CHITTENDEN CORP /VT/ - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended June 30, 2004

¨	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File Number 001-13769

CHITTENDEN CORPORATION

(Exact Name of Registrant as Specified in its Charter)


VERMONT		03-0228404
(State of Incorporation)		(IRS Employer Identification No.)

TWO BURLINGTON SQUARE BURLINGTON, VERMONT		05401
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s Telephone Number: (802) 658-4000

NOT APPLICABLE

Former Name, Former Address and Formal Fiscal Year

If Changed Since Last Report

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES x NO ¨

At July 30, 2004, there were 36,932,282 shares of the Corporation’s $1.00 par value common stock issued and outstanding.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Chittenden Corporation

Consolidated Balance Sheets

(Unaudited)


	June 30, 2004			December 31, 2003
	(in thousands)
Assets
Cash and cash equivalents	$	170,940		$	174,939
Securities available for sale		1,412,206			1,588,151
FHLB stock		12,240			20,753
Loans held for sale		49,497			25,262
Loans:
Commercial		740,410			658,615
Municipal		66,533			87,080
Real Estate:
Residential
1-4 family		667,676			700,671
Multi-family		189,589			176,478
Home equity		276,640			270,959
Commercial		1,505,880			1,430,945
Construction		129,901			140,801

Total Real Estate		2,769,686			2,719,854
Consumer		249,208			259,135

Total Loans		3,825,837			3,724,684
Less: Allowance for loan losses		(57,969	)		(57,464	)

Net loans		3,767,868			3,667,220

Accrued interest receivable		27,376			29,124
Other assets		64,145			68,587
Premises and equipment, net		80,241			75,179
Mortgage servicing rights		12,562			12,265
Identified intangibles		21,972			22,733
Goodwill		216,697			216,431

Total assets	$	5,835,744		$	5,900,644

Liabilities:
Deposits:
Demand	$	891,244		$	898,920
Savings		541,138			517,789
NOW		912,175			899,018
CMAs/ Money market		1,491,522			1,604,138
Certificates of deposit less than $100,000		779,492			789,066
Certificates of deposit $100,000 and over		298,721			260,960

Total deposits		4,914,292			4,969,891
Securities sold under agreements to repurchase		75,016			78,980
Borrowings		204,122			208,454
Accrued expenses and other liabilities		54,452			63,368

Total liabilities		5,247,882			5,320,693
Stockholders’ Equity:
Preferred stock - $100 par value authorized – 1,000,000 shares; issued and outstanding - none		—			—
Common stock - $1 par value; authorized – 60,000,000 shares; issued – 40,163,091 in 2004 and 40,142,289 in 2003		40,163			40,142
Surplus		258,280			256,974
Retained earnings		361,623			341,441
Treasury stock, at cost – 3,255,342 shares in 2004 and 3,505,739 shares in 2003		(72,967	)		(78,579	)
Accumulated other comprehensive income		(3,772	)		15,595
Directors deferred compensation to be settled in stock		4,562			4,413
Unearned portion of employee restricted stock		(27	)		(35	)

Total stockholders’ equity		587,862			579,951

Total liabilities and stockholders’ equity	$	5,835,744		$	5,900,644

The accompanying notes are an integral part of these consolidated financial statements.

Chittenden Corporation

Consolidated Statements of Income

(Unaudited)


	For the Three Months Ended June 30,					For the Six Months Ended June 30,
	2004		2003			2004			2003
	(in thousands, except per share amounts)
Interest income:
Interest on loans	$	50,461	$	52,543		$	99,715		$	100,124
Investment securities:
Taxable		14,757		18,511			30,337			36,727
Tax-favored		13		42			26			87
Short-term investments		52		123			59			135

Total interest income		65,283		71,219			130,137			137,073

Interest expense:
Deposits		8,539		11,264			16,728			23,060
Borrowings		1,820		3,855			3,774			6,965

Total interest expense		10,359		15,119			20,502			30,025

Net interest income		54,924		56,100			109,635			107,048
Provision for loan losses		1,100		2,050			1,527			4,100

Net interest income after provision for loan losses		53,824		54,050			108,108			102,948

Noninterest income:
Investment management and trust		4,573		3,841			8,922			7,652
Service charges on deposits		4,775		4,735			9,466			9,128
Mortgage servicing		1,204		(829	)		437			(1,587	)
Gains on sales of loans, net		3,039		6,099			4,940			10,535
Gains on sales of securities		240		9,054			2,042			10,444
Loss on prepayments of borrowings		—		—			(1,194	)		—
Credit card income, net		1,022		970			1,930			1,873
Insurance commissions, net		1,728		1,531			4,354			3,144
Retail investment services		903		1,314			1,850			2,210
Other		3,154		3,069			5,894			5,641

Total noninterest income		20,638		29,784			38,641			49,040

Noninterest expense:
Salaries		21,786		23,668			42,666			43,949
Employee benefits		5,679		5,145			11,650			10,002
Net occupancy expense		5,752		6,198			11,777			11,676
Data Processing		1,985		2,161			4,277			4,661
Amortization of intangibles		772		727			1,526			1,238
Conversion and restructuring charges		1,318		6,800			1,470			6,800
Other		8,671		9,561			17,199			18,110

Total noninterest expense		45,963		54,260			90,565			96,436

Income before income taxes		28,499		29,574			56,184			55,552
Income tax expense		10,345		10,947			20,563			20,334

Net income	$	18,154	$	18,627		$	35,621		$	35,218

Basic earnings per share	$	0.49	$	0.51		$	0.97		$	1.01

Diluted earnings per share		0.49		0.51			0.96			1.00

Dividends per share		0.22		0.20			0.42			0.40

The accompanying notes are an integral part of these consolidated financial statements.

Chittenden Corporation

Consolidated Statements of CashFlows

(Unaudited)


	For the Six Months Ended June 30,
	2004			2003
	(in thousands)
Cash flows from operating activities:
Net income	$	35,621		$	35,218
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,527			4,100
Depreciation		4,071			4,273
Amortization of intangible assets		1,526			1,238
Amortization of premiums, fees, and discounts, net		8,227			5,895
Provision for (recovery of) impairment of MSR asset		(2,079	)		(622	)
Investment securities gains		(2,042	)		(10,444	)
Deferred income taxes		(6,864	)		(9,739	)
Loans originated for sale		(295,842	)		(715,571	)
Proceeds from sales of loans		273,987			736,331
Gains on sales of loans, net		(4,940	)		(10,535	)
Changes in assets and liabilities, net of effect from purchase of acquired companies:
Accrued interest receivable		1,748			4,304
Other assets		8,696			12,552
Accrued expenses and other liabilities		7,659			2,588

Net cash provided by operating activities		31,295			59,588

Cash flows from investing activities:
Cash paid, net of cash acquired in acquisition		(1,120	)		(90,468	)
Proceeds from sales of Federal Home Loan Bank stock		8,513			946
Proceeds from sales of securities available for sale		141,600			402,045
Proceeds from maturing securities and principal payments on securities available for sale		151,190			305,385
Purchases of securities available for sale		(148,469	)		(566,569	)
Loans originated, net of principal repayments		(104,337	)		(8,022	)
Purchases of premises and equipment		(9,091	)		(7,618	)

Net cash provided by investing activities		38,286			35,699

Cash flows from financing activities:
Net decrease in deposits		(55,599	)		(41,812	)
Net decrease in borrowings		(8,296	)		(21,729	)
Proceeds from issuance of treasury and common stock		5,754			2,475
Dividends on common stock		(15,439	)		(13,689	)

Net cash used in financing activities		(73,580	)		(74,755	)

Net (increase) decrease in cash and cash equivalents		(3,999	)		20,532
Cash and cash equivalents at beginning of period		174,939			192,142

Cash and cash equivalents at end of period	$	170,940		$	212,674

Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	20,787		$	29,319
Income taxes		18,802			28,968
Non-cash investing and financing activities:
Loans transferred to other real estate owned		31			196
Issuance of treasury and common stock		5,612			3,839
Assets acquired and liabilities assumed through acquisitions:
Fair value of assets acquired	$	854		$	1,122,089
Fair value of liabilities assumed		—			1,044,334
Equity issued		—			115,931
Cash paid		1,120			122,998
Goodwill	$	266		$	161,174

The accompanying notes are an integral part of these consolidated financial statements.

NOTE 1 - ACCOUNTING POLICIES

The financial information included herein is unaudited; however, such information reflects all adjustments (consisting of normal recurring adjustments), which are, in the opinion of management, necessary for a fair statement of results for the interim periods. Results for interim periods are not necessarily indicative of the results of operations for the full year or any other interim period.

The Company’s significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements included in its 2003 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission. For interim reporting purposes, the Company follows the same basic accounting policies and considers each interim period as an integral part of an annual period.

NOTE 2 - ACCOUNTING POLICIES ADOPTED

On March 9, 2004, the Securities and Exchange Commission (SEC) issued SEC Staff Accounting Bulletin (SAB) No. 105 – Application of Accounting Principles to Loan Commitments. SAB No. 105 summarizes the views of the staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivative instruments. SAB No. 105 was issued to address divergence in practice regarding the timing of the recognition of a servicing asset, which some entities were recognizing upon the issuance of a commitment to the customer. Other entities were recording a servicing asset when a loan was funded for eventual sale on the secondary market, while others did not record a servicing asset until the sale of that loan on the secondary market. Specifically, the SAB states that at the date of origination, these loan commitments do not give rise to recognizable assets related to servicing rights or to selling the servicing rights, thus they may not be recorded. In effect, the SAB prohibits the recognition of an Originated Mortgage Servicing Right (OMSR) upon the issuance of a loan commitment that the entity intends to sell after it is funded. As described in footnote 1 of the Company’s 10-K/A for the year ended December 31, 2003, it is the Company’s accounting policy to recognize such OMSRs only upon the sale of the underlying loan.

In December 2003, the Financial Accounting Standards Board issued a revision to FASB Interpretation No. 46, Consolidation of Variable Interest Entities, (or VIEs) which addresses consolidation by business enterprises of variable interest entities. FIN 46R expands upon existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. Under previous guidance, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. The Interpretation requires a variable interest entity to be consolidated by a company if that company is the “primary beneficiary” of that entity. The primary beneficiary is subject to a majority of the risk of loss from the VIE’s activities, or is entitled to receive a majority of the VIE’s residual returns, or both. The Company has evaluated all of the variable interest entities with which it is associated. Based upon that evaluation, no VIE’s meeting the definition of a primary beneficiary were identified. The adoption of FIN 46R did not have a material effect on the Company’s financial position or results of operations.

As part of the Company’s first quarter 2004 adoption of FIN 46R, the Company no longer consolidates the Chittenden Capital Trust I (“the Trust”), which issued $125 million of 8% trust preferred securities to the public, in its financial statements. However, the $125 million of junior subordinated debentures issued by the Company to the Trust continues to be classified as borrowings on the Company’s balance sheet, and the related interest expense continues to be so classified on the statements of income. Certain balances between the Company and the Trust, which were previously eliminated in consolidation, have been recognized in the Company’s financial statements.

NOTE 3 – ACQUISITIONS AND SALES

On February 28, 2003, Chittenden acquired Granite State Bankshares, Inc., headquartered in Keene, New Hampshire, and its subsidiary, Granite Bank for $239 million in cash and stock. The transaction has been accounted for as a purchase and, accordingly, the operations of Granite Bank are included in Chittenden’s consolidated financial statements from the date of acquisition.

The purchase price has been 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 net tangible and intangible assets acquired has been recorded as goodwill. The fair value of these assets and liabilities is summarized as follows (in thousands):


Cash and cash equivalents	$	32,530
FHLB Stock		8,271
Securities available for sale		395,443
Net loans		626,238
Prepaid expenses and other assets		26,907
Premises and equipment		13,387
Identified intangibles		19,313
Goodwill		161,174
Deposits		(782,894	)
Borrowings		(247,102	)
Accrued expenses and other liabilities		(14,338	)

Total acquisition cost	$	238,929

Following is supplemental information reflecting selected pro forma results as if this acquisition had been consummated as of the beginning of the earliest period presented, January 1, 2003 (in thousands, except EPS):


	For the three months ended June 30,				For the six months ended June 30,
	2004		2003		2004		2003
Total revenue	$	75,562	$	85,486	$	148,276	$	164,330
Income before income taxes		28,499		29,153		56,184		58,528
Net income	$	18,154	$	18,358	$	35,621	$	36,562
Diluted earnings per share (EPS)	$	0.49	$	0.50	$	0.96	$	1.00

Total revenue includes net interest income and noninterest income.

NOTE 4 – ACQUIRED INTANGIBLE ASSETS


	As of June 30, 2004
	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
Amortized intangible assets
Core deposit intangibles	$	28,541	$	11,538	$	17,003
Customer list intangible		3,498		418		3,080
Acquired trust relationships		4,000		2,111		1,889

Total	$	36,039	$	14,067	$	21,972


Aggregate Amortization Expense:
For three months ended June 30, 2004	$	772
For six months ended June 30, 2004		1,526
Estimated Amortization Expense:

For year ended 12/31/05	$	2,768
For year ended 12/31/06		2,659
For year ended 12/31/07		2,659
For year ended 12/31/08		2,659
For year ended 12/31/09		2,659

NOTE 5 – GOODWILL

The changes in the carrying amount of goodwill for the six months ended June 30, 2004 are as follows:


	Commercial Banking Segment		Other Segment		Total
Balance as of December 31, 2003	$	211,379	$	5,052	$	216,431
Goodwill acquired during year		—		266		266
Impairment losses		—		—		—

Balance as of June 30, 2004	$	211,379	$	5,318	$	216,697

NOTE 6 – CAPITAL TRUST SECURITIES

On May 21, 2002, Chittenden Capital Trust I, (which, as a result of the adoption of FIN46-R and as discussed in Note 2, is no longer included in Chittenden Corporation’s consolidated financial statements), issued $125 million of 8% trust preferred securities (“Securities”) to the public and invested the proceeds from this offering in an equivalent amount of junior subordinated debentures issued by Chittenden. These debentures are the sole asset of the trust. The proceeds from the offering, which was net of $4.4 million of issuance costs, were primarily used to fund the cash consideration paid in the Granite Bank transaction. The Securities pay interest quarterly, are mandatorily redeemable on July 1, 2032 and may be redeemed by the Trust at par any time on or after July 1, 2007. Chittenden has fully and unconditionally guaranteed the Securities issued by the Chittenden Capital Trust I.

Concurrent with the issuance of these securities, Chittenden entered into interest rate swap agreements with two counterparties, in which Chittenden will receive 8% fixed on the notional amount of $125 million, while paying the counterparties a variable rate based on the three month LIBOR (London Interbank Offered Rate), plus approximately 122 basis points.

NOTE 7 – COMPREHENSIVE INCOME

The Company’s comprehensive income for the three and six months ended June 30, 2004 and 2003 is presented below (amounts in thousands):


	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2004			2003			2004			2003
Net Income	$	18,154		$	18,627		$	35,621		$	35,218

Unrealized gains/losses on investment securities:
Unrealized holding gains (losses) on securities available for sale, net of tax		(24,995	)		9,261			(17,455	)		14,980
Reclassification adjustments for (gains) losses arising during period, net of tax		(741	)		(6,275	)		(1,912	)		(7,179	)
Accrued minimum pension liability, net of tax		—			228			—			455

Total Comprehensive Income	$	(7,582	)	$	21,841		$	16,254		$	43,474

NOTE 8 – EARNINGS PER SHARE

The	following table summarizes the calculation of basic and diluted earnings per share:


	Three Months Ended June 30,				Six Months Ended June 30,
	2004		2003		2004		2003
	(in thousands except per share information)
Net income	$	18,154	$	18,627	$	35,621	$	35,218

Weighted average common shares outstanding		36,836		36,475		36,778		34,993
Dilutive effect of common stock equivalents		409		290		453		282

Weighted average common and common equivalent shares outstanding		37,245		36,765		37,231		35,275

Basic earnings per share	$	0.49	$	0.51	$	0.97	$	1.01
Diluted earnings per share		0.49	$	0.51		0.96	$	1.00

The following table summarizes options that could potentially dilute earnings per share in the future which were not included in the computation of the common stock equivalents because to do so would have been antidilutive:


	Three Months Ending June 30,				Six Months Ending June 30,
	2004		2003		2004		2003
Anti-dilutive options		381,134		813,326		360,134		937,147
Weighted average exercise price	$	34.51	$	30.09	$	34.66	$	29.69

NOTE 9 – STOCK PLANS

The Company has three stock option plans, which are described more fully in Note 10 of the Notes to Consolidated Financial Statements included in the Company’s Form 10-K/A for the period ended December 31, 2003. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock option-related compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock options granted in the respective periods.


	Three Months Ending June 30,				Six Months Ending June 30,
	2004		2003		2004		2003
	(in thousands except per share information)
Net Income:
As reported	$	18,154	$	18,627	$	35,621	$	35,218
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		353		73		1,198		1,157

Pro forma	$	17,801	$	18,554	$	34,423	$	34,061

Earnings Per Share:
Basic:
As reported	$	0.49	$	0.51	$	0.97	$	1.01
Pro forma	$	0.48		0.51	$	0.94		0.97
Diluted:
As reported	$	0.49	$	0.51	$	0.96	$	1.00
Pro forma	$	0.48		0.50	$	0.92		0.97

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 periods and is primarily affected by the number of stock options granted in a particular period.

NOTE 10 – EMPLOYEE BENEFITS

Pension Plan

The Company sponsors two qualified defined benefit pension plans that together cover substantially all of its employees. The Chittenden Pension Account Plan (“Chittenden Plan”) covers substantially all employees other than employees of Granite Bank and GSBI Insurance Group (“GSBI”) who meet minimum age and service requirements and provides benefits based on years of service and compensation earned during those years of service. The Retirement Plan of Granite State Bankshares, Inc. in RSI Retirement Trust (“Granite Plan”) covers substantially all employees of Granite Bank and GSBI who meet minimum age and service requirements and provides benefits based on years of service and final average compensation. Granite Bank and GSBI were acquired by the Company effective February 28, 2003.

Effective December 31, 2003, benefits earned under the Granite Plan were frozen. The Company expects to merge the Granite Plan into the Chittenden Plan in 2004 once a favorable determination letter is received from the IRS relative to the Granite Plan. Effective January 1, 2004, eligible employees of Granite Bank and GSBI began to earn benefits under the Chittenden Plan.

Net periodic pension expense components included in employee benefits in the consolidated statements of income are as follows:


	Six Months Ended June 30, (in thousands)
	2004			2003
Service cost	$	1,722		$	1,172
Interest cost		1,847			1,506
Expected return on plan assets		(2,223	)		(1,614	)

Net Amortization:
Prior service cost		(295	)		(294	)
Net actuarial loss		234			—
Transition cost		(72	)		(64	)

Total amortization		(133	)		(358	)

Net periodic pension (income) expense	$	1,213		$	706

As Chittenden previously disclosed in its financial statements for the year ended December 31, 2003, due to a prior contribution made in excess of the minimum required amounts, the Company does not anticipate a required contribution during 2004. On July 14, 2004, the Company made a voluntary contribution of $2 million to the Pension Account Plan.

NOTE 11 – BUSINESS SEGMENTS

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 five Commercial Banking subsidiaries and Chittenden Connecticut Corporation, 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, business services, investment management and trust, brokerage services, and mortgage banking.

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. Revenue derived from these segments includes insurance commissions from insurance related products and services, as well as other operations associated with the parent holding company.

The accounting policies used in the disclosure of business segments are the same as those described in the summary of significant accounting policies included in Note 1 of the Notes to Consolidated Financial Statements included in the Company’s Form 10-K/A for the period ended December 31, 2003. The consolidation adjustments reflect certain eliminations of inter-segment revenue, cash and parent company investments in subsidiaries.


For the Three Months Ended June 30, 2004 (in thousands)	Commercial Banking		Other ⁽²⁾			Consolidation Adjustments			Consolidated
Net interest income ⁽¹⁾	$	55,874	$	(950	)	$	—		$	54,924
Noninterest income		19,029		1,609			—			20,638
Provision for loan losses		1,100		—			—			1,100
Noninterest expense		44,640		1,323			—			45,963

Net income (loss) before income tax		29,163		(664	)		—			28,499
Income tax expense/(benefit)		10,630		(285	)		—			10,345

Net income (loss)	$	18,533	$	(379	)	$	—		$	18,154

End of Period Assets	$	5,864,996	$	754,352		$	(783,604	)	$	5,835,744

For the Three Months Ended June 30, 2003 (in thousands)	Commercial Banking		Other ⁽²⁾			Consolidation Adjustments			Consolidated
Net interest income ⁽¹⁾	$	56,772	$	(672	)	$	—		$	56,100
Noninterest income		28,242		1,542			—			29,784
Provision for loan losses		2,050		—			—			2,050
Noninterest expense		49,064		5,196			—			54,260

Net income (loss) before income tax		33,900		(4,326	)		—			29,574
Income tax expense/(benefit)		12,310		(1,363	)		—			10,947

Net income (loss)	$	21,590	$	(2,963	)	$	—		$	18,627

End of Period Assets	$	6,037,730	$	834,719		$	(829,768	)	$	6,042,681


For the Six Months Ended June 30, 2004 (in thousands)	Commercial Banking		Other ⁽²⁾			Consolidation Adjustments			Consolidated
Net interest income ⁽¹⁾	$	111,545	$	(1,910	)	$	—		$	109,635
Noninterest income		35,424		3,217			—			38,641
Provision for loan losses		1,527		—			—			1,527
Noninterest expense		88,442		2,123			—			90,565

Net income (loss) before income tax		57,000		(816	)		—			56,184
Income tax expense/(benefit)		20,820		(257	)		—			20,563

Net income (loss)	$	36,180	$	(559	)	$	—		$	35,621

End of Period Assets	$	5,864,996	$	754,352		$	(783,604	)	$	5,835,744

For the Six Months Ended June 30, 2003 (in thousands)	Commercial Banking		Other ⁽²⁾			Consolidation Adjustments			Consolidated
Net interest income ⁽¹⁾	$	107,921	$	(873	)	$	—		$	107,048
Noninterest income		45,848		3,192			—			49,040
Provision for loan losses		4,100		—			—			4,100
Noninterest expense		86,795		9,641			—			96,436

Net income (loss) before income tax		62,874		(7,322	)		—			55,552
Income tax expense/(benefit)		22,707		(2,373	)		—			20,334

Net income (loss)	$	40,167	$	(4,949	)	$	—		$	35,218

End of Period Assets	$	6,037,730	$	834,719		$	(829,768	)	$	6,042,681

⁽¹⁾	The Commercial Banking segment derives a majority of its revenue from interest. In addition, management primarily relies on net interest income, not the gross revenue and expense amounts, in managing the 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, as well as other operations associated with the parent holding company.

NOTE 12 – STOCKHOLDERS’ EQUITY

On July 21, 2004, the Company declared dividends of $0.22 per share or approximately $8.0 million, to be paid on August 13, 2004 to shareholders of record on July 30, 2004.

In addition, Chittenden’s Board of Directors declared a 5-for-4 common stock split. The effect will be an increase in outstanding shares of Chittenden’s common stock from 36.9 million to 46.1 million based on shares outstanding on June 30, 2004. The record date for the stock split is the close of business on August 27, 2004. The additional shares will be distributed on or about September 10, 2004.

NOTE 13 – 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.

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 June 30, 2004 (in thousands):


Loans and Other Committments
Commitments to originate loans		229,576
Unused home equity lines of credit		304,392
Other unused lines of credit		39,259
Unadvanced portions of construction loans		168,203
Equity investment commitments to limited partnerships		7,321


Standby Letters of Credit
Notional amount fully collateralized by cash		73,247
Notional amount of other standby letters of credit		36,173
Liability associated with letters of credit recorded on balance sheet		203

NOTE 14–RECENT ACCOUNTING PRONOUNCEMENTS

On December 12, 2003, the Accounting Standards Executive Committee (AcSEC) issued Statement of Position 03-3: Accounting for Certain Loans of Debt Securities Acquired in a Transfer. The Statement of Position (SOP) addresses the accounting for acquired loans that show evidence of having deteriorated in terms of credit quality since their origination (i.e., impaired loans as defined in SFAS 114). Because of their deteriorated credit quality, the loans are generally acquired at a discount (i.e., below their par value). It includes such loans acquired in purchase business combinations and applies to all nongovernmental entities, including not-for-profit organizations. SOP 03-3 does not apply to loans originated and held by the entity. SOP 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected not be recognized as an adjustment of yield, loss accrual, or valuation allowance. Subsequent increases in cash flows expected to be collected generally should be recognized prospectively through adjustment of the loan’s yield over its remaining life. Decreases in cash flows expected to be collected should be recognized as impairment.

SOP 03-3 would apply to the accounting for loans acquired as described above by the Company, after January 1, 2005. Other than recording the expected cash flows associated with the acquired loans on a net rather than a gross basis, it would not impact the day one accounting to record such a purchase. However, any differences between actual cash flows from the loans and those expected upon acquisition would be recognized in earnings after the acquisition.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

This report contains statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these statements by forward-looking words such as “may,” “could,” “should,” “would,” “intend,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “continue” or similar words. The Company intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and is including this statement for purposes of complying with these safe harbor provisions. You should read statements that contain these words carefully because they discuss the Company’s future expectations, contain projections of the Company’s future results of operations or financial condition, or state other “forward-looking” information.

There may be events in the future that the Company is not able to predict accurately or control and that may cause actual results to differ materially from the expectations described in forward-looking statements. Readers are cautioned that all forward-looking statements involve risks and uncertainties, and actual results may differ materially from those discussed in this report. These differences may be the result of various factors, including 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, changes in levels of income and expense in noninterest income and expense related activities and other risk factors identified from time to time in the Company’s periodic filings with the Securities and Exchange Commission.

The factors referred to above include many, but not all, of the factors that could impact the Company’s ability to achieve the results described in any forward-looking statements. You should not place undue reliance on forward-looking statements. You should be aware that the occurrence of the events described above and elsewhere in this report could harm the Company’s business, prospects, operating results or financial condition. The Company does not undertake any obligation to update any forward-looking statements as a result of future events or developments.

Application of Critical Accounting Policies

The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements included in the Company’s Form 10-K/A for the year-ended December 31, 2003. The Company considers the following accounting policies and related estimates to be the most critical in their potential effect on its financial position or results of operations:

Allowance for Loan Losses. The allowance for loan losses is established through a charge against current earnings to the provision for loan losses. The allowance for loan losses is based on management’s estimate of the amount required to reflect the probable inherent losses in the loan portfolio, based on circumstances and conditions known at each reporting date in accordance with Generally Accepted Accounting Principles (“GAAP”). There are three components of the allowance for loan losses: 1) specific reserves for loans considered to be impaired or for other loans for which management considers a specific reserve to be necessary; 2) allocated reserves based upon management’s formula-based process for assessing the adequacy of the allowance for loan losses; and 3) a non-specific environmentally-driven allowance considered necessary by management based on its assessment of other qualitative factors. The allowance for loan losses is a significant estimate and is regularly reviewed by the Company for adequacy using a consistent, systematic methodology which assesses such factors as changes in the mix and volume of the loan portfolio; trends in portfolio credit quality, including delinquency and charge-off rates; and current economic conditions that may affect a borrower’s ability to repay. Adverse changes in management’s assessment of these factors could lead to additional provisions for loan losses. The Company’s methodology with respect to the assessment of the adequacy of the allowance for loan losses is more fully discussed in its Form 10-K/A for the period ended December 31, 2003.

Goodwill Impairment. The Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangibles, effective January 1, 2002. The statement addresses the method of identifying and measuring goodwill and other intangible assets acquired in a business combination, eliminates further amortization of goodwill, and requires periodic impairment evaluations of goodwill. Impairment evaluations are required to be performed annually and may be required more frequently if certain conditions indicating potential impairment exist. In the event that the Company were to determine that its goodwill were impaired, the recognition of an impairment charge could have an adverse impact on its results of operations in the period that the impairment occurred or on its financial position.

Mortgage Servicing Rights (MSRs). Servicing assets are recognized as separate assets when rights are acquired through purchase or through the sale of financial assets on a servicing-retained basis. Capitalized servicing rights are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying servicing rights by predominant characteristics, such as interest rates and original loan terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. When the book value of an individual stratum exceeds its fair value, an impairment reserve is recognized so that each individual stratum is carried at the lower of its amortized book value or fair value. In periods of falling market interest rates, accelerated loan prepayment speeds can adversely impact the fair value of these mortgage-servicing rights relative to their book value. In the event that the fair value of these assets were to increase in the future, the Company can recognize the increased fair value to the extent of the impairment allowance but cannot recognize an asset in excess of its amortized book value. Future changes in management’s assessment of the impairment of these servicing assets, as a result of changes in observable market data relating to market interest rates, loan prepayment speeds, and other factors, could impact the Company’s financial condition and results of operations either positively or adversely.

Interest Income Recognition. 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 are nonaccruing. Interest on nonaccruing loans is recognized as 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; therefore an increase in loans on nonaccrual status could have an adverse impact on interest income recognized in future periods.

Income Taxes. The Company must estimate income tax expense in each of the jurisdictions in which it operates for each period for which a statement of operations is presented. This involves estimating the Company’s actual current tax exposure as well as assessing temporary differences resulting from differing treatment of items, such as timing of the deduction of expenses, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and to the extent that recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of June 30, 2004, there were no valuation allowances set aside against any deferred tax assets.

Conversion and Restructuring Charges. The Company recognizes restructuring charges in accordance with Statement of Financial Accounting Standard No. 146 Accounting for Costs Associated with Exit or Disposal Activities and SEC Staff Accounting Bulletin No. 10 Restructuring and Impairment Charges, which contain specific guidance regarding the types of, and circumstances under which, certain expenses can be accrued. In general, the Statements require that the Company have a detailed plan in place, which has been communicated to substantially all the employees affected in the staff reduction, branch closures/sales, or computer conversions. Significant management judgment is required in estimating the amount of expense that is appropriate to recognize in relation to these plans.

Management Overview

During the second quarter of 2004, the Company completed the conversion of its core banking applications, for all of its banking subsidiaries, to the Jack Henry Silverlake System. At the same time, the former Granite Bank was merged into Ocean National Bank. In addition, Granite’s former insurance subsidiary was consolidated into Chittenden Insurance Group during the quarter. As a result of these activities, conversion and restructuring charges of $1.3 million (pre-tax), or approximately $0.02 per share (after-tax) were incurred.

Results of Operations

Chittenden Corporation posted second quarter 2004 net income of $0.49 per diluted share, compared to $0.51 per diluted share posted in the second quarter of last year. Net income for the second quarter of 2004 was $18.2 million, compared to $18.6 million recorded in the same quarter a year ago and $17.5 million for the first quarter of 2004. Return on average equity (ROE) was 12.40% for the quarter ended June 30, 2004 compared with 13.34% for the same period in 2003. Return on average assets (ROA) was 1.26% for the second quarter of 2004, flat with the second quarter of last year.

Net interest income on a tax equivalent basis for the three months ended June 30, 2004 was $55.2 million, down from $56.4 million for the same period a year ago. The yield on earning assets was 4.18%, a slight increase from the first quarter of 2004 and up four basis points from the second quarter of 2003. The decline in net interest income is primarily due to lower interest income earned on investments. Investments declined from the second quarter of 2003 due to the sales of securities throughout 2003 to fund the prepayment of borrowings totaling $164 million.

On a year to date basis Chittenden posted net income of $0.96 per diluted share, compared to $1.00 per diluted share posted for the same period of last year. Net income for the first six months of 2004 was $35.6 million, compared to $35.2 million recorded for the first six months of 2003. Return on average equity (ROE) was 12.19% through June 30, 2004 compared with 13.87% for the same period in 2003. Return on average assets (ROA) was 1.24% for the six month period ended June 30, 2004, down from 1.27% for the same period in 2003. Net interest income on a tax equivalent basis for the six months ended June 30, 2004 was $110.2 million, up from $107.6 million for the same period a year ago. The yield on earning assets was 4.18%, flat with a year ago.

The following table presents an analysis of average rates and yields on a fully taxable equivalent basis for the three and six months ended June 30, 2004 and 2003:


	For the Three Months Ended June 30, 2004							For the Three Months Ended June 30, 2003
Description	Average Balance			Interest Income/ Expense⁽¹⁾		Average Yield/ Rate⁽¹⁾		Average Balance			Interest Income/ Expense⁽¹⁾		Average Yield/ Rate⁽¹⁾
ASSETS
Interest-Earning Assets:
Loans:
Commercial	$	715,030		$	9,561	5.38	%	$	618,983		$	8,796	5.70	%
Municipal		88,460			676	3.06	%		72,894			792	4.35	%
Real Estate:
Residential		1,163,196			15,197	5.24	%		1,302,745			18,259	5.61	%
Commercial		1,497,110			19,965	5.36	%		1,320,561			18,606	5.65	%
Construction		124,017			1,565	5.08	%		106,758			1,476	5.54	%

Total Real Estate		2,784,323			36,727	5.30	%		2,730,064			38,341	5.63	%
Consumer		247,169			3,778	6.15	%		273,858			4,897	7.17	%

Total loans		3,834,982			50,742	5.32	%		3,695,799			52,826	5.73	%
Investments:
Taxable		1,448,125			14,757	4.08	%		1,710,561			18,511	4.33	%
Tax-Favored Securities		1,294			20	6.34	%		10,274			58	2.32	%
Interest-Bearing Deposits		150			0	1.04	%		203			1	1.98	%
Federal Funds Sold		9,506			50	2.12	%		39,735			122	1.23	%

Total Interest-Earning Assets		5,294,057			65,569	4.97	%		5,456,572			71,518	5.25	%

Noninterest-Earning Assets		563,468							543,499
Allowance for Loan Losses		(57,942	)						(57,030	)

Total Assets	$	5,799,583						$	5,943,041

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-Bearing Liabilities:
Savings	$	527,304			399	0.30	%	$	505,310			623	0.49	%
NOW		894,578			593	0.27	%		880,119			1,113	0.51	%
CMA/money market		1,506,059			2,637	0.70	%		1,497,022			3,546	0.95	%
Certificates of deposit under $100,000		777,550			3,604	1.86	%		864,357			4,694	2.18	%
Certificates of deposit $100,000 and over		301,141			1,306	1.74	%		262,179			1,288	1.97	%

Total Interest-Bearing Deposits		4,006,632			8,539	0.86	%		4,008,987			11,264	1.13	%

Borrowings		222,299			1,682	3.04	%		391,389			3,340	3.42	%
Customer repurchase agreements		68,431			138	0.81	%		120,841			515	1.71	%

Total Interest-Bearing Liabilities		4,297,362			10,359	0.97	%		4,521,217			15,119	1.34	%

NonInterest-Bearing Liabilities:
Demand Deposits		862,052							788,966
Other Liabilities		51,102							72,649

Total Liabilities		5,210,516							5,382,832
Stockholders’ Equity		589,067							560,209

Total Liabilities and Stockholders’ Equity	$	5,799,583						$	5,943,041

Net Interest Income				$	55,210						$	56,399

Interest Rate Spread ⁽²⁾						4.00	%						3.91	%
Net Yield on Earning Assets ⁽³⁾						4.18	%						4.14	%

	For the Six Months Ended June 30, 2004							For the Six Months Ended June 30, 2003
Description	Average Balance			Interest Income/ Expense ⁽¹⁾		Average Yield/ Rate ⁽¹⁾		Average Balance			Interest Income/ Expense ⁽¹⁾		Average Yield/ Rate ⁽¹⁾
ASSETS
Interest-Earning Assets:
Loans:
Commercial	$	685,621		$	18,134	5.32	%	$	603,684		$	16,898	5.64	%
Municipal		89,814			1,363	3.04	%		76,021			1,388	3.65	%
Real Estate:
Residential		1,163,492			30,250	5.21	%		1,194,178			33,842	5.68	%
Commercial		1,473,235			39,380	5.38	%		1,245,908			35,698	5.78	%
Construction		132,567			3,336	5.06	%		98,996			2,933	5.97	%

Total Real Estate		2,769,294			72,966	5.29	%		2,539,082			72,473	5.74	%
Consumer		250,892			7,813	6.26	%		274,254			9,866	7.25	%

Total loans		3,795,621			100,276	5.31	%		3,493,041			100,625	5.80	%
Investments:
Taxable		1,488,681			30,337	4.08	%		1,645,015			36,727	4.47	%
Tax-Favored Securities		1,296			41	6.34	%		9,817			124	2.54	%
Interest-Bearing Deposits		150			1	1.26	%		214			2	2.02	%
Federal Funds Sold		6,123			57	1.86	%		21,622			133	1.25	%

Total Interest-Earning Assets		5,291,871			130,712	4.96	%		5,169,709			137,611	5.35	%

Noninterest-Earning Assets		561,661							470,245
Allowance for Loan Losses		(57,918	)						(54,174	)

Total Assets	$	5,795,614						$	5,585,780

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-Bearing Liabilities:
Savings	$	522,361			812	0.31	%	$	470,278			1,258	0.54	%
NOW		880,114			1,143	0.26	%		756,199			1,805	0.48	%
CMA/money market		1,510,412			5,051	0.67	%		1,501,868			7,783	1.04	%
Certificates of deposit under $100,000		779,769			7,281	1.88	%		809,683			9,627	2.40	%
Certificates of deposit $100,000 and over		290,933			2,441	1.69	%		252,594			2,587	2.07	%

Total Interest-Bearing Deposits		3,983,589			16,728	0.84	%		3,790,622			23,060	1.23	%
Borrowings		242,583			3,459	2.87	%		353,195			5,983	3.40	%
Customer repurchase agreements		72,752			315	0.87	%		107,461			982	1.83	%

Total Interest-Bearing Liabilities		4,298,924			20,502	0.96	%		4,251,278			30,025	1.42	%

NonInterest-Bearing Liabilities:
Demand Deposits		854,911							748,019
Other Liabilities		53,916							74,533

Total Liabilities		5,207,751							5,073,830
Stockholders’ Equity		587,863							511,950

Total Liabilities and Stockholders’ Equity	$	5,795,614						$	5,585,780

Net Interest Income				$	110,210						$	107,586

Interest Rate Spread ⁽²⁾						4.00	%						3.93	%
Net Yield on Earning Assets ⁽³⁾						4.18	%						4.18	%

⁽¹⁾	On a fully taxable equivalent basis. Calculated using a Federal income tax rate of 35%. Loan income includes fees.

⁽²⁾	Interest rate spread is the average rate earned on total interest-earning assets less the average rate paid on interest-bearing liabilities.

⁽³⁾	Net yield on earning assets is net interest income divided by total interest-earning assets.

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.


	YTD 2004 Compared with YTD 2003
	Increase (Decrease) in Net Interest Income Due to:						Total Increase (Decrease)
	Average Rate			Average Balance			Total Increase (Decrease)
	(in thousands)
Interest income:
Loans:
Commercial	$	(975	)	$	2,211		$	1,236
Municipal		(230	)		205			(25	)
Real estate
Residential		(2,801	)		(791	)		(3,592	)
Commercial		(2,487	)		6,169			3,682
Construction		(449	)		852			403

Total real estate		(5,737	)		6,230			493
Consumer		(1,356	)		(697	)		(2,053	)

Total loans		(8,298	)		7,949			(349	)
Investments:
Taxable		(3,128	)		(3,262	)		(6,390	)
Tax-favored		185			(268	)		(83	)
Interest-bearing deposits in banks		(1	)		0			(1	)
Federal funds sold		66			(142	)		(76	)

Total interest income		(11,176	)		4,277			(6,899	)

Interest expense:
Savings		522			(76	)		446
NOWs		816			(154	)		662
CMAs/ money market		2,732			0			2,732
Certificates of deposit under $100,000		2,029			317			2,346
Certificates of deposit $100,000 and over		454			(308	)		146
Repurchase agreements		515			152			667
Borrowings		932			1,592			2,524

Total interest expense		8,000			1,523			9,523

Change in net interest income	$	(3,176	)	$	5,800		$	2,624

Noninterest Income and Noninterest Expense

Noninterest income for the quarter ended June 30, 2004 declined $9.1 million from the same period a year ago. The primary driver was lower gains on sales of securities of $8.8 million. The securities gains generated in the second quarter of 2003 resulted primarily from the rebalancing of the Company’s investment portfolio; these gains were largely offset by conversion charges related to the Company’s decision to change its data processing system of $6.8 million and higher amortization of mortgage servicing rights of $2.1 million. Increases from the same quarter in the prior year in investment management and trust, credit card income, and insurance commissions offset declines in mortgage banking and retail investment services.

Noninterest income for the six months ended June 30, 2004 declined $10.4 million from the same period a year ago. The primary drivers were lower gains on sales of securities of $8.4 million and lower gains on sales of loans of $5.6 million. The gains generated in 2003 were largely offset by higher conversion and restructuring charges of $6.8 million related to the Company’s decision to change its data processing system and higher amortization of mortgage servicing rights of $2.1 million. Increases from the same six-month period a year ago in investment management and trust, and insurance commissions also offset the declines in gains on sales of loans and securities.

Noninterest expenses excluding conversion and restructuring charges were $44.6 million for the second quarter of 2004, a decline of $2.8 million from the same period a year ago. Decreases were recorded in salaries, and other noninterest expense. Salaries declined $1.9 million, which was due to lower levels of incentive accruals and sales-based commissions. Sales-based commissions were down as a result of lower volumes of mortgage loan sales and retail investments.

For the first six months of 2004 noninterest expenses excluding conversion and restructuring charges were $89.1 million, a decline of $541,000 from the same period a year ago. Decreases were recorded in salaries, and other expenses. Salaries declined $1.3 million, which was due to lower levels of incentive accruals and sales-based commissions. The lower variance year-to-date as compared to quarter-to-date was due to the inclusion of Granite Bank for the entire six months of 2004 versus only four months in 2003. Increases were seen in several categories including employee benefits, occupancy, and amortization of intangibles, primarily as a result of the inclusion of Granite for two additional months.

The Company incurred conversion and restructuring charges of $1.3 million in the second quarter of 2004, down from $6.8 million in the same period of 2003. Included in the 2004 charges were personnel costs totaling $600,000, due primarily to stay bonuses and vacation payouts for employees who had previously been notified that they would not be retained after the IT conversion. Other costs consisted of $335,000 related to printing and postage, outsourcing costs of $192,000, and approximately $132,000 of employees’ meals and travel costs. In 2003 conversion charges reflected the Company’s decision to convert its Information Technology (IT) platform to Jack Henry & Associates, Inc., and included $3.1 million related to the termination of existing IT contracts and $3.7 million related to the impairment of computer equipment not portable to the new operating platform.

Income Taxes

The Company and its subsidiaries are taxed on their income at the Federal level and by various states in which they do business. The State of Vermont levies franchise taxes on banks based upon average deposit levels in lieu of taxing income. Franchise taxes are included in income tax expense in the consolidated statements of income.

Year-to-date income tax expense for 2004 was $20.6 million, up from $20.3 million for the same period a year ago. The Company’s effective income tax rate for both periods was 36.6%.

Financial Position

Total loans at June 30, 2004 increased $45.7 million from March 31, 2004 and $101.2 million from year-end. The increase, consistent throughout the franchise, from the first quarter of 2004 was predominately in the commercial and commercial real estate loan portfolios; combined, these two portfolios increased $74.9 million from March 31, 2004 and $156.7 million from year-end. Municipal loans experienced their historical seasonal trend, declining $25.8 million from March 31, 2004, as June 30th coincides with the end of the fiscal year for most municipalities.

Total deposits increased $80.0 million from the first quarter and declined $55.6 million from year-end. Chittenden’s municipal deposit balances typically peak at year-end and decline steadily to their lows at mid-year. Declines in this sector were approximately $60 million and $45 million in the first and second quarters of 2004, respectively. Meanwhile, the non-municipal book grew approximately $125 million from March 31, 2004, after declining approximately $75 million in the first quarter. At June 30, 2004 borrowings declined $32.3 million from the first quarter. This decline was associated with lower levels of overnight Fed Funds purchased as a result of higher deposit levels.

Credit Quality

Net charge-off activity totaled $631,000 for the second quarter of 2004 compared to $1.2 million for the same period in 2003. The allowance for loan losses was $58.0 million at June 30, 2004, an increase of $505,000 from December 31, 2003. Nonperforming assets include nonaccrual loans and foreclosed real estate (Other Real Estate Owned). As of June 30, 2004, nonperforming assets (NPAs) were $20.6 million, an increase of $6.2 million from the exceptionally low level at December 31, 2003 and flat from March 31, 2004. As a percentage of total loans NPAs were 54 basis points compared with 55 basis points for the first quarter of 2004. The level of nonperforming assets in 2004 is consistent with the Company’s historical experience, which has averaged approximately 50 basis points over the last six years.

A summary of credit quality follows:


	6/30/04			3/31/04			12/31/03			6/30/03
	(in thousands)
Loans on nonaccrual	$	20,578		$	20,621		$	14,331		$	17,725
Troubled debt restructurings		—			—			—			215
Other real estate owned (OREO)		47			36			100			30

Total nonperforming assets (NPAs)	$	20,625		$	20,657		$	14,431		$	17,970

Loans past due 90 days or more and still accruing interest	$	3,777		$	3,201		$	4,029		$	1,921
Allowance for loan losses		57,969			57,500			57,464			57,591
NPAs as % of loans plus OREO		0.54	%		0.55	%		0.39	%		0.49	%
Allowance as % of loans		1.50	%		1.52	%		1.54	%		1.56	%
Allowance as % of nonperforming loans		281.70	%		278.85	%		400.99	%		321.01	%

Provisions for and activity in the allowance for loan losses are summarized as follows:


	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
	(in thousands)
Beginning balance	$	57,500		$	56,708		$	57,464		$	48,197
Provision for loan losses		1,100			2,050			1,527			4,100
Allowance acquired through acquisitions		—			—			—			7,937
Loans charged off		(1,433	)		(2,373	)		(2,684	)		(4,624	)
Loan recoveries		802			1,206			1,662			1,981

Ending balance	$	57,969		$	57,591		$	57,969		$	57,591

The allowance for loan losses is based on management’s estimate of the amount required to reflect the potential inherent losses in the loan portfolio, based on circumstances and conditions known or anticipated at each reporting date. There are inherent uncertainties with respect to the collectibility 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 this report.

Adequacy of the allowance is determined using a consistent, systematic methodology which analyzes the size and risk of the loan portfolio. In addition to evaluating the collectibility of specific loans when determining the adequacy of the allowance for 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 the delinquencies and loans adversely classified, and economic trends. The adequacy of the allowance for loan losses is assessed by an allocation process whereby specific loss allocations are made against certain adversely classified loans, and general loss allocations are made against segments of the loan portfolio which have similar attributes. 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 loan losses. For a full discussion on the Company’s allowance for loan loss policies see “Allowance for Loan Losses” in the Company’s 2003 annual report on Form 10-K/A.

Mortgage Servicing Rights

The following table summarizes activity for mortgage servicing rights purchased and originated for the six months ended June 30, 2004:


	Purchased			Originated			Total
	(in thousands)
Balance at December 31, 2003	$	624		$	11,641		$	12,265
Additions		0			2,560			2,560
Amortization		(340	)		(4,002	)		(4,342	)
Recovery of impairment		319			1,760			2,079

Balance at June 30, 2004	$	603		$	11,959		$	12,562

At June 30, 2004, a $521,000 impairment valuation allowance was necessary to recognize the excess of the mortgage-servicing rights’ book value over their current fair value.

Capital

Stockholders’ equity totaled $587.9 million at June 30, 2004, compared to $579.9 million at December 31, 2003. “Tier One” capital, consisting of common equity and certain types of preferred stock, including the Trust Preferred issuance, measured 10.46% of risk-weighted assets at June 30, 2004. Total capital, including the “Tier Two” allowance for loan losses, was 11.73% of risk-weighted assets and the leverage capital ratio was 8.22%. These ratios placed Chittenden in the “well-capitalized” category according to regulatory standards.

The trust subsidiary, which issued the Company’s trust preferred securities, is no longer consolidated into the Company’s financial statements upon the adoption of FIN 46R in the first quarter of 2004. However, the Company continues to reflect the amounts payable to the trust’s preferred shareholders as debt in its financial statements. On May 6, 2004 the Federal Reserve Board proposed a rule that would retain trust preferred securities in Tier One capital of bank holding companies, but with stricter quantitative limits and clearer standards. Under the proposal, after a three-year transition period, which would end on March 31, 2007, the aggregate amount of trust preferred securities would be limited to 25 percent of tier 1 capital elements, net of goodwill.

The Company has evaluated the potential impact of such a change on its Tier 1 capital ratio and has concluded that it would remain well capitalized in the event the FRB were to change the regulatory capital treatment of these securities. The regulatory capital treatment of the TPS in the Company’s total capital ratio would be unchanged.

Liquidity

The Company’s liquidity and rate sensitivity are monitored by the asset and liability committee, based upon policies approved by the Board of Directors. 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. The Company’s commercial banking operations generate significant amounts of low cost funds through their deposit gathering operations. For the quarter ended June 30, 2004, the Company’s ratio of average loans to average deposits was approximately 78.8%. At June 30, 2004, the Company maintained cash balances and short-term investments of approximately $170.9 million, compared with $174.9 million at December 31, 2004. Borrowings at June 30, 2004 were $279.1 million compared to $287.4 million on December 31, 2004. Borrowings declined from year-end due to lower levels of overnight Fed Funds purchased as a result of higher deposit levels.

The Company has available borrowing capacity under certain programs including Federal Home Loan Bank borrowings, Treasury Tax & Loan borrowings, repo lines with investment banks, and advised Fed Funds lines totaling more than $577 million. The Company also has an effective shelf registration statement under which an additional $225 million in debt securities, common stock, preferred stock, or warrants may be offered from time to time.

Aggregate Contractual Obligations


	Payments due by period
	(in thousands)
Contractual Obligations	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
FHLB borrowings	$	76,938	$	24,400	$	—	$	—	$	52,538
Trust preferred securities		125,000		—		—		—		125,000
Data processing contract		5,241		524		3,145		1,572		—
Equity investments commitments to limited partnerships		7,321		351		6,970		—		—
Operating leases		19,850		4,907		10,398		1,431		3,114

Total	$	234,350	$	34,587	$	16,108	$	3,003	$	180,652

FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

Financial instruments whose contractual amounts represent off-balance sheet risk at June 30, 2004 (in thousands):


Loans and Other Committments
Commitments to originate loans		229,576
Unused home equity lines of credit		304,392
Other unused lines of credit		39,259
Unadvanced portions of construction loans		168,203
Equity investment commitments to limited partnerships		7,321


Standby Letters of Credit
Notional amount fully collateralized by cash		73,247
Notional amount of other standby letters of credit		36,173
Liability associated with letters of credit recorded on balance sheet		203

Item 3.

Qualitative and Quantitative Disclosures About Market Risk

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. For a full discussion of interest-rate risk see “Liquidity and Rate Sensitivity” in the Company’s 2003 annual report on Form 10-K/A. There has not been a material change in the Company’s interest-rate exposure or its anticipated market risk during the current period.

Item 4.

Controls and Procedures

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of June 30, 2004, the end of the quarter covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Company’s management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company reviews its disclosure controls and procedures, which may include its internal controls over financial reporting on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business. As noted in item 2, Management’s Discussion & Analysis of Financial Condition and Results of Operations, the Company completed the conversion of its core banking applications, for all of its banking subsidiaries, to the Jack Henry Silverlake System. The nature of the conversion was to change the core processing tool used by the Company, which resulted in all banking affiliates being on a common platform. This conversion did not materially impact the procedures and controls the Company utilizes in the operation of its business.

PART II - OTHER INFORMATION

Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

(e)

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

As described in footnote 9 of the Company’s annual report on Form 10-K/A for the period ended December 31, 2003, the Company’s share repurchase program expired December 31, 2003.

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

Annual Meeting, April 21, 2004

Proposal 1:

Election of three directors, each to serve for a term of three years.


DIRECTOR	FOR	AUTHORITY WITHHELD
Charles W. Smith	30,382,916	1,963,866
Pall D. Spera	30,385,782	1,961,000
Owen D. Wells	30,546,419	1,800,363

Item 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)

EXHIBITS

31.1

Certification of Chairman, President and Chief Executive Officer, Paul A. Perrault pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

Certification of Executive Vice President and Chief Financial Officer, Kirk W. Walters pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

Certification of Chairman, President, and Chief Executive Officer, Paul A. Perrault, pursuant to 18 U. S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

Certification of Executive Vice President and Chief Financial Officer, Kirk W. Walters, pursuant to 18 U. S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b)

REPORTS ON FORM 8-K

The Company’s first quarter 2004 press release announcing earnings and quarterly dividends, as well as a copy of the quarterly comparative financial statements was filed on Form 8-K on April 22, 2004.

The Company’s investor presentation distributed at various analyst meetings was filed on Form 8-K on April 27, 2004.

A slide presentation as of March 31, 2004 was filed on Form 8-K on May 21, 2004.

CHITTENDEN CORPORATION

SIGNATURES

Pursuant to the requirement of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


				CHITTENDEN CORPORATION
				Registrant

August 5, 2004 Date				/S/ PAUL A. PERRAULT
				Paul A. Perrault,
				Chairman, President and
				Chief Executive Officer

August 5, 2004 Date				/S/ KIRK W. WALTERS
				Kirk W. Walters
				Executive Vice President,
				Treasurer, and Chief Financial Officer