitivity
 
  The Company's liquidity and rate sensitivity are monitored by the asset and
liability committee, based upon policies approved by the Board of Directors.
Strategies are implemented by the Banks' asset and liability committee. This
committee meets periodically to review and direct the Banks' lending and
deposit-gathering functions. Investment and borrowing activities are managed
by the Company's Treasury function.
 
  The measure of an institution's liquidity is its ability to meet its cash
commitments at all times with available cash or by conversion of other assets
to cash at a reasonable price. At December 31, 1998, the Company maintained
cash balances and short-term investments of approximately $134.7 million,
compared with $143.4 million at December 31, 1997. During 1998, the Company
continued to be an average daily net seller of Federal Funds.
 
  To measure the sensitivity of its income to changes in interest rates, the
Company uses a variety of methods, including simulation, valuation techniques
and gap analyses. Interest rate risk is the sensitivity of income to
variations in interest rates over both short-term and long-term horizons. The
primary goal of interest-rate management is to control this risk within limits
approved by the Board of Directors. These limits and guidelines reflect the
Company's tolerance for interest-rate risk. The Company attempts to control
interest-rate risk by identifying exposures, quantifying them and taking
appropriate actions. The Company quantifies its interest-rate risk exposure
using sophisticated simulation and valuation models, as well as simpler gap
analyses.
 
  The Company uses simulation analyses to measure the exposure of net interest
income to changes in interest rates over a relatively short (i.e., within one
year) time horizon. Simulation analysis incorporates what management believes
to be the most appropriate assumptions about customer and competitor behavior
in the specified interest rate scenario. These assumptions are the basis for
projecting future interest income and expense from the Company's assets and
liabilities under various scenarios. Simulation analysis may have certain
limitations caused by market conditions varying from those assumed in a model.
Actual results can often differ due to the effects of prepayments and
refinancing of loans and investments, as well as deposits ability to reprice
or runoff, which may be different from that which has been assumed.
 
                                      24
<PAGE>
 
  The Company's limits on interest-rate risk specify that if interest rates
were to shift immediately up or down 200 basis points, estimated net interest
income for the next 12 months should neither improve or be impacted by greater
than 10%. Based on an increase of 200 basis points over the next twelve months
the simulations will result in an increase of 4.09% in net interest income,
and a decline of 200 basis points will result in a decrease of 4.87% in net
interest income.
 
  As noted above, one of the tools used to measure rate sensitivity is the
funds gap. The funds gap is defined as the amount by which a bank's rate
sensitive assets exceed its rate sensitive liabilities. A positive gap exists
when rate sensitive assets exceed rate sensitive liabilities. This indicates
that a greater volume of assets than liabilities will reprice during a given
period. This mismatch will improve earnings in a rising rate environment and
inhibit earnings when rates decline. Conversely, when rate sensitive
liabilities exceed rate sensitive assets, the gap is referred to as negative
and indicates that a greater volume of liabilities than assets will reprice
during the period. In this case, a rising rate environment will inhibit
earnings and declining rates will improve earnings. Notwithstanding this
general description of the effect on income of the gap position, it may not be
an accurate predictor of changes in net income. The Company's limits on
interest-rate risk specify that the cumulative one-year gap should be less
than 15% of total assets. As of December 31, 1998, the estimated exposure was
5% asset-sensitive.
 
  The following table shows the amounts of interest-earning assets and
interest-bearing liabilities at December 31, 1998 that reprice during the
periods indicated:
 
<TABLE>
<CAPTION>
                                             Repricing Date
                            ---------------------------------------------------
                                        Over Six Over One
                                         Months  Year To
                            One Day To   To One    Five   Over Five
                            Six Months    Year    Years     Years      Total
                            ----------  -------- -------- ---------  ----------
                                              (in thousands)
<S>                         <C>         <C>      <C>      <C>        <C>
Interest-earning assets:
Loans...................... $  802,580  $191,822 $390,692 $  40,983  $1,426,077
Investment securities (1)..    176,149    54,732  277,292     1,117     509,290
Interest-bearing cash
 equivalents...............     50,409       --       --        --       50,409
                            ----------  -------- -------- ---------  ----------
  Total interest-earning
   assets..................  1,029,138   246,554  667,984    42,100   1,985,776
                            ----------  -------- -------- ---------  ----------
Interest-bearing
 liabilities:
Deposits...................  1,007,980   139,012  150,803   271,779   1,569,574
Borrowings.................     22,548         3      509       309      23,369
                            ----------  -------- -------- ---------  ----------
  Total interest-bearing
   liabilities.............  1,030,528   139,015  151,312   272,088   1,592,943
                            ----------  -------- -------- ---------  ----------
Net interest rate
 sensitivity gap........... $   (1,390) $107,539 $516,672 $(229,988) $  392,833
                            ==========  ======== ======== =========  ==========
Cumulative gap at December
 31, 1998.................. $   (1,390) $106,149 $622,821 $ 392,833
Cumulative gap at December
 31, 1997.................. $      659  $ 52,969 $535,834 $ 364,763
Cumulative gap at December
 31, 1996.................. $  (12,922) $ 31,228 $382,924 $ 321,201
</TABLE>
--------
(1)Amounts are based on amortized cost balances.
 
  The following table shows scheduled maturities of selected loans at December
31, 1998:
 
<TABLE>
<CAPTION>
                                              Less   One Year   Over
                                            Than One To Five    Five
                                              Year    Years    Years    Total
                                            -------- -------- -------- --------
                                                      (in thousands)
<S>                                         <C>      <C>      <C>      <C>
Predetermined rates:
  Commercial............................... $ 29,312 $ 73,136 $ 25,290 $127,738
  Commercial real estate and construction..   17,150   94,596   61,388  173,134
                                            -------- -------- -------- --------
                                              46,462  167,732   86,678  300,872
                                            ======== ======== ======== ========
Floating or adjustable rates:
  Commercial...............................   97,033   79,586   69,782  246,401
  Commercial real estate and construction
   ........................................   22,942   83,055   77,227  183,224
                                            -------- -------- -------- --------
                                            $119,975 $162,641 $147,009 $429,625
                                            ======== ======== ======== ========
</TABLE>
 
                                      25
<PAGE>
 
Results of Operations
 
 Comparison of Years Ended December 31, 1998 and 1997
 
  Net Interest Income
 
  The primary source of recurring income for the Company is the net interest
income of the Banks, which is the difference between interest income on loans
and investments, and interest paid on deposits and borrowings. Net interest
income is affected by changes in interest rates and the volumes of interest
earning assets and interest bearing liabilities.
 
  For 1998, net interest income was $91.0 million, up $474,000 from the 1997
level. On a fully taxable equivalent basis, net interest income increased
$785,000 from 1997, to $93.2 million in 1998. These improvements resulted from
higher levels of interest earning assets, which were up $79.3 million from
1997, to $1.888 billion for 1998. The increased level of earning assets offset
a decline in the net yield on earning assets from 5.11% in 1997 to 4.94% in
1998. The decrease in the net yield on earning assets was due to several
factors including a higher proportion of investments in the Company's mix of
earning assets, strong deposit growth, and relatively flat loan growth.
Additionally, declining yields in the Company's loan portfolio were caused by
reductions in market interest rates resulting from three rate cuts by the
Federal Reserve during the fourth quarter of 1998.
 
  The following table presents an analysis of average rates and yields on a
fully taxable equivalent basis for the years indicated:
<TABLE>
<CAPTION>
                                     1998                             1997                             1996
                         -------------------------------  -------------------------------  -------------------------------
<S>                      <C>         <C>         <C>      <C>         <C>         <C>      <C>         <C>         <C>
                                      Interest   Average               Interest   Average               Interest   Average
                          Average     Income/    Yield/    Average     Income/    Yield/    Average     Income/    Yield/
                          Balance    Expense (1) Rate (1)  Balance    Expense (1) Rate (1)  Balance    Expense (1) Rate (1)
                         ----------  ----------  -------  ----------  ----------  -------  ----------  ----------  -------
Assets                                                         (in thousands)
Interest-earning
 assets:
 Loans.................  $1,415,367    $123,794     8.75% $1,386,772    $125,076     9.02% $1,331,199    $120,362     9.04%
 Industrial revenue
  bonds (2)............       3,163         368    11.63       4,462         522    11.70       4,986         571    11.45
 Investments:
 Taxable...............     394,269      25,082     6.36     360,284      22,992     6.38     327,099      20,232     6.19
 Tax-favored debt
  securities...........         204          20     9.80         379          39    10.29       1,112         111     9.98
 Tax-favored equity
  securities...........      38,939       2,482     6.37      21,475       1,417     6.60      28,488       1,684     5.91
 Interest-bearing
  deposits in banks....         990          50     5.00         100           3     3.25         100           3     3.00
 Federal funds sold....      35,362       1,938     5.48      35,529       1,936     5.45      28,312       1,524     5.38
                         ----------     -------           ----------    --------           ----------    --------
 Total interest-earning
  assets...............   1,888,294     153,734     8.14   1,809,001     151,985     8.40   1,721,296     144,487     8.39
                                        -------                         --------                         --------
 Noninterest-earning
  assets...............     145,838                          153,172                          149,108
 Allowance for possible
  loan losses..........     (26,719)                         (27,840)                         (28,460)
                         ----------                       ----------                       ----------
 Total assets..........  $2,007,413                       $1,934,333                       $1,841,944
                         ==========                       ==========                       ==========
<CAPTION>
Interest-bearing
 liabilities:
<S>                      <C>         <C>         <C>      <C>         <C>         <C>      <C>         <C>         <C>
 Savings and interest-
  bearing transactional
  accounts.............  $  951,657    $ 31,294     3.29  $  886,516    $ 29,637     3.34  $  832,677    $ 27,268     3.27
 Certificates of
  deposit under
  $100,000 and other
  time deposits........     403,801      20,819     5.16     413,036      21,193     5.13     430,501      22,988     5.34
 Certificates of
  deposit $100,000 and
  over.................     119,059       6,163     5.18     117,367       6,267     5.34     113,380       6,259     5.52
                         ----------    --------           ----------    --------           ----------    --------
 Total interest-bearing
  deposits.............   1,474,517      58,276     3.95   1,416,919      57,097     4.03   1,376,558      56,515     4.11
 Short-term borrowings.      34,018       2,233     6.56      38,140       2,448     6.42      30,679       2,084     6.79
                         ----------    --------           ----------    --------           ----------    --------
 Total interest-bearing
  liabilities..........   1,508,535      60,509     4.01   1,455,059      59,545     4.09   1,407,237      58,599     4.16
                                       --------                         --------                         --------
Noninterest-bearing
 liabilities:
 Demand deposits ......     300,727                          279,034                          251,276
 Other liabilities ....      30,533                           32,672                           20,608
                         ----------                       ----------                       ----------
 Total liabilities ....   1,839,795                        1,766,765                        1,679,121
 Stockholders' equity .     167,618                          167,568                          162,823
                         ----------                       ----------                       ----------
 Total liabilities and
  stockholders' equity.  $2,007,413                       $1,934,333                       $1,841,944
                         ==========                       ==========                       ==========
 Net interest income ..                $ 93,225                         $ 92,440                         $ 85,888
                                       ========                         ========                         ========
 Interest rate spread
  (3)..................                             4.13%                            4.31%                            4.23%
 Net yield on earning
  assets (4) ..........                             4.94                             5.11                             4.99
</TABLE>
-------
(1)On a fully taxable equivalent basis. Calculated using a Federal income tax
   rate of 35%. Loan income includes fees.
(2)Industrial revenue bonds are included in loans in the financial statements.
(3)Interest rate spread is the average rate earned on total interest-earning
   assets less the average rate paid on interest-bearing liabilities.
(4)Net yield on earning assets is net interest income divided by total
   interest-earning assets.
 
                                      26
<PAGE>
 
  The following table attributes changes in the Company's net interest income
(on a fully taxable equivalent basis) to changes in either average balances or
average rates. Changes due to both interest rate and volume have been
allocated to change due to balance and change due to rate in proportion to the
relationship of the absolute dollar amounts of the change in each.
 
<TABLE>
<CAPTION>
                             1998 Compared With 1997          1997 Compared With 1996
                          ---------------------------------- ----------------------------
                                                                 Increase
                                                                (Decrease)
                          Increase (Decrease)                 Due to Change
                           Due to Change in:                       in:
                          ---------------------     Total    ----------------    Total
                           Average     Average     Increase  Average  Average   Increase
                            Rate       Balance    (Decrease)  Rate    Balance  (Decrease)
                          ----------  ---------   ---------- -------  -------  ---------- ---
<S>                       <C>         <C>         <C>        <C>      <C>      <C>        <C>
Interest income:
 Loans, including fees..  $   (3,783) $   2,501    $(1,282)  $ (298)  $5,012     $4,714
 Industrial revenue
  bonds.................          (3)      (151)      (154)      12      (61)       (49)
 Investments:
 Taxable................         (70)     2,207      2,137      642    2,118      2,760
 Tax-favored debt
  securities............          (2)       (17)       (19)       3      (75)       (72)
 Tax-favored equity
  securities............         (48)     1,113      1,065      196     (463)      (267)
 Federal funds sold.....          11         (9)         2       19      393        412
                          ----------  ---------    -------   ------   ------     ------
 Total interest income..      (3,895)     5,644      1,749      574    6,924      7,498
                          ----------  ---------    -------   ------   ------     ------
Interest expense:
 Savings and interest-
  bearing transactional
  accounts..............        (485)     2,142      1,657      569    1,800      2,369
 Certificates of deposit
  under $100,000 and
  other time deposits...         102       (476)      (374)    (899)    (896)    (1,795)
 Certificates of deposit
  $100,000 and over.....        (192)        88       (104)    (205)     213          8
                          ----------  ---------    -------   ------   ------     ------
 Total deposits.........        (575)     1,754      1,179     (535)   1,117        582
 Short-term borrowings..          70       (285)      (215)    (104)     468        364
                          ----------  ---------    -------   ------   ------     ------
 Total interest expense.        (505)     1,469        964     (639)   1,585        946
                          ----------  ---------    -------   ------   ------     ------
Change in net interest
 income.................  $   (3,390) $   4,175    $   785   $1,213   $5,339     $6,552
                          ==========  =========    =======   ======   ======     ======
</TABLE>
 
  Provision for Possible Loan Losses
 
   The Company provides for possible loan losses using the allowance method.
The allowance for possible loan losses is increased by provisions charged
against current earnings. Loan losses are charged against the allowance when
management believes that the collectibility of the loan principal is unlikely.
Recoveries on loans previously charged off are credited to the allowance.
 
  The allowance is the amount management believes is necessary to absorb
possible loan losses based on evaluations of collectibility and prior loan
loss experience, changes in the nature and volume of the loan portfolio,
overall portfolio quality, specific problem loans, and economic conditions
that may affect the borrowers' ability to pay.
 
  Management believes that the allowance for possible loan losses is adequate.
While management uses available information to assess possible losses on
loans, future additions to the allowance may be necessary. In addition,
various regulatory agencies periodically review the Company's allowance for
possible loan losses as an integral part of their examination process. Such
agencies may require the Company to recognize additions to the allowance based
on judgements different from those of management. The provision for possible
loan losses totaled $5.1 million in 1998 compared to $4.1 million in 1997.
(See "Allowance for Possible Loan Losses)
 
  Noninterest Income and Noninterest Expense
 
  Noninterest income was $32.4 million in 1998, up $4.2 million from the $28.2
million reported in 1997. Investment management income was up $1.1 million
from the 1997 level, to $6.7 million. This was due to the effects of an
increase in the number of investment management clients served and higher
levels of administered assets, which were enhanced by the impact of advances
in the stock and bond markets during the year. Gains on sales of mortgage
loans increased $2.3 million to $4.8 million, compared to gains of $2.5
million in 1997. This was a result of increases in the volume of loans sold
from $182.4 million in 1997 to $442.1 million in 1998, due to a reduction in
mortgage rates.
 
                                      27
<PAGE>
 
  Net income related to credit card activities includes fees and costs related
to the issuance of credit cards and revenue generated (net of processing
costs) when credit card transactions are processed through the Company's
commercial credit card processing customers. Net credit card income declined
$1.2 million to $3.6 million. Processing volumes decreased by $226 million,
from $1.137 billion in 1997 to $911 million in 1998. Lower processing volumes
in 1998 accounted for approximately $1.083 million of the reduced credit card
income, while lower margins on processed volume accounted for approximately
$498,000 of the decreased income. These decreases were offset by an increase
of $346,000 in noninterest income on the banks' credit card portfolio. The
decrease in margin and volume reflect the Company's ongoing evaluation of its
commercial credit card processing base to reduce its risk profiles.
 
  Net insurance commissions generated by the insurance agency acquired in May
1997 totaled $2.9 million in 1998, compared to $1.3 million in the prior year.
Included in the 1998 amount were supplemental commissions of $768,000 which
are earned based on the volume of policies sold by the agency, as well as the
loss experience on the policies sold. Mortgage servicing income declined
during 1998 by $407,000 to $1.9 million. Although the servicing portfolio
increased by 10% in 1998, the reduction in mortgage servicing income resulted
from a reduction in the average servicing fee caused by adjustable rate loan
prepayments, and increased amortization expense related to originated mortgage
servicing rights. In addition, the Company posted a total of $5.5 million in
other noninterest income, compared to $4.8 million in 1997. This category
represents over thirty categories of fee income.
 
  Noninterest expense totaled $71.8 million in 1998, up $1.8 million from the
1997 level. Noninterest expenses related to Pomerleau Agency were $2.4
million, compared with 1997 expenses of $1.5 million. Excluding the expenses
related to the insurance agency, total noninterest expenses were approximately
1% higher in 1998 than 1997.
 
  Salaries increased $2.1 million from $28.2 million in 1997. Salaries
attributed to The Pomerleau Agency were $1.1 million in 1998, a $466,000
increase from the $673,000 expensed in the seven months of the previous year.
The increase in salaries excluding The Pomerleau Agency was 5.8%. Employee
benefits increased by $118,000 to $9.5 million in 1998, which was primarily
related to the increased expenses of The Pomerleau Agency. FDIC insurance
premiums totaled $234,000, a slight increase from the $231,000 paid in 1997.
Similar to 1997, net OREO expenses were more than offset by recoveries on OREO
properties sold, so that a net credit of $33,000 was posted in 1998. This was
a $103,000 decrease from the net credit posted in 1997.
 
  Total other noninterest expense for 1998 totaled $22.6 million, down
slightly from $23.0 million in 1997. The components of other noninterest
expense for the years presented are as follows:
 
<TABLE>
<CAPTION>
                                                         1998    1997    1996
                                                        ------- ------- -------
                                                            (in thousands)
      <S>                                               <C>     <C>     <C>
      Data processing.................................. $ 5,371 $ 5,424 $ 5,023
      Amortization of intangible assets................   1,359   1,310   1,223
      Legal and professional...........................   1,180   1,443   1,453
      Marketing........................................   1,816   2,164   2,154
      Software and Supplies............................   2,362   2,275   2,077
      Other............................................  10,547  10,351  10,126
                                                        ------- ------- -------
                                                        $22,635 $22,967 $22,056
                                                        ======= ======= =======
</TABLE>
 
  Income Taxes
 
  The Company and the Banks are taxed on income by the IRS at the Federal
level and by various states in which they do business. The majority of the
Company's income is generated in the State of Vermont, which levies franchise
taxes on banking institutions based upon average deposit levels in lieu of
taxing income. Franchise taxes are included in income tax expense in the
consolidated statements of income. On August 1, 1997,
 
                                      28
<PAGE>
 
the franchise tax rate increased from $0.04 to $0.096 per $1,000 of deposits.
Due to this change in the tax rate, franchise tax expense for 1998 totaled
$1.4 million, up $539,000 over 1997.
 
  For 1998, the Federal and state income tax provisions amounted to $15.9
million. This compares with an income tax provision of $15.3 million for 1997.
The effective tax rates for 1998 and 1997 were 34.1% and 34.3%, respectively.
During 1998 and 1997, the Company's statutory Federal corporate tax rate was
35%. The Company's effective tax rates differed from the statutory rates
primarily because of 1) the proportion of interest income from state and
municipal securities and corporate dividend income which are partially exempt
from Federal taxation and 2) tax credits on investments in qualified low
income housing projects.
 
  Year 2000
 
  The Year 2000 problem, which is common to most corporations, concerns the
inability of information systems, primarily computer software programs, to
properly recognize and process date sensitive information as the year 2000
approaches. In April 1997, the Company formed a task force to manage the
completion of the five phases of the Year 2000 (Y2K) readiness process which
had informally started in November 1996. These phases include awareness of the
Y2K problem; the assessment of its impact on the Company; the subsequent
renovation of affected systems; the validation of designed Y2K renovations;
and the implementation of the validated renovations.
 
  The Company's information systems include larger programs that run on
mainframe systems and smaller programs that reside on individual or networked
personal computers. The vast majority of the systems considered by the Company
to be mission-critical (vital to the successful continuance of the Company's
core business activities) are mainframe-based systems. The assessment of all
mission-critical mainframe systems has been completed. In addition, the
renovation, testing, and implementation of the renovations to all but one
mission-critical mainframe system (the trust accounting system) are also
complete. The Company's trust accounting system, which is used to maintain
detailed accounting records for the Company's trust customers, has been
represented by the vendor to be Y2K compliant but management has chosen to
replace that system rather than renovate it. The new system has been installed
but will not be placed into production until user testing is completed, which
is expected to be completed by April 30, 1999. Validation testing for Y2K
compliance will commence after that date and is expected to be completed by
the end of the second quarter of 1999. The vendor of the new system has
certified to the Company that the system is Y2K compliant. The Company has
developed an internal reporting system to track its deadlines relating to the
renovation, testing, and implementation of Y2K related tasks to ensure that
they are completed on schedule.
 
  The personal computer (PC) based systems considered to be mission-critical
by management are smaller in scope than the mainframe-based systems. The
Company's assessment of its mission-critical PC-based systems is complete.
Renovation, testing, and implementation of all but one mission-critical PC-
based system is completed. The PC-based mission critical system for which
remediation is not complete is the credit desk system, which supports the
credit approval process for automotive finance lending. The Y2K compliant
version has been installed, has been user tested, and is in production. The
system is currently in Y2K validation testing, which is expected to be
completed during the second quarter of 1999.
 
  The Company's Y2K readiness is also affected by the readiness of its
vendors. The Company's most significant vendors are those that provide the
mainframe software that the Company uses to process its mission-critical
systems. The Company has two major vendors that provide the majority of the
mainframe based computer programs used in mission-critical systems. The
Company has confirmed with each of these vendors that they expect to be ready
for the Year 2000 within mandated timeframes. The vendor who will provide the
new trust accounting system has also confirmed that it is Y2K compliant. The
Company has also contacted the remainder of its vendors to determine their
compliance and has developed a tracking mechanism that will provide immediate
notification if a vendor does not meet a promised deadline.
 
  The Company also performs ongoing evaluations of the Y2K readiness of its
significant customers. The results of this evaluation to date include
responses from approximately 92% of the Company's significant customers. These
customers responded to a questionnaire which asked them detailed questions
regarding their Year 2000 readiness, including:
 
 
  . whether or not they had developed a comprehensive plan for Year 2000
    compliance;
 
                                      29
<PAGE>
 
  . whether or not a specific individual had been assigned responsibility for
    managing Y2K compliance;
 
  . whether or not senior management had reviewed and approved the plan;
 
  . whether or not the customer had inventoried its hardware, software,
    telecommunications, and facilities for Y2K compliance;
 
  . whether or not the customer had budgeted sufficient resources to
    accomplish its Y2K mission;
 
  . whether or not the plan had been reviewed by outside auditors;
 
  . the timing for the completion of testing of critical systems and the
    preparation of contingency plans for those systems;
 
  . whether or not the customers had discussed Y2K related issues with their
    attorneys and insurers.
 
  The responses were directed to the customer's primary customer service
contact, who reviewed their responses and then forwarded them to a specific
individual responsible for coordinating all responses and assessing their
impact on the Company. Responses were rated from 1 to 6, with 1 representing
the most progress and 6 representing the least. Of those customers who
responded, 90% have been rated as either 1 or 2. None of the responses have
indicated the existence of any Y2K related issues which might have a material
impact on the Company. Alternative assessments will be performed on a case-by-
case basis for the five significant customers who have not yet responded to
the questionnaire. These assessments will include any procedures considered
necessary to satisfy the Company that there are no Y2K related issues
associated with these five significant customers.
 
  The monitoring of the Y2K readiness of these customers will continue until
after January 1, 2000 and could result in future increased credit risk to the
Company in the event that these customers do not successfully remediate any
Y2K issues that they might have.
 
  The Company expects that it will incur costs to replace existing hardware
and software which will be capitalized and depreciated in accordance with the
Company's existing accounting policy as well as maintenance and software
modification costs which will be expensed as incurred. The Company's current
estimate of the total costs expected to be incurred, and those already
incurred, relative to Y2K follows:
 
<TABLE>
<CAPTION>
                                                                       Costs
                                                                      expected
                                                             Costs     to be
                                                            incurred  incurred
                                                            through    after
                                                            December  December
                                                            31, 1998  31, 1998
                                                            -------- ----------
      <S>                                                   <C>      <C>
      Software Modification................................ $ 22,000 $  275,000
      Replacement of non-compliant software................  109,000    500,000
      Replacement of non-compliant hardware................  119,000    575,000
                                                            -------- ----------
        Total.............................................. $250,000 $1,350,000
                                                            ======== ==========
</TABLE>
 
  Of the $1.35 million in estimated future costs of Y2K compliance, it is
expected that approximately 80% will consist of hardware and software
purchases that will have future utility and expanded functionality and
therefore will be capitalized and depreciated in accordance with the Company's
existing accounting policy. The above costs do not include salaries and
benefits of Company personnel or allocated costs of the Company's two major
mainframe contracts as these costs would have been incurred regardless of the
Y2K problem. The Company has not deferred any significant information
technology (IT) projects that would have a material adverse effect on its
future operations if not performed in a timely manner. Funds allocated for
remediation of Year 2000 issues have not been appropriated from the Company's
ongoing IT budget.
 
  Based upon the Company's progress in its Y2K readiness process, management
considers its most reasonably likely worst case Year 2000 mainframe-based
scenario to be that its final validation testing for the two systems being
converted (trust accounting and credit desk) does not pass and that additional
time will be
 
                                      30
<PAGE>
 
required in 1999 to correct any resultant problems. In the event that this
were to occur, the Company would reassign existing personnel or hire
additional personnel as necessary. If the trust system were to fail, the
Company would perform all tasks manually until system problems could be
resolved. As noted above, the vendor has certified that the system is Y2K
compliant. Therefore, management considers the failure of the trust system to
be unlikely. If the credit desk system were to fail, the Company would return
to manual procedures that were used in the approval process for automotive
finance loans prior to the original installation of the system in 1998.
Management considers its most reasonably likely worst case PC-based scenario
to be that certain vendors will not provide software renovations or upgrades
for non-mission critical applications on a timely basis and that the Company
will need to convert to other software providers or to temporarily adopt
manual procedures to replace these systems. The Company has identified those
instances in which alternate software providers are available, as well as
those for which the only alternative is manual processing.
 
  The Company has been notified by IBM that after December 31, 1999, it will
no longer support the compiler that the Company currently employs to convert
source programming code to machine language. Management has chosen to replace
this compiler and expects to complete this replacement by the end of the third
quarter of 1999. The compiler will not have any impact on the Company's Year
2000 readiness other than that the renovated systems will be running on a
compiler supported by IBM through and beyond the Year 2000. As part of the
replacement, all mainframe-based systems will be re-validated on the new
compiler.
 
  The agencies that regulate the Company (the Federal Reserve Board) and its
subsidiary banks (the Federal Deposit Insurance Corporation, the State of
Vermont and the Commonwealth of Massachusetts) have issued guidance as to the
standards they will use in assessing Year 2000 readiness. If, in the judgment
of these regulatory agencies, a regulated institution, such as the Company and
its subsidiaries, fails to take appropriate action to address its Y2K issues,
the regulatory agencies could impose enforcement actions which could have a
material adverse impact on such an institution, including the imposition of
civil money penalties, or the delay of applications seeking to complete
acquisitions.
 
Results of Operations
 
 Comparison of Years Ended December 31, 1997 and 1996
 
  Net Interest Income
 
  For 1997, net interest income was $90.5 million, compared with $84.0 million
for 1996. On a fully taxable equivalent basis, net interest income increased
$6.6 million from 1996 to $92.4 million in 1997. These improvements resulted
from higher levels of interest-earning assets and an increase in the net yield
on those assets. Average interest-earning assets totaled $1.809 billion for
1997, up $87.7 million from the 1996 level. The taxable equivalent net yield
on earning assets was 5.11% in 1997, an increase of 12 basis points from 4.99%
in 1996.
 
  Provision for Possible Loan Losses
 
  The provision for possible loan losses totaled $4.1 million in 1997 and $4.2
million in 1996. The slight reduction in provision expense was primarily
attributable to the reduction in the level of nonperforming assets and the
strength of the ratios in connection with the allowance for possible loan
losses.
 
  Noninterest Income and Noninterest Expense
 
  Noninterest income was $28.2 million in 1997, up $3.3 million from the $24.8
million reported in 1996. Investment management income was up $707,000 from
the 1996 level, to $5.6 million, due to trends similar to those experienced in
1998. Service charges on deposit accounts increased again in 1997, rising to
$7.0 million from $6.3 million in the previous year. This was partially
attributable to CTC's new deposit fee schedule, which was implemented during
the second quarter of 1997.
 
  Commercial card processing activities generated net income of $4.8 million
in 1997, up from $4.2 million in the prior year. This increase resulted
primarily from an increase in the number of customers serviced, and
consequently, significantly higher levels of credit card processing volume;
$1.137 billion was processed in 1997,
 
                                      31
<PAGE>
 
compared with $800 million in 1996. Net insurance commissions generated by the
insurance agency acquired in May 1997 totaled $1.3 million. In addition, the
Company posted a total of $4.7 million in other noninterest income compared to
$4.4 million in 1996. This category represents over thirty categories of fee
income.
 
  Noninterest expense totaled $70.0 million in 1997, up $5.5 million from the
1996 level. Salaries increased to $28.1 million from $25.7 million in 1996.
Employee benefits increased by $1.8 million to $9.4 million in 1997. The
increases in salaries and benefits during 1997 were primarily attributable to
an increase of approximately $1.6 million resulting from higher staffing
levels and related recruitment expenses and an $808,000 increase in accruals
for incentive compensation plans due to stronger profits.
 
  Other noninterest expense for 1997 totaled $23.0 million, up from $22.1
million in 1996. This increase was primarily due to increases in data
processing costs of $401,000, and expense related to amortization of
intangibles from the Pomerleau acquisition, which increased by $87,000. FDIC
insurance premiums totaled $231,000, up from $27,000 in 1996. In 1997,
expenses associated with OREO were more than offset by recoveries on OREO
properties sold, so that a net credit of $136,000 was posted. Net OREO
expenses in 1996 were $153,000. Included in the increases of the various
noninterest expense categories (except FDIC Premium) during 1997 were
administrative expenses for The Pomerleau Insurance Agency acquired during the
second quarter of 1997. Excluding the effects of Pomerleau, total noninterest
expenses increased 8.1% over 1996.
 
  Income Taxes
 
  For 1997, the Federal and state income tax provisions amounted to $15.3
million. This compares with an income tax provision of $13.5 million for 1996.
The effective tax rates for 1997 and 1996 were 34.3% and 33.5%, respectively.
During 1997 and 1996, the Company's statutory Federal corporate tax rate was
35%. The Company's effective tax rates differed from the statutory rates
primarily because of 1) the proportion of interest income from state and
municipal securities and corporate dividend income which are partially exempt
from Federal taxation and 2) tax credits on investments in qualified low
income housing projects. On August 1, 1997, the franchise tax rate increased
from $0.04 to $.096 per $1,000 of deposits. This change in the tax rate
increased franchise tax expense from approximately $47,000 per month prior to
August 1, 1997 to approximately $113,000 per month thereafter. For the year
ended December 31, 1997, total franchise taxes of $898,000 were approximately
$335,000 higher than in 1996.
 
                                      32
<PAGE>
 
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                             CHITTENDEN CORPORATION
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                             December 31,
                                                         ----------------------
                                                            1998        1997
                                                         ----------  ----------
                                                            (in thousands)
Assets
<S>                                                      <C>         <C>
Cash and cash equivalents..............................  $  134,678  $  143,394
Securities available for sale..........................     503,699     363,279
Federal Home Loan Bank stock...........................       5,591       5,591
Mortgage loans held for sale...........................      25,974      16,433
Loans..................................................   1,400,103   1,399,138
Less: Allowance for possible loan losses...............     (24,510)    (26,721)
                                                         ----------  ----------
  Net loans............................................   1,375,593   1,372,417
Accrued interest receivable............................      14,374      14,431
Other real estate owned................................         695         747
Other assets...........................................      19,480      19,593
Premises and equipment, net............................      29,441      27,412
Intangible assets......................................      12,494      13,853
                                                         ----------  ----------
  Total assets.........................................  $2,122,019  $1,977,150
                                                         ==========  ==========
<CAPTION>
Liabilities and Stockholders' Equity
<S>                                                      <C>         <C>
Liabilities:
Deposits:
  Demand...............................................  $  321,179  $  302,555
  Savings..............................................   1,056,550     924,846
  Certificates of deposit less than $100,000 and other
   time deposits.......................................     394,310     409,055
  Certificates of deposit $100,000 and over............     118,715     121,089
                                                         ----------  ----------
    Total deposits.....................................   1,890,754   1,757,545
Short-term borrowings..................................      23,369      25,489
Accrued expenses and other liabilities.................      32,749      31,843
                                                         ----------  ----------
    Total liabilities..................................   1,946,872   1,814,877
Commitments and contingencies
Stockholders' equity:
Preferred stock--$100 par value--authorized: 200,000
 shares--issued and outstanding: none..................         --          --
Common stock--$1 par value--authorized: 30,000,000
 shares--issued and outstanding: 15,929,661 in 1998 and
 1997..................................................      15,930      15,930
Surplus................................................      72,468      72,611
Retained earnings......................................     122,056     102,553
Treasury stock, at cost--1,747,354 shares in 1998 and
 1,508,076 shares in 1997..............................     (38,852)    (30,084)
Accumulated other comprehensive income.................       3,811       1,675
Unearned portion of employee restricted stock..........        (266)       (412)
                                                         ----------  ----------
    Total stockholders' equity.........................     175,147     162,273
                                                         ----------  ----------
    Total liabilities and stockholders' equity.........  $2,122,019  $1,977,150
                                                         ==========  ==========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       33
<PAGE>
 
                             CHITTENDEN CORPORATION
 
                       CONSOLIDATED STATEMENTS OF INCOME
 
<TABLE>
<CAPTION>
                                                      Years Ended December 31,
                                                     --------------------------
                                                       1998     1997     1996
                                                     -------- -------- --------
                                                       (in thousands, except
Interest Income:                                         per share amounts)
<S>                                                  <C>      <C>      <C>
  Interest on loans................................. $122,626 $124,041 $119,398
  Interest on investment securities:
    Taxable.........................................   25,082   22,992   20,232
    Tax-favored.....................................    1,815    1,057    1,401
  Short-term investments............................    1,988    1,939    1,527
                                                     -------- -------- --------
      Total interest income.........................  151,511  150,029  142,558
                                                     -------- -------- --------
Interest Expense:
  Deposits:
    Savings.........................................   31,294   29,592   27,268
    Time............................................   26,982   27,460   29,247
                                                     -------- -------- --------
      Total interest on deposits....................   58,276   57,052   56,515
  Short-term borrowings.............................    2,232    2,448    2,084
                                                     -------- -------- --------
      Total interest expense........................   60,508   59,500   58,599
                                                     -------- -------- --------
Net interest income.................................   91,003   90,529   83,959
Provision for possible loan losses..................    5,100    4,050    4,183
                                                     -------- -------- --------
Net interest income after provision for possible
 loan losses........................................   85,903   86,479   79,776
                                                     -------- -------- --------
Noninterest Income:
  Investment management income......................    6,668    5,602    4,895
  Service charges on deposit accounts...............    7,067    6,952    6,260
  Mortgage servicing income ........................    1,907    2,314    2,454
  Gains on sales of mortgage loans, net.............    4,814    2,470    2,606
  Credit card income, net...........................    3,582    4,774    4,198
  Insurance commissions, net........................    2,878    1,327      --
  Other.............................................    5,486    4,761    4,393
                                                     -------- -------- --------
      Total noninterest income......................   32,402   28,200   24,806
                                                     -------- -------- --------
Noninterest Expense:
  Salaries..........................................   30,161   28,103   25,654
  Employee benefits.................................    9,483    9,365    7,574
  Net occupancy expense.............................    9,488    9,512    9,125
  Other.............................................   22,635   22,967   22,056
                                                     -------- -------- --------
      Total noninterest expense.....................   71,767   69,947   64,409
                                                     -------- -------- --------
Income before income taxes..........................   46,538   44,732   40,173
Provision for income taxes..........................   15,873   15,326   13,452
                                                     -------- -------- --------
Net income.......................................... $ 30,665 $ 29,406 $ 26,721
                                                     ======== ======== ========
Basic earnings per share............................ $   2.14 $   1.99 $   1.75
Diluted earning per share...........................     2.09     1.94     1.72
Dividends per share.................................     0.78     1.29     0.57
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       34
<PAGE>
 
                             CHITTENDEN CORPORATION
 
  Consolidated Statements of Changes in Stockholders' Equity and Comprehensive
                                     Income
 
                   Years ended December 31, 1998, 1997, 1996
 
<TABLE>
<CAPTION>
                                                                                            Unearned
                                                                              Accumulated  Portion of  Total
                                                                                 Other      Employee   Stock-
                          Comprehensive Common           Retained  Treasury  Comprehensive Restricted holders'
                             Income      Stock  Surplus  Earnings   Stock       Income       Stock     Equity
                          ------------- ------- -------  --------  --------  ------------- ---------- --------
<S>                       <C>           <C>     <C>      <C>       <C>       <C>           <C>        <C>
Balance at December 31,
 1995...................                $15,432 $67,719  $ 74,065  $ (3,967)    $  768       $ (68)   $153,949
Comprehensive Income:
 Net income.............     $26,721        --      --     26,721       --         --          --       26,721
 Total Other
  Comprehensive Income
  (Note 8)..............        (976)       --      --        --        --        (976)        --         (976)
                             -------
 Total Comprehensive
  Income................     $25,745
                             =======
Cash dividends declared
 ($0.57 per share)......                    --      --     (8,747)      --         --          --       (8,747)
Shares issued/forfeited
 under various
 stockplans, net........                    416   3,818       --       (803)       --          --        3,431
Amortization of deferred
 compensation for
 restricted stock
 earned.................                    --      --        --        --         --           23          23
                                        ------- -------  --------  --------     ------       -----    --------
Balance at December 31,
 1996...................                 15,848  71,537    92,039    (4,770)      (208)        (45)    174,401
Comprehensive Income:
 Net income.............     $29,406        --      --     29,406       --         --          --       29,406
 Total Other
  Comprehensive Income
  (Note 8)..............       1,883        --      --        --        --       1,883         --        1,883
                             -------
 Total Comprehensive
  Income................     $31,289
                             =======
Cash dividends declared
 ($1.29 per share)......                    --      --    (18,892)      --         --          --      (18,892)
Shares issued/forfeited
 under various
 stockplans, net........                     82   1,101       --        642        --         (444)      1,381
Amortization of deferred
 compensation for
 restricted stock
 earned.................                    --      --        --        --         --           77          77
Purchase of treasury
 stock..................                    --      --        --    (25,956)       --          --      (25,956)
Cash paid for fractional
 shares.................                    --      (27)      --        --         --          --          (27)
                                        ------- -------  --------  --------     ------       -----    --------
Balance at December 31,
 1997...................                 15,930  72,611   102,553   (30,084)     1,675        (412)    162,273
Comprehensive Income:
 Net income.............     $30,665        --      --     30,665       --         --          --       30,665
 Total Other
  Comprehensive Income
  (Note 8)..............       2,136        --      --        --        --       2,136         --        2,136
                             -------
 Total Comprehensive
  Income................     $32,801
                             =======
Cash dividends declared
 ($0.78 per share)......                    --      --    (11,162)      --         --          --      (11,162)
Shares issued/forfeited
 under various
 stockplans, net........                    --      (50)      --      1,230        --           42       1,222
Amortization of deferred
 compensation for
 restricted stock
 earned.................                    --      --        --        --         --          104         104
Purchase of treasury
 stock..................                    --      --        --     (9,998)       --          --       (9,998)
Cost associated with
 listing on NYSE, net of
 tax....................                    --      (93)      --        --         --          --          (93)
                                        ------- -------  --------  --------     ------       -----    --------
Balance at December 31,
 1998...................                $15,930 $72,468  $122,056  $(38,852)    $3,811       $(266)   $175,147
                                        ======= =======  ========  ========     ======       =====    ========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       35
<PAGE>
 
                             CHITTENDEN CORPORATION
 
                     Consolidated Statements of Cash Flows
 
<TABLE>
<CAPTION>
                                                    Years Ended December 31,
                                                   ----------------------------
                                                     1998      1997      1996
                                                   --------  --------  --------
                                                         (in thousands)
<S>                                                <C>       <C>       <C>
Cash Flows From Operating Activities:
 Net income......................................  $ 30,665  $ 29,406  $ 26,721
   Adjustments to reconcile net income to net
    cash provided by operating activities:
   Provision for possible loan losses............     5,100     4,050     4,183
   Depreciation and amortization.................     3,673     3,581     3,551
   Amortization of intangible assets ............     1,359     1,311     1,223
   Accretion (amortization) of premiums, fees,
    and discounts, net...........................     2,101    (1,119)   (1,570)
   Investment securities (gains) losses..........        81       (53)       98
   Deferred (prepaid) income taxes...............    (4,463)    7,759      (133)
   Loans originated and purchased for sale.......  (451,636) (189,207) (196,439)
   Proceeds from sales of loans..................   446,909   184,863   203,867
   Gains on sales of loans.......................    (4,814)   (2,470)   (2,606)
 Changes in assets and liabilities, net of
  effect from purchase of acquired companies:
   Accrued interest receivable...................        57      (252)   (1,299)
   Other assets..................................     1,289    (3,775)   (2,721)
   Accrued expenses and other liabilities........     4,772     5,957       896
                                                   --------  --------  --------
     Net cash provided by operating activities...    35,093    40,051    35,771
                                                   --------  --------  --------
Cash Flows From Investing Activities:
 Net cash acquired in relation to acquisitions...       --        721       --
 Proceeds from sales of securities available for
  sale...........................................    18,727   206,340     9,291
 Proceeds from maturing securities and principal
  payments on securities available for sale......   345,435   201,886   256,506
 Purchases of securities available for sale......  (500,913) (417,301) (329,832)
 Proceeds from sales of securities held for
  investment.....................................       --      6,843       --
 Proceeds from principal payments on securities
  held for investment............................       --      6,960     4,352
 Purchases of securities held for investment.....       --       (199)     (321)
 Loans originated, net of principal repayments...   (11,615)  (60,611)  (91,207)
 Purchases of premises and equipment.............    (5,702)   (6,696)   (2,901)
                                                   --------  --------  --------
 Net cash used in investing activities...........  (154,068)  (62,057) (154,112)
                                                   --------  --------  --------
Cash Flows From Financing Activities:
 Net increase (decrease) in deposits.............   133,209    (4,049)  173,653
 Net decrease in short-term borrowings...........    (2,120)   (1,043)     (977)
 Cash paid to list on New York Stock Exchange,
  net of taxes...................................       (93)      --        --
 Proceeds from issuance of treasury and common
  stock..........................................       423       908     3,431
 Dividends on common stock.......................   (11,162)  (18,892)   (8,747)
 Repurchase of common stock......................    (9,998)  (25,983)      --
                                                   --------  --------  --------
     Net cash provided by (used in) financing
      activities.................................   110,259   (49,059)  167,360
                                                   --------  --------  --------
 Net increase (decrease) in cash and cash
  equivalents....................................    (8,716)  (71,065)   49,019
 Cash and cash equivalents at beginning of year..   143,394   214,459   165,440
                                                   --------  --------  --------
 Cash and cash equivalents at end of year........  $134,678  $143,394  $214,459
                                                   ========  ========  ========
Supplemental Disclosure of Cash Flow Information:
 Cash paid during the year for:
   Interest......................................  $ 60,535  $ 59,861  $ 58,201
   Income taxes..................................     7,091     8,882     9,950
 Non-cash investing and financing activities:
   Securities transferred from held for
    investment to held for sale..................       --     21,920       --
   Loans transferred to other real estate owned..     1,124     1,810     2,444
 Issuance of treasury and restricted stock.......       118       502     3,216
 Assets acquired and liabilities assumed through
  acquisitions:
   Fair value of assets acquired.................       --   $  7,937       --
   Liabilities assumed...........................       --     (3,182)      --
   Debt issued...................................       --     (3,700)      --
                                                   --------  --------  --------
   Cash paid.....................................       --   $  1,055       --
                                                   ========  ========  ========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       36
<PAGE>
 
                            CHITTENDEN CORPORATION
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 1 Summary of Significant Accounting Policies
 
 Principles of Consolidation
 
  The accompanying consolidated financial statements include the accounts of
Chittenden Corporation (the "Company") and its subsidiaries: Chittenden Trust
Company (CTC), and its subsidiaries The Pomerleau Agency (Pomerleau) and
Chittenden Securities, Inc. (CSI); The Bank of Western Massachusetts (BWM);
Flagship Bank & Trust Company (FBT); and Chittenden Connecticut Corporation
(CCC). (CTC, BWM, and FBT are collectively referred to as the "Banks.") All
material intercompany accounts and transactions have been eliminated in
consolidation.
 
 Nature of Operations
 
  CTC operates thirty-six branches throughout the state of Vermont; BWM
operates five branches in the greater Springfield, Massachusetts area and FBT
operates six branches in the greater Worcester, Massachusetts area. The Banks'
primary business is providing loans, deposits, and other banking services to
commercial, individual, and public sector customers. CCC is a mortgage banking
operation with offices in Brattleboro, Vermont and Southbury, Connecticut. The
Pomerleau Agency is an independent insurance agency with offices in Waterbury
and Burlington, Vermont. Chittenden Securities, Inc. is a registered
broker/dealer providing brokerage services to its customers through existing
branch locations located in Vermont and Massachusetts.
 
 Use of Estimates in the preparation of Financial Statements
 
  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
 Securities
 
  Under Statement of Financial Accounting Standards No. 115, Accounting for
Certain Investments in Debt and Equity Securities (SFAS 115), investments in
debt securities may be classified as held for investment and measured at
amortized cost only if the Company has the positive intent and ability to hold
such securities to maturity. Investments in debt securities that are not
classified as held for investment and equity securities that have readily
determinable fair values are classified as either trading securities or
securities available for sale. Trading securities are investments purchased
and held principally for the purpose of selling in the near term; securities
available for sale are investments not classified as trading or held for
investment.
 
  Securities transferred between categories are accounted for at market value.
Unrealized holding gains and losses on trading securities are included in
earnings; unrealized holding gains and losses on securities available for sale
or on securities transferred into the available for sale category from the
held for investment category are reported as a separate component of
stockholders' equity, net of applicable income taxes. Unrealized losses, which
are considered other than temporary in nature, are recognized in earnings.
 
 Loans
 
  Loans are stated at the amount of unpaid principal, net of unearned
discounts, unearned net loan origination fees and net any government agency
guarantees. Such fees and discounts are accreted using methods that
approximate the effective-interest method.
 
                                      37
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  Interest on loans is included in income as earned based upon interest rates
applied to unpaid principal. Interest is not accrued on loans 90 days or more
past due unless they are adequately secured and in the process of collection,
or on other loans when management believes collection is doubtful. All loans
considered impaired under SFAS 114 (except troubled debt restructurings), as
defined below, are nonaccruing. Interest on nonaccruing loans is recognized
when payments are received when the ultimate collectibility of interest is no
longer considered doubtful. When a loan is placed on nonaccrual status, all
interest previously accrued is reversed against current-period interest
income.
 
 Allowance for Possible Loan Losses
 
  The allowance for possible loan losses is based on management's estimate of
the amount required to reflect the risks in the loan portfolio, based on
circumstances and conditions known or anticipated at each reporting date.
There are inherent uncertainties with respect to the final outcome of the
Banks' loans. Because of these inherent uncertainties, it is reasonably
possible that actual losses experienced in the near term may differ from the
amounts reflected in these consolidated financial statements.
 
  Factors considered in evaluating the adequacy of the allowance for possible
loan losses include previous loss experience, current economic conditions and
their effect on borrowers, the performance of individual loans in relation to
contract terms, and estimated fair values of underlying collateral. Losses are
charged against the allowance for possible loan losses when management
believes that the collectibility of principal is doubtful.
 
  Key elements of the above estimates, including assumptions used in
developing independent appraisals, are dependent on the economic conditions
prevailing at the time such estimates are made. Accordingly, uncertainty
exists as to the final outcome of certain valuation judgments as a result of
changes in economic conditions in the Banks' lending areas.
 
  As of January 1, 1995, the Company adopted Statement of Financial Accounting
Standards No. 114, Accounting by Creditors for Impairment of a Loan, as
amended by SFAS No. 118 (hereafter collectively referred to as SFAS 114). A
loan is impaired when, based on current information and events, it is probable
that a creditor will be unable to collect all amounts due according to the
contractual terms of the loan agreement. SFAS 114 requires that impaired loans
be measured based on the present value of the expected future cash flows
discounted at the loan's effective interest rate. In the case of collateral
dependent loans, impairment may be measured based on the fair value of the
collateral. When the measure of the impaired loan is less than the recorded
investment in the loan, the impairment is recorded through a valuation
allowance.
 
 Loan Origination and Commitment Fees
 
  Loan origination and commitment fees, and certain loan origination costs,
are deferred and amortized over the contractual terms of the related loans as
yield adjustments using primarily the level-yield method. When loans are sold
or paid off, the unamortized net fees and costs are recognized in income. Net
deferred loan fees amounted to $1,790,000 and $542,000 at December 31, 1998
and 1997, respectively.
 
 Purchased Mortgage Servicing Rights
 
  Purchased Mortgage Servicing Rights (PMSRs) are initially recorded at the
lower of cost or the present value of the estimated future net servicing
income. Such amounts are amortized in proportion to and over the period of the
estimated net servicing income. The Company regularly evaluates the carrying
value of PMSRs for individual servicing acquisitions, compared with the
present value of estimated future net servicing income. Amortization is
adjusted to reflect changes in prepayment experience.
 
                                      38
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 Originated Mortgage Servicing Rights
 
  Effective January 1, 1997, the Company adopted Statement of Financial
Accounting Standards No. 125, Accounting For Transfers And Servicing Of
Financial Assets And Extinguishment Of Liabilities ("SFAS 125"), as amended by
SFAS No. 127, Deferral of the Effective Date of Certain Provisions of FASB
Statement No. 125. SFAS 125 superseded SFAS 122, Accounting For Mortgage
Servicing Rights. Under the financial-components approach set forth in SFAS
125, after a transfer of financial assets, an entity recognizes the financial
and servicing assets it controls and the liabilities it has incurred,
derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. The Statement also provides
consistent standards for distinguishing transfers of financial assets that are
sales from transfers that are secured borrowings. SFAS 125 did not have a
significant impact on the Company's financial position or results of
operations.
 
 Mortgage Loans Held for Sale
 
  Mortgage loans held for sale are carried at the lower of aggregate cost or
market value. Gains and losses on sales of mortgage loans are recognized at
the time of the sale and are adjusted when the interest rate charged to the
borrower and the interest rate paid to the purchaser, after considering a
normal servicing fee (and, in the case of mortgage-backed securities, a
guarantee fee), differ.
 
 Premises and Equipment
 
  Premises and equipment are stated at cost, less accumulated depreciation.
Depreciation is provided using the straight line method over the estimated
useful lives of the premises and equipment. Leasehold improvements are
amortized over the shorter of the terms of the respective leases or the
estimated useful lives of the improvements. Expenditures for maintenance,
repairs, and renewals of minor items are charged to expense as incurred.
 
 Other Real Estate Owned
 
  Collateral acquired through foreclosure ("Other Real Estate Owned" or
"OREO") is recorded at the lower of the carrying amount of the loan or the
fair value of the property, less estimated costs to sell, at the time of
acquisition. Net operating income or expense related to OREO is included in
noninterest expense in the accompanying consolidated statements of income.
 
 Intangible Assets
 
  Intangible assets include the excess of the purchase price over the fair
value of net assets acquired (goodwill) in the acquisitions of BWM and
Pomerleau, as well as a core deposit intangible related to BWM. Goodwill is
being amortized on a straight-line basis over 15 years. The core deposit
intangible is being amortized on an accelerated basis over 10 years. The
Company periodically evaluates intangible assets for impairment on the basis
of whether these assets are fully recoverable from projected, undiscounted net
cash flows of the related acquired entity.
 
 Income Taxes
 
  The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS
109), which recognizes income taxes under the asset and liability method.
Under this method, deferred tax assets and liabilities are established for the
temporary differences between the accounting basis and the tax basis of the
Company's assets and liabilities at enacted tax rates expected to be in effect
when the amounts related to such temporary differences are realized or
settled.
 
                                      39
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 Earnings Per Share
 
  Statement of Financial Accounting Standards No. 128, Earnings Per Share
("SFAS 128") established new standards for calculating and presenting earnings
per share. The standard requires the reporting of basic earnings per share and
diluted earnings per share.
 
  The calculation of basic earnings per share is based on the weighted average
number of shares of common stock outstanding during the period. Diluted
earnings per share is based on the weighted average number of shares of common
stock outstanding adjusted for the incremental shares attributed to
outstanding common stock equivalents, using the treasury stock method. Common
stock equivalents include options granted under the Company's stock plans and
shares to be issued under the Company's Directors' Deferred Compensation Plan.
 
 Cash and Cash Equivalents
 
  Cash and cash equivalents consist of cash on hand, amounts due from banks,
interest-bearing deposits and certain money market fund investments. Cash
equivalents are accounted for at cost, which approximates fair value.
 
 Trust
 
  Trust administered assets of approximately $3.2 billion and $2.8 billion at
December 31, 1998 and 1997, respectively, held by the Banks in a fiduciary or
agency capacity for customers, are not included in the accompanying
consolidated balance sheets as they are not assets of the Company. Trust
income is recorded on the cash basis in accordance with industry practice.
 
 Credit Card Income
 
  Credit card income includes annual fees and interchange income from credit
cards issued by the Company, and merchant discount income. Merchant discount
income consists of the fees charged on credit card receipts submitted by the
Company's commercial customers. Credit card income is presented net of credit
card expense, which includes fees paid by the Company to credit card issuers
and third-party processors. Such amounts are recognized on the accrual basis,
and are presented in the noninterest income section of the statement of
operations.
 
 Stock-Based Compensation
 
  Statement of Financial Accounting Standards No. 123, Accounting for Stock-
Based Compensation, encourages but does not require companies to record
compensation cost for stock-based employee compensation plans at fair value.
The Company has chosen to continue to account for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. Accordingly, compensation cost for stock options is measured
as the excess, if any, of the quoted market price of the Company's stock at
the date of the grant over the amount an employee must pay to acquire the
stock.
 
 Pensions
 
  Effective January 1, 1998, The Company adopted SFAS No. 132, Employers
Disclosures about Pensions and Other Postretirement Benefits an amendment to
FASB Statements No. 87, 88, and 106. This statement revises employer's
disclosures about pension and other postretirement benefit plans. It does not
change the measurement or recognition of those plans but standardizes the
disclosure requirements. This statement requires restatement for disclosures
for earlier periods as well. The adoption of SFAS 132 did not have a material
effect on the Company's financial position or results of operations, but did
affect the disclosure of employee benefits expenses presented in Note 10.
 
                                      40
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 Reclassifications
 
  Certain amounts in the 1997 and 1996 financial statements have been
reclassified to be consistent with current year presentation.
 
Note 2 Acquisitions
 
 The Pomerleau Agency
 
  On May 31, 1997, CTC acquired certain assets and assumed certain liabilities
of Pomerleau. This transaction was accounted for as a purchase and,
accordingly, all results of operations subsequent to the transaction have been
included in the Company's consolidated statement of income. The purchase price
was allocated to assets acquired and liabilities assumed based on estimates of
fair value at the date of acquisition. The excess of purchase price over the
fair value of assets acquired has been recorded as goodwill. The impact of the
acquisition was not material to consolidated operations and therefore, pro
forma disclosures have been omitted.
 
 Vermont Financial Services Corporation
 
  On December 16, 1998, the Company announced the signing of a definitive
merger agreement whereby Chittenden Corporation would acquire Vermont
Financial Services Corporation (VSFC), a $2.1 billion bank holding company
headquartered in Brattleboro, Vermont in a stock-for-stock merger. Under the
terms of the agreement, each share of VFSC stock would be exchanged for 1.07
shares of Chittenden stock. The transaction will be accounted for as a pooling
of interests and is expected to be completed in the second quarter of 1999,
following the receipt of all regulatory approvals, as well as approval of the
shareholders of each company. Based on the closing price of the Company's
stock as of December 14, 1998, the transaction would be valued at
approximately $454 million. In connection with the transaction, the Company
expects to incur a one-time charge of between $25 million to $35 million ($35
to $45 million pre-tax) in acquisition related costs including severance
payments and integration of duplicative systems.
 
                                      41
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Note 3 Securities
 
  Investment securities at December 31, 1998 and 1997 are as follows:
 
<TABLE>
<CAPTION>
                                       Amortized Unrealized Unrealized   Fair
                                         Cost      Gains      Losses    Value
                                       --------- ---------- ---------- --------
                                                    (in thousands)
<S>                                    <C>       <C>        <C>        <C>
1998
Securities available for sale:
  U.S. Treasury securities............ $ 12,718    $  112     $ --     $ 12,830
  U.S. government agency obligations..  257,407     3,037        (2)    260,442
  Obligations of states and political
   subdivisions ......................      342         2       --          344
  Mortgage-backed securities..........   65,182       920       (30)     66,072
  Corporate bonds and notes...........  126,864     2,514       (22)    129,356
  Government bond mutual funds........    9,526       --       (526)      9,000
  Money market preferred..............   25,504         9       --       25,513
  Other debt securities...............      142       --        --          142
                                       --------    ------     -----    --------
Total securities available for sale... $497,685    $6,594     $(580)   $503,699
                                       ========    ======     =====    ========
1997
Securities available for sale:
  U.S. Treasury securities............ $ 23,087    $  247     $ --     $ 23,334
  U.S. government agency obligations..  136,872     1,348       (17)    138,203
  Obligations of states and political
   subdivisions ......................      314       --        --          314
  Mortgage-backed securities..........   90,873       987      (422)     91,438
  Corporate bonds and notes...........   89,877       956       (21)     90,812
  Government bond mutual funds........    9,526       --       (476)      9,050
  Money market preferred..............   10,000         7       --       10,007
  Other debt securities...............      121       --        --          121
                                       --------    ------     -----    --------
Total securities available for sale... $360,670    $3,545     $(936)   $363,279
                                       ========    ======     =====    ========
</TABLE>
 
  Proceeds from sales of debt securities amounted to $18,727,000, $206,340,000
and $9,291,000 in 1998, 1997, and 1996, respectively. Realized losses on sales
of debt securities were $96,000, $532,000 and $98,000 in 1998, 1997, and 1996,
respectively. Realized gains on sales of debt securities were $15,000 and
$529,000 in 1998 and 1997, respectively. During 1997, the Company sold
government bond mutual funds at a loss of $58,000 and marketable equity
securities for gains of $114,000.
 
  The market value of securities pledged to secure U.S. Treasury borrowings,
public deposits, securities sold under agreements to repurchase, and for other
purposes required by law, amounted to $116,897,000 and $101,932,000 at
December 31, 1998 and 1997, respectively.
 
                                      42
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  The following table shows the maturity distribution of the amortized cost of
the Company's investment securities at December 31, 1998, with comparative
totals for 1997. Expected maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations:
 
<TABLE>
<CAPTION>
                                      After    After
                                     One But  Five But
                             Within   Within   Within  After
                              One      Five     Ten     Ten   No Fixed
                              Year    Years    Years   Years  Maturity  Total
                            -------- -------- -------- ------ -------- --------
                                              (in thousands)
<S>                         <C>      <C>      <C>      <C>    <C>      <C>
Investment securities:
  U.S. Treasury securities. $ 12,718 $    --  $   --   $  --   $  --   $ 12,718
  U.S. government agency
   obligations.............  104,876  149,531   3,000     --      --    257,407
  Obligations of states and
   political subdivisions..        3      206      60      73     --        342
  Mortgage-backed
   securities (1)..........   23,392   40,489   1,130     171     --     65,182
  Corporate bonds and
   notes...................   11,539  115,300      25     --      --    126,864
  Government bond mutual
   funds...................      --       --      --      --    9,526     9,526
  Money market preferred...   25,500      --      --      --        4    25,504
  Other debt securities....      --        80      62     --      --        142
                            -------- -------- -------  ------  ------  --------
Total investment
 securities................ $178,028 $305,606 $ 4,277  $  244  $9,530  $497,685
                            ======== ======== =======  ======  ======  ========
Comparative totals for
 1997...................... $ 54,115 $265,305 $29,566  $2,158  $9,526  $360,670
</TABLE>
--------
(1)  Maturities of mortgage-backed securities are based on contractual
     payments and estimated mortgage loan prepayments.
 
  The following table shows the maturity distribution of the fair value of the
Company's investment securities at December 31, 1998, with comparative totals
for 1997. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations:
 
<TABLE>
<CAPTION>
                                      After    After
                                     One But  Five But
                             Within   Within   Within  After
                              One      Five     Ten     Ten   No Fixed
                              Year    Years    Years   Years  Maturity  Total
                            -------- -------- -------- ------ -------- --------
                                              (in thousands)
<S>                         <C>      <C>      <C>      <C>    <C>      <C>
Investment securities:
  U.S. Treasury securities. $ 12,830 $    --  $   --   $  --   $  --   $ 12,830
  U.S. government agency
   obligations.............  104,876  152,515   3,051     --      --    260,442
  Obligations of states and
   political subdivisions..        3      208      60      73     --        344
  Mortgage-backed
   securities (1)..........   23,712   41,042   1,145     173     --     66,072
  Corporate bonds and
   notes...................   11,611  117,720      25     --      --    129,356
  Government bond mutual
   funds...................      --       --      --      --    9,000     9,000
  Money market preferred...   25,500      --      --      --       13    25,513
  Other debt securities....      --        80      62     --      --        142
                            -------- -------- -------  ------  ------  --------
Total investment
 securities................ $178,532 $311,565 $ 4,343  $  246  $9,013  $503,699
                            ======== ======== =======  ======  ======  ========
Comparative totals for
 1997...................... $ 54,298 $267,948 $29,815  $2,161  $9,057  $363,279
</TABLE>
--------
(1)  Maturities of mortgage-backed securities are based on contractual
     repayments and estimated mortgage loan prepayments.
 
                                      43
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Note 4 Loans
 
  Major classifications of loans at December 31, 1998 and 1997 are as follows:
 
<TABLE>
<CAPTION>
                                                            1998        1997
                                                         ----------  ----------
                                                            (in thousands)
<S>                                                      <C>         <C>
Commercial.............................................. $  374,139  $  364,864
Real estate:
  Residential...........................................    307,598     375,967
  Commercial............................................    332,018     314,477
  Construction..........................................     24,340      21,900
                                                         ----------  ----------
    Total real estate...................................    663,956     712,344
Home equity.............................................     67,359      80,491
Consumer................................................    187,592     168,877
Lease financing.........................................    107,057      72,562
                                                         ----------  ----------
    Total gross loans...................................  1,400,103   1,399,138
Allowance for possible loan losses......................    (24,510)    (26,721)
                                                         ----------  ----------
Net loans............................................... $1,375,593  $1,372,417
                                                         ==========  ==========
Mortgage loans held for sale............................ $   25,974  $   16,433
                                                         ==========  ==========
</TABLE>
 
  Lease financing receivable includes the estimated residual value of leased
vehicles of approximately $68,516,000 and $46,295,000 at December 31, 1998 and
1997, respectively, and is net of unearned interest income of approximately
$17,134,000 and $10,829,000 at those dates.
 
  CTC's lending activities are conducted primarily in Vermont, with additional
activity relating to nearby trading areas in Quebec, New York, New Hampshire,
Maine, and Connecticut. BWM's lending activities are conducted primarily in
the greater Springfield, Massachusetts area while FBT's lending activities are
conducted primarily in the greater Worcester, Massachusetts area. The Banks
make single-family and multi-family residential loans, commercial real estate
loans, commercial loans, and a variety of consumer loans. In addition, the
Banks make loans for the construction of residential homes, multi-family and
commercial properties, and for land development. The ability and willingness
of the Banks' borrowers to honor their repayment commitments are impacted by
many factors, including the level of overall economic activity within the
borrowers' geographic areas.
 
  Changes in the allowance for possible loan losses are summarized as follows:
 
<TABLE>
<CAPTION>
                                                       1998     1997     1996
                                                      -------  -------  -------
                                                          (in thousands)
<S>                                                   <C>      <C>      <C>
Balance at beginning of year......................... $26,721  $28,096  $27,818
Provision for possible loan losses...................   5,100    4,050    4,183
Loan recoveries......................................   2,148    2,812    2,204
Loans charged off....................................  (9,459)  (8,237)  (6,109)
                                                      -------  -------  -------
Balance at end of year............................... $24,510  $26,721  $28,096
                                                      =======  =======  =======
</TABLE>
 
  The principal amount of loans on nonaccrual status was $10,011,000 and
$6,481,000 at December 31, 1998 and 1997, respectively. Loans whose terms have
been substantially modified in troubled debt restructurings amounted to
$767,000 at December 31, 1997.
 
                                      44
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  The amount of interest which was not earned but which would have been earned
had the nonaccrual and restructured loans performed in accordance with their
original terms and conditions was as follows:
 
<TABLE>
<CAPTION>
                                                             1998   1997   1996
                                                            ------ ------ ------
                                                               (in thousands)
<S>                                                         <C>    <C>    <C>
Interest income in accordance with original loan terms .... $1,476 $1,164 $1,668
Interest income recognized.................................    581    353    721
                                                            ------ ------ ------
Reduction in interest income............................... $  895 $  811 $  947
                                                            ====== ====== ======
</TABLE>
 
  At December 31, 1998, the Banks were not committed to lend any additional
funds to borrowers with loans whose terms have been restructured.
 
  At December 31, 1998, the recorded investment in loans that are considered
to be impaired under SFAS 114 was $2,788,000 (all such loans, except troubled
debt restructurings, were on a nonaccrual basis). Included in this amount is
$1,564,000 of impaired loans for which the related allowance for possible loan
losses is $362,000 and $1,224,000 of impaired loans for which no specific
allowance for possible loan losses has been allocated. The average recorded
investment in impaired loans during the year ended December 31, 1998 was
approximately $2,781,000. For the year ended December 31, 1998, interest
income on impaired loans totaled $88,000, of which $78,000 was recognized on a
cash basis.
 
  Residential mortgage loans serviced for others, which are not reflected in
the consolidated balance sheets, totaled approximately $1,105.4 million and
$1,024.4 million at December 31, 1998 and 1997, respectively. No recourse
provisions exist in connection with such servicing.
 
  The following table is a summary of activity for mortgage servicing rights
purchased and originated for three years ended December 31, 1998:
 
<TABLE>
<CAPTION>
                                                   Purchased Originated  Total
                                                   --------- ---------- -------
                                                          (in thousands)
<S>                                                <C>       <C>        <C>
Balance at December 31, 1995......................  $2,126     $  --    $ 2,126
  Additions.......................................      35      1,334     1,369
  Amortization....................................    (325)      (145)     (470)
                                                    ------     ------   -------
Balance at December 31, 1996......................   1,836      1,189     3,025
  Additions.......................................     --       1,250     1,250
  Amortization....................................    (286)      (422)     (708)
                                                    ------     ------   -------
Balance at December 31, 1997......................   1,550      2,017     3,567
  Additions.......................................     --       2,563     2,563
  Amortization....................................    (251)      (796)   (1,047)
                                                    ------     ------   -------
Balance at December 31, 1998......................  $1,299     $3,784   $ 5,083
                                                    ======     ======   =======
</TABLE>
 
  SFAS 125 requires enterprises to measure the impairment of servicing rights
based on the difference between the carrying amount of the servicing rights
and current fair value. At December 31, 1998 and 1997, no allowance for
impairment in the Company's mortgage servicing rights was necessary.
 
                                      45
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Note 5 Premises and Equipment
 
  Premises and equipment at December 31, 1998 and 1997 are summarized as
follows:
 
<TABLE>
<CAPTION>
                                                             Estimated Original
                                           1998      1997       Useful Lives
                                         --------  --------  ------------------
                                          (in thousands)
<S>                                      <C>       <C>       <C>
Land.................................... $  3,221  $  3,158          --
Buildings and improvements..............   10,348    10,906    25 - 50 years
Leasehold improvements..................   18,312    15,050     2 - 50 years
Furniture and equipment.................   24,493    23,848     3 - 15 years
Construction in progress................      710       883          --
                                         --------  --------
                                           57,084    53,845
Accumulated depreciation and
 amortization...........................  (27,643)  (26,433)
                                         --------  --------
                                         $ 29,441  $ 27,412
                                         ========  ========
</TABLE>
 
  The Company is obligated under various noncancelable operating leases for
premises and equipment expiring in various years through the year 2021. Total
lease expense, less income from subleases, amounted to approximately
$2,263,000, $2,225,000 and $2,031,000 in 1998, 1997, and 1996, respectively.
 
  Future minimum rental commitments for noncancelable operating leases on
premises and equipment with initial or remaining terms of one year or more at
December 31, 1998 are as follows:
 
<TABLE>
<CAPTION>
Year                                                           Lease Obligations
----                                                           -----------------
                                                                (in thousands)
<S>                                                            <C>
1999..........................................................      $ 2,194
2000..........................................................        2,006
2001..........................................................        1,692
2002..........................................................        1,387
2003..........................................................        1,157
Thereafter....................................................        5,559
                                                                    -------
Total minimum lease payments..................................      $13,995
                                                                    =======
</TABLE>
 
Note 6 Borrowings
 
  Borrowings at December 31, 1998 and 1997 consist of the following:
<TABLE>
<CAPTION>
                                                                  1998    1997
                                                                 ------- -------
                                                                 (in thousands)
<S>                                                              <C>     <C>
Federal funds purchased, rate 5.25%, maturing January 4, 1999... $ 1,000 $    --
Securities sold under agreements to repurchase:
  Due through January 5, 1998, weighted average rate of 9.20%...      --  10,000
  Due through January 4, 1999, weighted average rate of 9.20%...  10,000      --
U.S. Treasury borrowings, 4.12% in 1998 and 5.27% in 1997, due
 on demand .....................................................  11,384  12,044
Note Payable, 5.90%, due on June 1, 1999........................     642     642
FHLB Term Advances, 5.81% in 1997 due on October 18, 1998.......      --   1,000
FHLB Affordable Housing Program, 5.09% in 1998 and 4.43% in
 1997, due on
 May 29, 2018...................................................     343     206
Capital lease obligation........................................      --   1,597
                                                                 ------- -------
                                                                 $23,369 $25,489
                                                                 ======= =======
</TABLE>
 
                                      46
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  Certain borrowings are collateralized by U.S. Treasury and agency
securities, and mortgage-backed securities. These assets had a carrying value
and a fair value of $23,926,000 and $24,455,000, respectively, at December 31,
1998, and $27,474,000 and $27,848,000, respectively, at December 31, 1997.
 
  The following information relates to securities sold under agreements to
repurchase:
 
<TABLE>
<CAPTION>
                                                       1998     1997     1996
                                                      -------  -------  -------
                                                          (in thousands)
<S>                                                   <C>      <C>      <C>
Average balance outstanding during the year.......... $10,108  $10,596  $10,097
Average interest rate during the year................    9.15%    8.99%    9.18%
Maximum amount outstanding at any month-end.......... $11,500  $10,000  $10,000
</TABLE>
 
  The following information relates to U.S. Treasury borrowings:
 
<TABLE>
<CAPTION>
                                                       1998     1997     1996
                                                      -------  -------  -------
                                                          (in thousands)
<S>                                                   <C>      <C>      <C>
Average balance outstanding during the year.......... $20,753  $22,442  $15,282
Average interest rate during the year................    5.19%    5.28%    5.16%
Maximum amount outstanding at any month-end.......... $60,295  $62,381  $62,858
 
  The following information relates to FHLB borrowings:
 
<CAPTION>
                                                       1998     1997     1996
                                                      -------  -------  -------
                                                          (in thousands)
<S>                                                   <C>      <C>      <C>
Average balance outstanding during the year.......... $ 1,078  $ 1,203  $ 2,404
Average interest rate during the year................    5.75%    5.72%    5.77%
Maximum amount outstanding at any month-end.......... $ 1,345  $ 1,348  $ 3,098
</TABLE>
 
Note 7 Income Taxes
 
  The provision for income taxes consists of the following:
 
<TABLE>
<CAPTION>
                                                       1998     1997     1996
                                                      -------  -------  -------
                                                          (in thousands)
<S>                                                   <C>      <C>      <C>
Current payable
  Federal............................................ $18,176  $ 6,001  $12,414
  State..............................................   2,160    1,566    1,171
                                                      -------  -------  -------
                                                       20,336    7,567   13,585
Deferred (prepaid)
  Federal............................................  (4,658)   7,920     (147)
  State..............................................     195     (161)      14
                                                      -------  -------  -------
                                                      (4,463)    7,759     (133)
                                                      -------  -------  -------
Provision for income taxes........................... $15,873  $15,326  $13,452
                                                      =======  =======  =======
</TABLE>
 
  Current income taxes receivable, included in other assets, were $247,000 and
$2,445,000, at December 31, 1998 and 1997, respectively. Current income taxes
payable, included in accrued expenses and other liabilities, was $298,000 at
December 31, 1998.
 
  The State of Vermont assesses a franchise tax for banks in lieu of a bank
income tax. The franchise tax, assessed based on deposits, amounted to
approximately $1,436,000, $898,000, and $562,000 in 1998, 1997, and
 
                                      47
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1996, respectively. These amounts are included in provision for income taxes
in the accompanying consolidated statements of income.
 
  The following is a reconciliation of the provision for Federal income taxes,
calculated at the statutory rate, to the recorded provision for income taxes:
 
<TABLE>
<CAPTION>
                                                       1998     1997     1996
                                                      -------  -------  -------
                                                          (in thousands)
<S>                                                   <C>      <C>      <C>
Computed tax at statutory Federal rate............... $16,288  $15,656  $14,061
Increase (decrease) in taxes from:
  Amortization of intangible assets (1)..............     166      166      166
  Tax-exempt interest, net...........................    (998)    (908)    (992)
  Dividends received deduction.......................    (354)    (187)    (238)
  State taxes, net of Federal tax benefit............   1,404    1,018      770
  Other, net.........................................    (633)    (419)    (315)
                                                      -------  -------  -------
    Total............................................ $15,873  $15,326  $13,452
                                                      =======  =======  =======
Effective income tax rate............................    34.1%    34.3%    33.5%
</TABLE>
--------
(1) The goodwill expense related to the acquisition of Pomerleau is tax
    deductible and therefore not included in this reconciliation.
 
  The components of the net deferred tax asset (liability) at December 31,
1998 and 1997 are as follows:
 
<TABLE>
<CAPTION>
                                                                1998     1997
                                                              --------  -------
                                                               (in thousands)
<S>                                                           <C>       <C>
Allowance for possible loan losses........................... $  8,773  $ 9,077
Deferred compensation and pension............................    1,639    1,409
Other real estate owned writedowns...........................       34       26
Depreciation.................................................      (77)    (287)
Accrued liabilities..........................................    1,398    1,920
Unrealized (gain) on securities available for sale...........   (2,140)    (934)
Basis differences, purchase accounting.......................      174      356
Core deposit intangible......................................   (1,152)  (1,364)
Leasing program..............................................  (11,044)  (7,336)
Mortgage servicing...........................................   (1,324)    (706)
Other........................................................      (99)    (304)
                                                              --------  -------
                                                              $ (3,818) $ 1,857
                                                              ========  =======
</TABLE>
 
                                      48
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Note 8 Stockholders' Equity
 
 Treasury Stock
 
  On June 17, 1998, the Company's Board of Directors authorized an expansion
of the Company's common stock repurchase program by 500,000 shares to a total
of 1.75 million shares of the Company's common stock to be repurchased in
negotiated transactions or on the open market. The plan was rescinded prior to
the announcement of the definitive agreement to acquire VFSC. During 1998, the
Company repurchased 297,700 shares of its common stock at a total cost of
$10.0 million.
 
 Dividends
 
  Dividends paid by the Banks are the primary source of funds available to the
Company for payment of dividends to its stockholders and for other corporate
needs. Applicable federal and state statutes, regulations, and guidelines
impose restrictions on the amount of dividends that may be declared by the
Banks.
 
  The Company paid dividends of $11,162,000, $18,892,000, and $8,747,000
during 1998, 1997, and 1996, respectively. These amounts represented $0.78,
$1.29, and $0.57 per share. Included in dividends for 1997 was a special cash
dividend of $8,675,000 or $0.60 per share, which was paid to shareholders to
maintain capital at a level consistent with the Company's requirements at that
time.
 
 Surplus
 
  CTC is required by Vermont statute to transfer a minimum of 10% of net
income from retained earnings to surplus on an annual basis. No transfer is
required if net worth as a percentage of deposits and other liabilities
exceeds 10%.
 
  The payments of dividends by BWM and FBT are subject to Massachusetts
banking law restrictions which require that the capital stock and surplus
account of the bank must amount, in the aggregate, to at least 10% of the
bank's deposit liability or there shall be transferred from net profits to the
surplus account: (1) the amount required to increase the surplus account so
that it, together with the capital stock, will amount to at least 10% of
deposit liability or; (2) the amount required to increase the surplus account
so that it shall amount to 50% of the common stock, and thereafter, the amount
, not exceeding 50% of net profits, required to increase the surplus account
so that it shall amount to 100% of capital stock. Because one or both of these
tests were met at the individual banks, no transfers were made during the
year.
 
 Stock Splits
 
  On December 12, 1997 and May 24, 1996, the Company distributed five-for-four
stock splits. All historical share information presented in the consolidated
financial statements has been restated to reflect these events.
 
 Earnings Per Share
 
  The following table summarizes the calculation of basic and diluted earnings
per share:
 
<TABLE>
<CAPTION>
                                                       1998     1997     1996
                                                      -------  -------  -------
                                                       (in thousands except
                                                      per share information)
<S>                                                   <C>      <C>      <C>
Net Income........................................... $30,665  $29,406  $26,721
Weighted average common shares outstanding...........  14,303   14,812   15,229
Dilutive effect of common stock equivalents..........     380      355      315
                                                      -------  -------  -------
 Weighted average common and common equivalent shares
  outstanding........................................  14,683   15,167   15,544
                                                      =======  =======  =======
Basic earnings per share............................. $  2.14  $  1.99  $  1.75
Dilutive effect of common stock equivalents..........   (0.05)   (0.05)   (0.03)
                                                      -------  -------  -------
Diluted earnings per share...........................    2.09     1.94     1.72
                                                      =======  =======  =======
</TABLE>
 
                                      49
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  For 1998 and 1996, options that could potentially dilute earnings per share
in the future were not included in the computation of the common stock
equivalents because to do so would have been antidilutive. There were 129,750
and 125,000 of these options with a weighted average exercise price of $42.77
and $22.52 respectively, at December 31, 1998 and 1996. There were no
antidilutive options excluded from the 1997 calculation.
 
 Comprehensive Income
 
  On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income ("SFAS 130"). SFAS 130
established standards for the reporting and display of comprehensive income
and its components (revenues, expenses, gains, and losses) in a full set of
general purpose financial statements. Comprehensive income is the total of net
income and all other non-owner changes in equity. The statement requires that
all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that
is displayed with the same prominence as other financial statements in the
year end financial statements. The statement does not require a specific
format for that financial statement. The Company has chosen to display
comprehensive income in the Consolidated Statements of Changes in
Stockholders' Equity.
 
  Reclassification detail for other comprehensive income for the years ended
December 31, 1998, 1997, and 1996:
 
<TABLE>
<CAPTION>
                                                          1998   1997    1996
                                                         ------ ------  -------
                                                            (in thousands)
<S>                                                      <C>    <C>     <C>
Unrealized holding gains (losses) on available for sale
 for period, net of tax................................  $2,083 $1,919  $(1,034)
Reclassification adjustment for (gains) losses arising
 during period, net of tax.............................      53    (36)      58
                                                         ------ ------  -------
Total Other Comprehensive Income.......................  $2,136 $1,883  $  (976)
                                                         ====== ======  =======
</TABLE>
 
 
Note 9 Stock Plans
 
  The Company has three stock option plans: a 1988 Employee Stock Option plan,
a 1993 Stock Incentive Plan, and a 1998 Directors' Omnibus Long-term Incentive
Plan. The Company accounts for these plans in accordance with APB Opinion No.
25, under which no compensation cost has been recognized.
 
  Under the plans, certain key employees and directors are eligible to receive
various types of stock incentives, including options to purchase a specified
number of shares of stock at a specified price (including incentive stock
options and non-qualified stock options); restricted stock which vests after a
specified period of time; and non-employee directors' stock options to
purchase stock at predetermined fixed prices over a five-year period. At
December 31, 1998 and 1997, there were a total of 1,640,527 and 1,540,527
shares, respectively, allocated to the plans. Of these shares, 1,174,420 and
905,421 shares were reserved at December 31, 1998 and 1997, respectively.
 
  During 1998 and 1997, 1,000 and 18,125 shares, respectively, of restricted
stock were issued, with a weighted average grant-date fair values of $38.25
and $24.67 per share. These shares vest five years from the grant date. There
were no similar shares issued during 1996.
 
                                      50
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  The following tables summarize information regarding the Company's stock
option plans:
 
<TABLE>
<CAPTION>
                                                      Weighted Average
                                                      Price Per Share  Options
                                                      ---------------- --------
<S>                                                   <C>              <C>
December 31, 1995....................................      $ 7.50       813,599
  Granted............................................       20.38       221,916
  Exercised..........................................        4.70      (405,060)
  Expired............................................       14.10       (32,380)
                                                           ------      --------
December 31, 1996....................................       13.82       598,075
  Granted............................................       25.71        22,756
  Exercised..........................................        9.92       (92,076)
  Expired............................................       21.00        (1,250)
                                                           ------      --------
December 31, 1997....................................       15.00       527,505
  Granted............................................       36.15       268,000
  Exercised..........................................        8.59       (52,441)
  Expired............................................         --            --
                                                           ------      --------
December 31, 1998....................................      $23.08       743,064
                                                           ======      ========
</TABLE>
 
Options Outstanding and Exercisable
 
<TABLE>
<CAPTION>
                                Options Outstanding                  Options Exercisable
December 31, 1998  --------------------------------------------- ----------------------------
                               Weighted Average     Weighted                     Weighted
Range of Exercise    Options      Remaining     Average exercise   Options   Average exercise
Prices:            Outstanding Contractual Life      Price       Outstanding      Price
-----------------  ----------- ---------------- ---------------- ----------- ----------------
<S>                <C>         <C>              <C>              <C>         <C>
$2.56-
 $15.31              254,183         5.28            $11.02        254,183        $11.02
$17.80-
 $29.09              334,381         8.31             23.81        198,567         22.08
$33.75-
 $56.28              154,500         9.14             41.33         37,500         35.19
                     -------         ----            ------        -------        ------
$2.56-
 $56.28              743,064         7.45            $23.08        490,250        $17.35
                     =======         ====            ======        =======        ======
</TABLE>
 
  If compensation cost for these plans had been determined in accordance with
SFAS 123, the Company's net income and earnings per share would have been
reduced to the following pro forma amounts:
 
<TABLE>
<CAPTION>
                                                          1998    1997    1996
                                                         ------- ------- -------
                                                          (in thousands, except
                                                             per share data)
<S>                                                      <C>     <C>     <C>
Net Income:
  As Reported........................................... $30,665 $29,406 $26,721
  Pro Forma.............................................  29,006  28,989  26,434
Earnings Per Share:
 Basic:
  As Reported........................................... $  2.14 $  1.99 $  1.75
  Pro Forma.............................................    2.03    1.96    1.74
 Diluted:
  As Reported........................................... $  2.09    1.94    1.72
  Pro Forma.............................................    1.98    1.91    1.70
</TABLE>
 
  The SFAS 123 method of accounting has not been applied to options granted
prior to January 1, 1995; the resulting pro forma compensation cost may not be
representative of that to be expected in future years.
 
                                      51
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted-
average assumptions used for grants in 1998, 1997 and 1996:
 
<TABLE>
<CAPTION>
                                                               1998  1997  1996
                                                               ----  ----  ----
<S>                                                            <C>   <C>   <C>
Expected life (years)......................................... 6.75  7.75  7.75
Interest rate................................................. 4.82% 5.97% 6.75%
Volatility.................................................... 30.8  29.0  25.4
Dividend yield................................................ 2.34% 2.74% 3.60%
</TABLE>
 
  Using these assumptions, the weighted average fair value of options granted
was $9.54, $8.22 and $4.62 in 1998, 1997 and 1996, respectively.
 
Note 10 Employee Benefits
 
 Pension Plan
 
  CTC has a noncontributory pension plan covering substantially all of its
employees. Benefits are based on years of service and the level of
compensation during the final years of employment. CTC's funding policy for
the plan is to contribute annually the amount necessary to meet the minimum
funding standards established by the Employee Retirement Income Security Act
(ERISA). Additional contributions may be made at the election of the Company.
This contribution is based on an actuarial method that recognizes estimated
future salary levels and service.
 
  The changes in the benefit obligation for the years ended December 31, 1998
and 1997 are as follows:
 
<TABLE>
<CAPTION>
                                                                1998     1997
                                                               -------  -------
                                                               (in thousands)
<S>                                                            <C>      <C>
Projected Benefit Obligation at beginning of year............. $17,728  $15,726
  Service cost................................................     692      589
  Interest cost...............................................   1,254    1,208
  Actuarial loss..............................................   1,057      974
  Disbursements...............................................  (1,066)    (769)
                                                               -------  -------
Projected Benefit Obligation at end of year................... $19,665  $17,728
                                                               =======  =======
</TABLE>
 
  The changes in the plan assets for the years ended December 31, 1998 and
1997 are as follows:
 
<TABLE>
<CAPTION>
                                                                1998     1997
                                                               -------  -------
                                                               (in thousands)
<S>                                                            <C>      <C>
Fair Value of Assets at beginning of year....................  $18,122  $16,036
  Actual return on plan assets...............................    3,350    2,855
  Company Contributions......................................    1,500      --
  Disbursements..............................................   (1,066)    (769)
                                                               -------  -------
Fair Value of Assets at end of year..........................  $21,906  $18,122
                                                               =======  =======
Projected Benefit Obligation less than Fair Value of Assets..  $ 2,241  $   394
Prior service cost not yet recognized in net periodic pension
 cost........................................................   (2,093)  (2,377)
Unrecognized net transition asset being amortized over
 participants' period of service.............................      (92)    (105)
Unrecognized net (gain) loss from past experience different
 from that assumed...........................................     (899)    (193)
                                                               -------  -------
Accrued pension cost included in accrued expenses and other
 liabilities.................................................  $  (843) $(2,281)
                                                               =======  =======
</TABLE>
 
                                      52
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  Weighted-average assumptions as of December 31, 1998 and 1997:
 
<TABLE>
<CAPTION>
                                                                     1998  1997
                                                                     ----  ----
<S>                                                                  <C>   <C>
Discount Rate....................................................... 6.50% 7.00%
Expected return on plan assets...................................... 9.00% 9.00%
Rate of compensation increase....................................... 5.00% 5.00%
</TABLE>
 
  Net pension expense components included in employee benefits in the
consolidated statements of income are as follows for December 31, 1998, 1997
and 1996:
 
<TABLE>
<CAPTION>
                                                       1998     1997     1996
                                                      -------  -------  -------
                                                          (in thousands)
<S>                                                   <C>      <C>      <C>
Service cost......................................... $   692  $   589  $   441
Interest cost........................................   1,254    1,208    1,112
Expected return on plan assets.......................  (1,588)  (1,409)  (1,257)
                                                      -------  -------  -------
Net Amortization:
  Prior service cost.................................    (283)    (283)    (283)
  Net Actuarial loss/(gain)..........................      --       --       25
  Transition amount..................................     (13)     (13)     (13)
                                                      -------  -------  -------
Total Amortization...................................    (296)    (296)    (271)
Net pension expense.................................. $    62  $    92  $    25
                                                      =======  =======  =======
</TABLE>
 
  Amounts resulting from changes in actuarial assumptions used to measure the
Bank's benefit obligations are not recognized as they occur, but are amortized
systematically over subsequent periods.
 
  CTC has supplemental pension arrangements with certain retired employees.
The liability, included in accrued expenses and other liabilities, related to
such arrangements was $553,000 and $660,000 at December 31, 1998 and 1997,
respectively.
 
  The Company has established a supplemental executive retirement plan (SERP)
for members of the executive management group. This plan is intended to cover
only those benefits excluded from coverage under the Bank's qualified defined
benefit pension plan as a result of IRS regulations. The design elements of
this SERP mirror those of the Bank's qualified plan. In addition to the SERP,
the Company has a separate arrangement with its Chief Executive Officer under
which contributions are accrued based upon the Company's Return on Equity
(ROE). An ROE of 10% is the minimum threshold at which any contribution will
be made. Benefits are payable upon attaining the age of 55, except in the
event of death or disability. The liability related to the SERPs, included in
accrued expenses and other liabilities, was $961,000 and $678,000 at December
31, 1998 and 1997, respectively.
 
 Other Benefit Plans
 
  CTC has an incentive savings and profit sharing plan to provide eligible
employees with a means to save and invest a portion of their earnings,
supplemented by contributions from CTC. Investment in the Company's common
stock is one of seven investment options available to employees.
 
  Eligible employees of CTC may contribute, by salary reductions, up to 6% of
their compensation as a basic employee contribution and may contribute up to
an additional 10% of their compensation as a supplemental employee
contribution. CTC makes an incentive savings contribution in an amount equal
to 35% of each employee's basic contribution. In 1998, 1997, and 1996, 39,981,
74,631, and 49,422 shares, respectively, of the Company's common stock were
purchased through the incentive savings and profit sharing plan; $387,000,
$330,000, and $290,000, respectively, were charged to expense for
contributions and payments made or to be
 
                                      53
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
made under the plan. In 1997, the Company established a supplemental executive
savings plan. This plan is intended to cover only those benefits excluded from
coverage under the Bank's qualified defined benefit pension plan as a result
of IRS regulations. Under this plan, participants agree to elect a reduction
in their earnings and the Company credits their retirement account in the
amount of the reduction. This contribution, when combined with the regular
pre-tax contributions, shall not exceed 16% of the individual's earnings.
Expenses related to this plan were $27,500 and $9,000 in 1998 and 1997,
respectively, and are included in the contribution expenses above.
 
  CTC may also make an additional matching contribution based on the extent to
which the annual corporate profitability goals established by the Board of
Directors are met. Expenses related to achievement of profitability goals
totaled $238,000, $345,000, and $319,000, in 1998, 1997, and 1996,
respectively.
 
  CTC also has an Executive Management Incentive Compensation Plan. Executives
at defined levels of responsibility are eligible to participate in the plan.
Incentive award payments are determined on the basis of corporate
profitability and individual performance, with incentive awards ranging from
zero to 100% of annual compensation. These awards are paid over a four-year
period, contingent upon meeting profitability goals in the subsequent three
years. Expenses for this plan totaled $938,000, $1,099,000, and $769,000 in
1998, 1997, and 1996, respectively.
 
  The Company has a Directors' Deferred Compensation Plan. Under the plan,
Directors may defer fees and retainers that would otherwise be payable
currently. Deferrals may be made to an uninsured interest account or an
account recorded in equivalents of the Company's common stock. Expenses for
this plan totaled $448,000, $519,000, and $365,000 for 1998, 1997, and 1996,
respectively. Included in the expenses for 1997 was $116,000 related to the
$0.60 per share special dividend paid in during the year. Shares which will be
issued under the plan totaled 217,451 at December 31, 1998.
 
  BWM and FBT have separate 401(k) plans under which those banks contributed
$292,000, $222,000 and $178,000 in 1998, 1997 and 1996 respectively. Pomerleau
has a separate 401(k) under which they contributed $47,000 and $40,000 in 1998
and 1997, respectively.
 
Note 11 Financial Instruments with Off-Balance Sheet Risk
 
  In the normal course of business, to meet the financing needs of their
customers and to reduce their own exposure to fluctuations in interest rates,
the Banks are parties to financial instruments with off-balance sheet risk,
held for purposes other than trading. The financial instruments involve, to
varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the consolidated balance sheets. The Banks' exposure to
credit loss in the event of nonperformance by the other party to the financial
instrument, for loan commitments and standby letters of credit, is represented
by the contractual amount of those instruments, assuming that the amounts are
fully advanced and that collateral or other security is of no value. The Banks
use the same credit policies in making commitments and conditional obligations
as they do for on-balance sheet instruments. The Banks evaluate each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Banks upon extension of credit, is based
on management's credit evaluation of the borrower. Collateral held varies, but
may include accounts receivable, inventory, property, plant and equipment, and
income-producing commercial properties.
 
  Commitments to originate loans, unused lines of credit, and unadvanced
portions of construction loans are agreements to lend to a customer provided
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Many of the commitments are expected to
expire without being drawn upon. Therefore, the amounts presented below do not
necessarily represent future cash requirements.
 
                                      54
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  Standby letters of credit are conditional commitments issued by the Banks to
guarantee the performance by a customer to a third party. These guarantees are
issued primarily to support public and private borrowing arrangements, bond
financing, and similar transactions. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
commitments to customers.
 
  Financial instruments whose contractual amounts represent off-balance sheet
risk at December 31, 1998 and 1997 are as follows:
 
<TABLE>
<CAPTION>
                                                                1998     1997
                                                              -------- --------
                                                               (in thousands)
<S>                                                           <C>      <C>
Commitments to originate loans............................... $ 77,579 $ 54,834
Unused lines of credit.......................................  214,969  188,570
Standby letters of credit....................................   19,272   25,665
Unadvanced portions of construction loans....................   25,195   16,658
Equity commitments to limited partnerships...................    2,673      675
</TABLE>
 
Note 12 Commitments and Contingencies
 
  As nonmembers of the Federal Reserve System, the Banks are required to
maintain certain reserve requirements of vault cash and/or deposits with the
Federal Reserve Bank of Boston. The amount of this reserve requirement,
included in cash and cash equivalents, was $12,864,000 and $14,265,000 at
December 31, 1998 and 1997, respectively.
 
  CTC and FBT have contracts for data processing services that extend to March
2003 and April 1999, respectively. Base fees required to be paid during the
remaining term of the contract are approximately $17,022,000. Total fees to be
paid may be the same as or exceed the base fees depending on additional
services rendered and consumer price index changes during the remaining term
of the contract.
 
  The Company has entered into severance agreements with the Chief Executive
Officer and several members of senior management. These agreements are
triggered by a change of control under certain circumstances. Payments are
equal to 2.99 times annual salary for the Chief Executive Officer and from 1
to 2 times annual salary for the individual participating members of senior
management.
 
  Various legal claims against the Company arising in the normal course of
business were outstanding at December 31, 1998. Management, after reviewing
these claims with legal counsel, is of the opinion that the resolution of
these claims will not have a material effect on the financial condition or
results of operations of the Company.
 
Note 13 Other Noninterest Expense
 
  The components of other noninterest expense for the years presented are as
follows:
 
<TABLE>
<CAPTION>
                                                         1998    1997    1996
                                                        ------- ------- -------
                                                            (in thousands)
<S>                                                     <C>     <C>     <C>
Data processing........................................ $ 5,371 $ 5,424 $ 5,023
Amortization of intangible assets .....................   1,359   1,310   1,223
Legal and professional.................................   1,180   1,443   1,453
Marketing..............................................   1,816   2,164   2,154
Software and supplies..................................   2,362   2,275   2,077
Other..................................................  10,547  10,351  10,126
                                                        ------- ------- -------
                                                        $22,635 $22,967 $22,056
                                                        ======= ======= =======
</TABLE>
 
                                      55
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Note 14 Related Party Transactions
 
  Directors and executive officers of the Banks and their associates are
credit customers of the Banks in the normal course of business. All loans and
commitments included in such transactions are made on substantially the same
terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with unaffiliated persons, and do not involve
more than normal risk of collectibility or present other unfavorable features.
 
  An analysis of loans to directors and executive officers of the Banks and
their associates, for 1998, is as follows (in thousands):
 
<TABLE>
<CAPTION>
         Balance at                                                   Balance at
      December 31, 1997       Additions         Reductions         December 31, 1998
      -----------------       ---------         ----------         -----------------
      <S>                     <C>               <C>                <C>
           $8,262              11,581             4,285                 $15,558
           ======              ======             =====                 =======
</TABLE>
 
Note 15 Quarterly Financial Data (Unaudited)
 
  A summary of quarterly financial data for 1998 and 1997 is presented below:
 
<TABLE>
<CAPTION>
                                                      Three Months Ended
                                               --------------------------------
                                                                 Sept.
1998                                           March 31 June 30   30    Dec. 31
----                                           -------- ------- ------- -------
                                               (in thousands, except per share
                                                           amounts)
<S>                                            <C>      <C>     <C>     <C>
Total interest income......................... $37,509  $37,883 $38,167 $37,952
Total interest expense........................  15,070   15,291  15,108  15,039
                                               -------  ------- ------- -------
Net interest income...........................  22,439   22,592  23,059  22,913
Provision for possible loan losses............   1,275    1,275   1,275   1,275
Noninterest income............................   7,841    8,280   8,170   8,111
Noninterest expense...........................  17,749   17,882  18,149  17,987
                                               -------  ------- ------- -------
Income before income taxes....................  11,256   11,715  11,805  11,762
Provision for income taxes....................   3,920    3,885   4,101   3,967
                                               -------  ------- ------- -------
Net income.................................... $ 7,336  $ 7,830 $ 7,704 $ 7,795
                                               =======  ======= ======= =======
Basic earnings per share...................... $  0.51  $  0.54 $  0.54 $  0.55
Diluted earnings per share....................    0.50     0.53    0.53    0.54
Dividends paid per share......................   0.177     0.20    0.20    0.20
<CAPTION>
                                                      Three Months Ended
                                               --------------------------------
                                                                 Sept.
1997                                           March 31 June 30   30    Dec. 31
----                                           -------- ------- ------- -------
                                               (in thousands, except per share
                                                           amounts)
<S>                                            <C>      <C>     <C>     <C>
Total interest income......................... $36,165  $37,427 $38,110 $38,327
Total interest expense........................  14,236   14,685  15,280  15,299
                                               -------  ------- ------- -------
Net interest income...........................  21,929   22,742  22,830  23,028
Provision for possible loan losses............   1,013    1,012   1,013   1,012
Noninterest income (1)........................   6,399    7,322   7,060   7,419
Noninterest expense (1).......................  16,917   17,668  17,363  17,999
                                               -------  ------- ------- -------
Income before income taxes....................  10,398   11,384  11,514  11,436
Provision for income taxes....................   3,514    3,867   3,978   3,967
                                               -------  ------- ------- -------
Net income.................................... $ 6,884  $ 7,517 $ 7,536 $ 7,469
                                               =======  ======= ======= =======
Basic earnings per share......................  $0.45    $0.50   $0.52   $0.52
Diluted earnings per share....................   0.44     0.49    0.50    0.50
Dividends paid per share......................   0.160    0.176   0.176   0.776
</TABLE>
--------
(1) Includes the operations of The Pomerleau Agency as of its acquisition in
May 1997.
 
                                      56
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Note 16 Fair Value of Financial Instruments
 
 Cash and Cash Equivalents
 
  The carrying amounts for cash and cash equivalents approximate fair value
because they mature in 90 days or less and do not present unanticipated
valuation risk.
 
 Securities
 
  The fair value of investment securities, other than obligations of states,
political subdivisions, and Federal Home Loan Bank (FHLB) stock, is based on
quoted market prices. The fair value of obligations of states and political
subdivisions is estimated to be equal to amortized cost. The carrying value of
FHLB stock represents its redemption value.
 
 Loans
 
  Fair values are estimated for portfolios of loans with similar financial and
credit characteristics. The loan portfolio was evaluated in the following
segments: commercial, residential real estate, commercial real estate,
construction, home equity, lease financing receivables and other consumer
loans. Other consumer loans include installment, credit card. Each of these
consumer portfolios also was evaluated separately.
 
  The fair value of performing commercial and real estate loans is estimated
by discounting cash flows through the estimated maturity using discount rates
that reflect the expected maturity and the credit and interest rate risk
inherent in such loans. The fair value of nonperforming commercial and real
estate loans is estimated using historical net charge-off experience applied
to the nonperforming balances. For performing residential mortgage loans, fair
value is estimated by discounting contractual cash flows adjusted for
prepayment estimates using discount rates based on secondary market sources.
The fair value of municipal loans estimated to be equal to amortized cost
since most of these loans mature within six months. The fair value of home
equity, credit card, lease financing receivables and other consumer loans is
estimated based on secondary market prices for asset-backed securities with
similar characteristics.
 
 Mortgage Servicing Rights
 
  The fair value is estimated by discounting the future cash flows through the
estimated maturity of the underlying mortgage loans.
 
 Deposits
  The fair value of deposits with no stated maturity, such as noninterest-
bearing demand deposits, savings and N.O.W. accounts, and money market and
checking accounts, is equal to the amount payable on demand, that is, the
carrying amount. The fair value of certificates of deposit and retirement
accounts is based on the discounted value of contractual cash flows. The
discount rate used is based on the estimated rates currently offered for
deposits of similar remaining maturities.
 
 Borrowings
 
  The carrying amounts for short-term borrowings approximate fair value
because they mature or are callable in ten days or less and do not present
unanticipated valuation risk. Long-term debt has an estimated fair value equal
to its carrying amount.
 
 
                                      57
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 Commitments to Extend Credit and Standby Letters of Credit
 
  The fair value of commitments to extend credit is estimated using the fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
counterparties. For fixed rate loan commitments, fair value also considers the
difference between current levels of interest rates and the committed rates.
The fair value of financial standby letters of credit is based on fees
currently charged for similar agreements or on the estimated cost to terminate
them or otherwise settle the obligations with the counterparties.
 
 Assumptions
 
  Fair value estimates are made at a specific point in time, based on relevant
market information and information about specific financial instruments. These
estimates do not reflect any premium or discount that could result from
offering for sale at one time the Banks' entire holdings of a particular
financial instrument. Because no active observable market exists for a
significant portion of the Banks' financial instruments, fair value estimates
are based on judgments regarding future expected loss experience, current
economic conditions, risk characteristics of various financial instruments,
and other factors. 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.
 
  The estimated fair values of the Company's financial instruments are as
follows:
 
<TABLE>
<CAPTION>
                                               December 31,
                                -------------------------------------------
                                        1998                  1997
                                --------------------- ---------------------
                                 Carrying              Carrying
                                  Amount   Fair Value   Amount   Fair Value
                                ---------- ---------- ---------- ----------
                                              (in thousands)
<S>                             <C>        <C>        <C>        <C>        <C>
Financial assets:
  Cash and cash equivalents.... $  134,678 $  134,678 $  143,394 $  143,394
  Securities available for
   sale........................    503,699    503,699    363,279    363,279
  Federal Home Loan Bank Stock.      5,591      5,591      5,591      5,591
  Loans, net...................  1,375,593  1,380,683  1,372,417  1,385,437
  Mortgage loans held for sale.     25,974     25,974     16,433     16,433
  Mortgage servicing rights ...      5,083      6,296      3,567      3,959
Financial liabilities:
  Deposits:
    Demand.....................    321,179    321,179    302,555    302,555
    Savings....................  1,056,550  1,056,550    924,846    924,846
    Certificates of deposit
     less than $100,000 and
     other time deposits.......    394,310    394,991    409,055    409,996
    Certificates of deposit
     $100,000 and over.........    118,715    118,822    121,089    121,282
  Short-term borrowings........     23,369     23,369     25,489     25,489
  Commitments..................        143        143        152        135
</TABLE>
 
                                      58
<PAGE>
 
                             CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Note 17 Parent Company Financial Statements
 
Chittenden Corporation (Parent Company Only)
 
Balance Sheets
 
<TABLE>
<CAPTION>
                                                                December 31,
                                                              -----------------
                                                                1998     1997
                                                              -------- --------
                                                               (in thousands)
<S>                                                           <C>      <C>
Assets
Cash and cash equivalents.................................... $  9,852 $  7,586
Investment in subsidiaries at equity in net assets...........  164,025  153,589
Other assets.................................................    1,972    1,493
                                                              -------- --------
  Total assets............................................... $175,849 $162,668
                                                              ======== ========
Liabilities and stockholders' equity
Liabilities:
Accrued expenses and other liabilities....................... $    702 $    395
                                                              -------- --------
  Total liabilities..........................................      702      395
                                                              -------- --------
  Total stockholders' equity.................................  175,147  162,273
                                                              -------- --------
  Total liabilities and stockholders' equity ................ $175,849 $162,668
                                                              ======== ========
</TABLE>
 
Statements of Income
 
<TABLE>
<CAPTION>
                                                         Years Ended December
                                                                  31,
                                                        ------------------------
                                                         1998    1997     1996
                                                        ------- -------  -------
Operating income:                                            (in thousands)
<S>                                                     <C>     <C>      <C>
  Dividends from bank subsidiaries....................  $23,597 $42,250  $10,383
  Interest income.....................................      109     175      103
  Gain on sale of securities..........................      --      114      --
                                                        ------- -------  -------
    Total operating income............................   23,706  42,539   10,486
                                                        ------- -------  -------
Operating expense.....................................    1,094     782      929
                                                        ------- -------  -------
    Total operating expense...........................    1,094     782      929
                                                        ------- -------  -------
Income before income taxes and equity in undistributed
 earnings of subsidiaries.............................   22,612  41,757    9,557
Income tax benefit....................................      309     155      260
                                                        ------- -------  -------
Income before equity in undistributed earnings of
 subsidiaries.........................................   22,921  41,912    9,817
Equity in undistributed earnings of bank subsidiaries
 .....................................................    7,744 (12,506)  16,904
                                                        ------- -------  -------
Net income............................................  $30,665 $29,406  $26,721
                                                        ======= =======  =======
</TABLE>
 
                                       59
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Statements of Cash Flows
 
<TABLE>
<CAPTION>
                                                      Years Ended December
                                                               31,
                                                     -------------------------
                                                      1998     1997     1996
                                                     -------  -------  -------
                                                         (in thousands)
<S>                                                  <C>      <C>      <C>
Cash flows from operating activities:
  Net income........................................ $30,665  $29,406  $26,721
  Adjustments to reconcile net income to net cash
   provided by operating activities:
    Equity in undistributed earnings of bank
     subsidiaries ..................................  (7,744)  12,506  (16,904)
    Gain on sale of securities......................     --      (114)     --
  (Increase) decrease in other assets...............    (480)    (280)    (136)
  Increase (decrease) in accrued expenses and other
   liabilities......................................     576     (100)     (29)
                                                     -------  -------  -------
    Net cash provided by operating activities.......  23,017   41,418    9,652
                                                     -------  -------  -------
Cash flows from investing activities:
  Proceeds from the sale of securities..............     --       345      --
                                                     -------  -------  -------
    Net cash provided by investing activities.......     --       345      --
                                                     -------  -------  -------
Cash flows from financing activities:
  Proceeds from issuance of treasury and common
   stock............................................     502      966    2,206
  Dividends on common stock......................... (11,162) (18,892)  (8,747)
  Repurchase of common stock........................  (9,998) (25,983)     --
  Cash paid to list on New York Stock Exchange, net
   of taxes.........................................     (93)     --       --
                                                     -------  -------  -------
    Net cash used in financing activities........... (20,751) (43,909)  (6,541)
                                                     -------  -------  -------
  Net increase (decrease) in cash and cash
   equivalents......................................   2,266   (2,146)   3,111
  Cash and cash equivalents at beginning of year....   7,586  $ 9,732    6,621
                                                     -------  -------  -------
  Cash and cash equivalents at end of year.......... $ 9,852  $ 7,586  $ 9,732
                                                     =======  =======  =======
</TABLE>
 
Note 18 Regulatory Matters
 
  The Company and the Banks are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have
a direct material effect on the Company's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Company and the Banks must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities, and certain off-balance
sheet items as calculated under regulatory accounting practices. Each entity's
capital amounts and classification are also subject to qualitative judgments
by the regulators about components, risk weightings, and other factors.
 
  Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Banks to maintain minimum amounts and ratios (set
forth in the tables below) of total and Tier I capital (as defined in the
regulation) to risk-weighted assets (as defined), and of Tier I capital to
average assets (as defined). Management believes, as of December 31, 1998,
that the Company and the Banks meet all capital adequacy requirements.
 
  As of December 31, 1998, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Company and the Banks as "well
capitalized" under the regulatory framework for prompt corrective action. To
be categorized as adequately or well capitalized, the Company and the Banks
must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage
ratios as set forth in the tables below. There are no conditions or events
since that notification that management believes have changed the
institutions' categories.
 
                                      60
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  The Company's and the Banks' actual capital amounts (dollars in thousands)
and ratios are presented in the following tables:
<TABLE>
<CAPTION>
                                                                  To Be Well
                                                                 Capitalized
                                                                 Under Prompt
                                                                  Corrective
                                               For Capital          Action
                                Actual      Adequacy Purposes    Provisions:
                            --------------  ------------------- --------------
                             Amount  Ratio    Amount    Ratio    Amount  Ratio
                            -------- -----  ---------- -------- -------- -----
<S>                         <C>      <C>    <C>        <C>      <C>      <C>
As of December 31, 1998:
Total Capital (to Risk
 Weighted Assets):
  Consolidated............  $178,508 11.18% $  127,691   8.00%       N/A   N/A
  Chittenden Trust
   Company................   119,335 10.49      90,978   8.00   $113,722 10.00%
  Bank of Western
   Massachusetts..........    23,507 10.00      18,801   8.00     23,501 10.00
  Flagship Bank & Trust...    24,480 10.58      18,502   8.00     23,128 10.00
Tier 1 Capital (to Risk
 Weighted Assets):
  Consolidated............   158,500  9.90      64,026   4.00        N/A   N/A
  Chittenden Trust
   Company................   105,094  9.22      45,572   4.00     68,358  6.00
  Bank of Western
   Massachusetts..........    20,535  8.64       9,508   4.00     14,263  6.00
  Flagship Bank & Trust...    21,957  9.49       9,251   4.00     13,877  6.00
Tier 1 Capital (to Average
 Assets):
  Consolidated............   158,500  7.37      85,974   4.00        N/A   N/A
  Chittenden Trust
   Company................   105,094  6.89      61,034   4.00     76,293  5.00
  Bank of Western
   Massachusetts..........    20,535  7.57      10,849   4.00     13,561  5.00
  Flagship Bank & Trust...    21,957  6.33      13,875   4.00     17,344  5.00
</TABLE>
 
<TABLE>
<CAPTION>
                                                                To Be Well
                                                            Capitalized Under
                                            For Capital     Prompt Corrective
                              Actual     Adequacy Purposes  Action Provisions:
                          -------------- --------------------------------------
                           Amount  Ratio   Amount    Ratio    Amount    Ratio
                          -------- ----- ---------- ------------------ --------
<S>                       <C>      <C>   <C>        <C>     <C>        <C>
As of December 31, 1997:
Total Capital (to Risk
 Weighted Assets):
  Consolidated........... $165,004 11.17 $  118,201   8.00         N/A     N/A
  Chittenden Trust
   Company...............  111,312 10.60     84,016   8.00  $  105,050   10.00
  Bank of Western
   Massachusetts.........   21,181 10.14     16,708   8.00      20,885   10.00
  Flagship Bank & Trust..   23,983 10.98     17,480   8.00      21,850   10.00
Tier 1 Capital (to Risk
 Weighted Assets):
  Consolidated...........  146,434  9.86     59,426   4.00         N/A     N/A
  Chittenden Trust
   Company...............   98,118  9.30     42,221   4.00      63,332    6.00
  Bank of Western
   Massachusetts.........   18,543  8.79      8,443   4.00      12,664    6.00
  Flagship Bank & Trust..   21,244  9.70      8,764   4.00      13,146    6.00
Tier 1 Capital (to
 Average Assets):
  Consolidated...........  146,434  7.43     78,793   4.00         N/A     N/A
  Chittenden Trust
   Company...............   98,118  7.05     55,680   4.00      69,600    5.00
  Bank of Western
   Massachusetts.........   18,543  7.31     10,141   4.00      12,676    5.00
  Flagship Bank & Trust..   21,244  6.65     12,773   4.00      15,967    5.00
</TABLE>
 
Note 19 Business Segments
 
  On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 131, Disclosures about Segments of an Enterprise and
Related Information, which establishes standards for reporting operating
segments of a business enterprise. SFAS No. 131 has established revised
standards for public companies relating to the reporting of financial and
descriptive information about their operating segments in financial
statements. Operating segments are components of an enterprise, which are
evaluated regularly by the
 
                                      61
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
chief operating decision maker in deciding how to allocate resources and in
assessing performance. The Company's chief operating decision maker is the
President and Chief Executive Officer of the Company. The adoption of SFAS 131
did not have a material effect on the Company's primary financial statements,
but did result in the disclosure of segment information contained herein.
 
  The Company has identified Commercial Banking as its reportable operating
business segment based on the fact that the results of operations are viewed
as a single strategic unit by the chief operating decision maker. The
Commercial Banking segment is comprised of the three Commercial Banking
subsidiaries and CCC, which provide similar products and services, have
similar distribution methods, types of customers and regulatory
responsibilities. Commercial Banking derives its revenue from a wide range of
banking services, including lending activities, acceptance of demand, savings
and time deposits, safe deposit facilities, merchant credit card services,
trust and investment management, data processing, brokerage services, mortgage
banking, and loan servicing for investor portfolios.
 
  Immaterial operating segments of the Company's operations, which do not have
similar characteristics to the commercial banking operations and do not meet
the quantitative thresholds requiring disclosure, are included in the Other
category in the disclosure of business segments below.
 
  The accounting policies used in the disclosure of business segments are the
same as those described in the summary of significant accounting policies. The
consolidation adjustment reflects certain eliminations of inter-segment
revenue, cash and Parent Company investments in subsidiaries.
 
  The following tables present the results of the Company's reportable
operating business segment results as of December 31, 1998, 1997 and 1996:
 
<TABLE>
<CAPTION>
                                 Commercial           Consolidation
                                  Banking   Other(2)   Adjustments  Consolidated
                                 ---------- --------  ------------- ------------
<S>                              <C>        <C>       <C>           <C>
Year Ended December 31, 1998
Net Interest Revenue (1).......  $   91,003 $    211    $    (211)   $   91,003
Non Interest Income:
 Investment Management Income..       6,668      --           --          6,668
 Service Charges on Deposits...       7,067      --           --          7,067
 Mortgage Servicing Income.....       1,907      --           --          1,907
 Gains on sales of mortgage
  loans, net...................       4,814      --           --          4,814
 Credit Card Income, net.......       3,582      --           --          3,582
 Insurance Commissions, net....         --     2,917          (39)        2,878
 Other non-interest income.....       5,459       27          --          5,486
                                 ---------- --------    ---------    ----------
Total non-interest income......      29,497    2,944          (39)       32,402
                                 ---------- --------    ---------    ----------
Total income...................     120,500    3,155         (250)      123,405
Provision for Possible Loan
 Losses........................       5,100      --           --          5,100
Depreciation and Amortization
 Expense.......................       4,686      346          --          5,032
Salaries and Employee Benefits.      38,248    1,396          --         39,644
Other non-interest expense.....      25,380    1,711          --         27,091
                                 ---------- --------    ---------    ----------
Total non-interest expense.....      68,314    3,453          --         71,767
                                 ---------- --------    ---------    ----------
Income (loss) before income
 taxes.........................      47,086     (298)        (250)       46,538
Income tax expense (benefit)...      15,907      (34)         --         15,873
                                 ---------- --------    ---------    ----------
Net Income (Loss)..............  $   31,179 $   (264)   $    (250)   $   30,665
                                 ========== ========    =========    ==========
End of Period Assets...........  $2,117,687 $183,921    $(179,589)   $2,122,019
End of Period Loans, net.......   1,401,568      --           --      1,401,568
End of Period Deposits.........   1,900,698      --        (9,943)    1,890,755
Expenditures for long-lived
 assets........................       5,500      202          --          5,702
</TABLE>
 
 
                                      62
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
<TABLE>
<CAPTION>
                                 Commercial           Consolidation
                                  Banking   Other(2)   Adjustments  Consolidated
                                 ---------- --------  ------------- ------------
<S>                              <C>        <C>       <C>           <C>
Year Ended December 31, 1997
Net Interest Revenue (1).......  $   90,529 $    221    $    (221)   $   90,529
Non Interest Income:
 Investment Management Income..       5,385      --           --          5,385
 Service Charges on Deposits...       6,952      --           --          6,952
 Mortgage Servicing Income.....       2,314      --           --          2,314
 Gains on sales of mortgage
  loans, net...................       2,470      --           --          2,470
 Credit Card Income, net.......       4,774      --           --          4,774
 Insurance Commissions, net....         --     1,380          (53)        1,327
 Other non-interest income.....       4,864      114          --          4,978
                                 ---------- --------    ---------    ----------
Total non-interest income......      26,759    1,494          (53)       28,200
                                 ---------- --------    ---------    ----------
Total income...................     117,288    1,715         (274)      118,729
Provision for Possible Loan
 Losses........................       4,050      --           --          4,050
Depreciation and Amortization
 Expense.......................       4,680      211          --          4,891
Salaries and Employee Benefits.      36,617      851          --         37,468
Other non-interest expense.....      26,415    1,173          --         27,588
                                 ---------- --------    ---------    ----------
Total non-interest expense.....      67,712    2,235          --         69,947
                                 ---------- --------    ---------    ----------
Income (loss) before income
 taxes.........................      45,526     (520)        (274)       44,723
Income tax expense (benefit)...      15,492     (166)         --         15,326
                                 ---------- --------    ---------    ----------
Net Income (Loss)..............  $   30,034 $   (354)   $    (274)   $   29,406
                                 ========== ========    =========    ==========
End of Period Assets...........  $1,970,135 $170,305    $(163,290)   $1,977,150
End of Period Loans, net.......   1,388,850      --           --      1,388,850
End of Period Deposits.........   1,765,078      --        (7,533)    1,757,545
Expenditures for long-lived
 assets........................       6,662       34          --          6,696
</TABLE>
 
<TABLE>
<CAPTION>
                                 Commercial           Consolidation
                                  Banking   Other(2)   Adjustments  Consolidated
                                 ---------- --------  ------------- ------------
<S>                              <C>        <C>       <C>           <C>
Year Ended December 31, 1996
Net Interest Revenue (1).......  $   83,959 $     92    $     (92)   $   83,959
Non Interest Income:
 Investment Management Income..       4,895      --           --          4,895
 Service Charges on Deposits...       6,260      --           --          6,260
 Mortgage Servicing Income.....       2,454      --           --          2,454
 Gains on sales of mortgage
  loans, net...................       2,606      --           --          2,606
 Credit Card Income, net.......       4,198      --           --          4,198
 Insurance Commissions, net....         --       --           --            --
 Other non-interest income.....       4,382       11          --          4,393
                                 ---------- --------    ---------    ----------
Total non-interest income......      24,795       11          --         24,806
                                 ---------- --------    ---------    ----------
Total income...................     108,754      103          (92)      108,765
Provision for Possible Loan
 Losses........................       4,183      --           --          4,183
Depreciation and Amortization
 Expense.......................       4,774      --           --          4,774
Salaries and Employee Benefits.      33,228      --           --         33,228
Other non-interest expense.....      25,480      928          --         26,408
                                 ---------- --------    ---------    ----------
Total non-interest expense.....      63,482      928          --         64,410
                                 ---------- --------    ---------    ----------
Income (loss) before income
 taxes.........................      41,089     (825)         (92)       40,172
Income tax expense (benefit)...      13,711     (260)         --         13,451
                                 ---------- --------    ---------    ----------
Net Income (Loss)..............  $   27,378 $   (565)   $     (92)   $   26,721
                                 ========== ========    =========    ==========
End of Period Assets...........  $1,970,135 $170,305    $(163,290)   $1,977,150
End of Period Loans, net.......   1,326,441      --           --      1,326,441
End of Period Deposits.........   1,771,386      --        (9,807)    1,761,579
Expenditures for long-lived
 assets........................       2,901      --           --          2,901
</TABLE>
--------
(1) The Commercial Banking segment derives a majority of its revenue from
    interest. In addition, management primarily relies on net interest
    revenue, not the gross revenue and expense amounts, in managing that
    segment. Therefore, only the net amount has been disclosed.
(2) Revenue derived from these non-reportable segments includes insurance
    commissions from various insurance related products and services, which
    began during 1997.
 
                                      63
<PAGE>
 
                            CHITTENDEN CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Note 20 Recent Accounting Pronouncements
 
  In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statements of Position (SOP) 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use. SOP 98-1 requires
computer software costs associated with internal-use software to be expensed
as incurred until certain capitalization criteria are met. SOP 98-1 is
effective for the Company's fiscal year beginning January 1, 1999. The Company
does not believe that adoption of SOP 98-1 will have a material impact on the
Company's financial statements.
 
  In April 1998, the AICPA issued SOP 98-5, Reporting on the Costs of Start-Up
Activities. SOP 98-5 requires all costs associated with pre-opening, pre-
operating and organization activities to be expensed as incurred. SOP 98-5
will be effective for the company beginning January 1, 1999. The Company
believes that adoption of SOP 98-5 will not have a material impact on the
Company's financial position and results of operation.
 
  In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities ("SFAS 133"). SFAS 133 establishes the accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or a liability measured at its fair value.
The Statement requires that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. Special accounting for qualifying hedges allows a derivative's gains and
losses to offset related results on the hedged item in the income statement,
and requires that a company must formally document, designate, and assess the
effectiveness of transactions that receive hedge accounting treatment.
Statement 133 is effective for the Company's fiscal year beginning January 1,
2000. The Company has the option to elect to early adopt the Statement at the
beginning of its next fiscal quarter. The statement cannot be applied
retroactively. Statement 133 must be applied to (a) derivative instruments and
(b) certain derivative instruments embedded in hybrid contracts that were
issued, acquired, or substantively modified after December 31, 1997 (and, at
the Company's election, before January 1, 1998). The Company has not yet
quantified the impact of adopting Statement 133 on its consolidated financial
statements and has not determined the timing of or method of its adoption of
the Statement. However, the Company does not expect that the adoption will
have a material impact on its financial position or results of operation.
 
  In October 1998, the FASB issued SFAS No. 134, Accounting for Mortgage-
Backed Securities Retained After the Securitization of Mortgage Loans Held for
Sale by a Mortgage Banking Enterprise. This statement requires that after the
securitization of mortgage loans held for sale, an entity engaged in mortgage
banking activities classify the resulting mortgage-backed securities or other
retained interests based on its ability and intent to sell or hold those
investments. This statement will be effective for the fiscal quarter beginning
January 1, 1999. This statement is not expected to have a material effect on
the Company's financial condition.
 
 
                                      64
<PAGE>
 
To the Board of Directors and Stockholders of
Chittenden Corporation:
 
  We have audited the accompanying consolidated balance sheets of Chittenden
Corporation and its subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of income, changes in stockholders' equity and
comprehensive income, and cash flows for each of the three years in the 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 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 consolidated financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall consolidated 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 Chittenden
Corporation and its subsidiaries as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years
in the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
 
Boston, Massachusetts
January 15, 1999
 
                                      65
<PAGE>
 
                   MANAGEMENT'S STATEMENT OF RESPONSIBILITY
 
  The consolidated financial statements contained in this annual report on
Form 10-K have been prepared in accordance with generally accepted accounting
principles and, where appropriate, include amounts based upon management's
best estimates and judgments. Management is responsible for the integrity and
the fair presentation of the consolidated financial statements and related
information.
 
  Management maintains an extensive system of internal controls to provide
reasonable assurance that the Company's assets are safeguarded against loss
and that financial information is reliable. These internal controls include
the establishment and communication of policies and procedures, the selection
and training of qualified personnel and an internal auditing program that
evaluates the adequacy and effectiveness of such internal controls, policies
and procedures.
 
  The Audit Committee, which is comprised entirely of non-employee directors,
is responsible for ensuring that management, internal auditors, and the
independent public accountants fulfill their respective responsibilities with
regard to the consolidated financial statements. The Audit Committee meets
periodically with management, internal auditors and the independent public
accountants to assure that each is carrying out its responsibilities. The
internal auditors and the independent public accountants have full and free
access to the Audit Committee and meet with it, with and without management
being present, to discuss the scope and results of their audits and any
recommendations regarding the system of internal controls.
 
  The responsibility of the Company's independent public accountants, Arthur
Andersen LLP, is limited to an expression of their opinion as to the fairness
of the consolidated financial statements presented. Their opinion is based on
an audit conducted in accordance with generally accepted auditing standards as
described in the second paragraph of their report.
 
/s/ Paul A. Perrault                      /s/ Kirk W. Walters
President, Chief Executive Officer        Executive Vice President and
and Chair of Board of Directors           Chief Financial Officer
 
                                      66
<PAGE>
 
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
       FINANCIAL DISCLOSURE
 
  Not Applicable
 
                                   PART III
 
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
  Information regarding the directors of the Registrant is included in the
Company's Joint Proxy Statement/Prospectus for the 1999 Annual Meeting of
Stockholders of Chittenden Corporation and the Special Meeting of Stockholders
of Vermont Financial Services Corporation at pages 103-105, and is
specifically incorporated herein by reference.
 
  At December 31, 1998, the principal officers of the Company and its
principal subsidiary, CTC, with their ages, positions, and years of
appointment, were as follows:
 
<TABLE>
<CAPTION>
                                     Year
 Name                          Age Appointed              Positions
 ----                          --- ---------              ---------
 <C>                           <C> <C>       <S>
 Paul A. Perrault............   47   1990    President, Chief Executive Officer
                                              of the Company and CTC, and Chair
                                              of the Company and CTC
 John P. Barnes..............   43   1990    Executive Vice President of the
                                              Company and CTC
 Lawrence W. DeShaw..........   52   1990    Executive Vice President of the
                                              Company and CTC
 John W. Kelly...............   49   1990    Executive Vice President of the
                                              Company and CTC
 Danny H. O'Brien............   48   1990    Executive Vice President of the
                                              Company and CTC
 Kirk W. Walters.............   43   1996    Executive Vice President, Chief
                                              Financial Officer, and Treasurer
                                              of the Company and CTC
 F. Sheldon Prentice.........   48   1985    Senior Vice President, General
                                              Counsel, and Secretary of the
                                              Company and CTC
 Howard L. Atkinson..........   54   1996    Chief Auditor of the Company and
                                              CTC
</TABLE>
 
  All of the current officers, except Mr. Walters and Mr. Atkinson, have been
principally employed in executive positions with CTC for more than seven
years.
 
  In accordance with the provisions of the Company's By-laws, the officers,
with the exception of the Secretary, hold office at the pleasure of the Board
of Directors. The Secretary is elected annually by the Board of Directors.
 
ITEM 11 EXECUTIVE COMPENSATION
 
  Information regarding remuneration of the directors and officers of the
Company is included in the Company's Joint Proxy Statement/Prospectus for the
1999 Annual Meeting of Stockholders of Chittenden Corporation and the Special
Meeting of Stockholders of Vermont Financial Services Corporation at pages
107-111 and is specifically incorporated herein by reference.
 
                                      67
<PAGE>
 
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  Information regarding the security ownership of directors and director-
nominees of the Company, all directors and officers of the Company as a group,
and certain beneficial owners of the Company's common stock, as of January 22,
1999, is included in the Company's Joint Proxy Statement/Prospectus for its
1999 Annual Meeting of Stockholders of Chittenden Corporation and the Special
Meeting of Stockholders of Vermont Financial Services Corporation at pages
113-114, and is specifically incorporated herein by reference.
 
  There are no arrangements known to the registrant that may, at a subsequent
date, result in a change of control of the registrant.
 
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  Information regarding certain relationships and transactions between the
Company and its Directors, Director-Nominees, Executive Officers, and family
members of these individuals, is included in the Company's Joint Proxy
Statement/Prospectus for its 1999 Annual Meeting of Stockholders of Chittenden
Corporation and the Special meeting of Stockholders of Vermont Financial
Services Corporation at page 114, and is specifically incorporated herein by
reference.
 
                                    PART IV
 
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
  (a)
 
  (1) Financial Statements
 
  The financial statements of the Company and its subsidiaries are included in
Part II, Item 8 hereof and are incorporated herein by reference.
 
  (2) Financial Statement Schedules
 
  There are no financial statement schedules required to be included in this
report.
 
  (3) Exhibits
 
  (a) The following are included as exhibits to this report:
 
<TABLE>
<S>      <C> 
 2.1     Agreement and Plan of Merger, dated as of December 16, 1998, between the Company,
         Chittenden Acquisition Subsidiary, Inc. and Vermont Financial Services Corp.,
         incorporated by reference to the Company's Form 8-K/A filed with the SEC on
         January 6, 1999.
 3(i).1  Amended and restated Articles of Incorporation of the Company, incorporated
         herein by reference to the Proxy Statement for the 1994 Annual Meeting of
         Stockholders.
 3(ii).1 By-laws of the Company, as amended and restated as of October 18, 1997.
 4.      Statement of the Company regarding its Dividend Reinvestment Plan is incorporated
         herein by reference to the Company's Annual Report on Form 10-K for the year
         ended December 31, 1993.
 10.1    Directors' Deferred Compensation Plan, dated April 1972, as amended May 20, 1992,
         incorporated herein by reference to the Company's Annual Report on Form 10-K for
         the year ended December 31, 1992.
 10.2    Amended and Restated Pension Plan, incorporated herein by reference to the
         Company's Annual Report on Form 10-Q for the period ended September 30, 1996.
 10.3    Incentive Savings and Profit Sharing Plan, attached to the Company's Annual
         Report on Form 10-K for the year ended December 31, 1994, as amended for the year
         ended December 31, 1995.
</TABLE>
 
                                      68
<PAGE>
 
<TABLE>
<S>    <C> 
 10.4  Letter from the Company to Paul A. Perrault, dated July 26, 1990, regarding terms
       of employment, incorporated herein by reference to the Company's Annual Report on
       Form 10-K for the year ended December 31, 1990.
 10.5  The Company's 1988 Stock Option Plan, incorporated herein by reference to the
       Company's Annual Report on Form 10-K for the year ended December 31, 1987.
 10.6  The Company's Restricted Stock Plan, incorporated herein by reference to the
       Company's Proxy Statement in connection with the 1986 Annual Meeting of
       Stockholders.
 10.8  Executive Management Incentive Compensation Plan ("EMICP"), incorporated herein by
       reference to the Company's Annual Report on Form 10-K for the year ended December
       31, 1994.
 10.9  Amendment to EMICP to increase cap on awards from 60% to 100% of base salary,
       incorporated herein by reference to the Company's Annual Report on Form 10-K for
       the year ended December 31, 1996.
 10.10 The Company's Stock Incentive Plan, amended and restated January 1, 1997,
       incorporated herein by reference to the Company's Proxy Statement for the 1997
       Annual Meeting of Stockholders.
 10.11 Compensation plan of Paul A. Perrault, incorporated herein by reference to the
       Company's Annual Report on Form 10-K for the year ended December 31, 1996.
 10.12 Supplemental Executive Retirement Plan of Paul A. Perrault, incorporated herein by
       reference to the Company's Annual Report on Form 10-K for the year ended December
       31, 1996.
 10.13 Supplemental Executive Cash Balance Restoration Plan incorporated herein by
       reference to the Company's Annual Report on Form 10-K for the year ended December
       31, 1997.
 10.14 Supplemental Executive Savings Plan, incorporated herein by reference to the
       Company's Annual Report on Form 10-K for the year ended December 31, 1997.
 10.15 The 1998 Directors' Omnibus Long-Term Incentive Plan, incorporated herein by
       reference to the Company's Proxy Statement for the 1998 Annual Meeting of
       Stockholders.
 10.16 Stock Option Agreement, dated as of December 16, 1998, between the Company and
       Vermont Financial Services Corp., incorporated by reference to the Company's Form
       8-K/A filed with the SEC on January 6, 1999.
 21.   List of subsidiaries of the Registrant.
 23.   Consent of Arthur Andersen LLP
 27.   Financial Data Schedule
</TABLE>
 
  (b) Reports on Form 8-K
 
  A report was filed by the Company on Form 8-K on December 17, 1998 in
connection with the signing of a definitive merger agreement between
Chittenden Corporation, Chittenden Acquisition Subsidiary Inc. and Vermont
Financial Services Corp.
 
                                      69
<PAGE>
 
                                   EXHIBITS
 
  (c)
 
EXHIBIT 3(ii).1  BY-LAWS OF THE COMPANY, AS AMENDED AND RESTATED AS OF OCTOBER
18, 1997, HAVE BEEN FILED AS AN EXHIBIT.
 
EXHIBIT 21 LIST OF SUBSIDIARIES OF CHITTENDEN CORPORATION
 
Chittenden Trust Company, Vermont, d/b/a Chittenden Bank, Mortgage Service
Center of New England and CUMEX Mortgage Service Center, and Chittenden Trust
Company's subsidiaries Chittenden Securities, Inc. and Chittenden Insurance
Products and Services, Inc, d/b/a The Pomerleau Agency
 
The Bank of Western Massachusetts, Massachusetts
 
Flagship Bank and Trust Company, Massachusetts
 
Chittenden Connecticut Corporation, Vermont, d/b/a Mortgage Service Center of
New England and CUMEX Mortgage Service Center
 
EXHIBIT 23 CONSENT OF ARTHUR ANDERSEN LLP HAS BEEN FILED AS AN EXHIBIT
 
EXHIBIT 27 FINANCIAL DATA SCHEDULE HAS BEEN FILED AS AN EXHIBIT
 
                                      70
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereto duly authorized.
 
Date: March 17, 1999                      CHITTENDEN CORPORATION
 
                                          By: /s/ Paul A. Perrault
                                            -----------------------------------
                                              Paul A. Perrault
                                              President, Chief Executive
                                              Officer
                                              and Chairman of the Board of
                                              Directors
 
                                      71
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
                Name                             Title                  Date
                ----                             -----                  ----
 
<S>                                  <C>                           <C>
        /s/ Paul A. Perrault         President, Chief Executive    March 17, 1999
____________________________________  Officer
          Paul A. Perrault            and Chairman of the Board
                                      of Directors
 
        /s/ Kirk W. Walters          Executive Vice President,     March 17, 1999
____________________________________  Chief
          Kirk W. Walters             Financial Officer and
                                      Treasurer
                                      (principal accounting
                                      officer)
 
      /s/ Frederic H. Bertrand       Director                      March 17, 1999
____________________________________
        Frederic H. Bertrand
         David M. Boardman           Director                      March 17, 1999
____________________________________
         David M. Boardman
        /s/ Paul J. Carrara          Director                      March 17, 1999
____________________________________
          Paul J. Carrara
      /s/ Richard D. Driscoll        Director                      March 17, 1999
____________________________________
        Richard D. Driscoll
           /s/ Lyn Hutton            Director                      March 17, 1999
____________________________________
             Lyn Hutton
       /s/ Philip A. Kolvoord        Director                      March 17, 1999
____________________________________
         Philip A. Kolvoord
      /s/ James C. Pizzagalli        Director                      March 17, 1999
____________________________________
        James C. Pizzagalli
         /s/ Pall D. Spera           Director                      March 17, 1999
____________________________________
           Pall D. Spera
        /s/ Martel D. Wilson         Director                      March 17, 1999
____________________________________
       Martel D. Wilson, Jr.
</TABLE>
 
                                      72
<PAGE>
 
 
 
                             CHITTENDEN CORPORATION