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Alliance Financial 10-Q 2009 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
FORM 10-Q
For the Quarterly Period Ended March 31, 2009 OR
For the transition period from to Commission File Number: 000-15366
ALLIANCE FINANCIAL CORPORATION (Exact name of Registrant as specified in its charter)
120 Madison Street, Syracuse, New York 13202 (Address of Principal Executive Offices) (Zip Code) (315) 475-2100 (Registrant’s Telephone Number including area code)
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 has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer, large accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x The number of shares outstanding of the Registrant’s common stock, $1.00 par value, on April 30, 2009 was 4,585,660 shares.
Table of ContentsTABLE OF CONTENTS
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Table of ContentsAlliance Financial Corporation and Subsidiaries Consolidated Balance Sheets (Unaudited)
(In thousands, except share data)
The accompanying notes are an integral part of the consolidated financial statements.
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Table of ContentsAlliance Financial Corporation and Subsidiaries Consolidated Statements of Income (Unaudited)
The accompanying notes are an integral part of the consolidated financial statements.
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Table of ContentsAlliance Financial Corporation and Subsidiaries Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
The accompanying notes are an integral part of the consolidated financial statements.
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Table of ContentsAlliance Financial Corporation and Subsidiaries Condensed Consolidated Statements of Cash Flow (Unaudited)
The accompanying notes are an integral part of the consolidated financial statements.
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Table of ContentsAlliance Financial Corporation and Subsidiaries Notes to Consolidated Financial Statements
The accompanying unaudited financial statements were prepared in accordance with the instructions for Form 10-Q and Regulation S-X and, therefore, do not include information for footnotes necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with generally accepted accounting principles. The following material under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is written with the presumption that the users of the interim financial statements have read, or have access to, the latest audited financial statements and notes thereto of the Company, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2008 and for the three-year period then ended, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. Accordingly, only material changes in the results of operations and financial condition are discussed in the remainder of Part I. Certain amounts from prior year periods are reclassified, when necessary, to conform to the current period presentation. All adjustments that in the opinion of management are necessary for a fair presentation of the financial statements have been included in the results of operations for the three months ended March 31, 2009 and 2008. Critical Accounting Estimates and Policies The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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. Management has identified the allowance for credit losses, income taxes, and the carrying value of goodwill and intangible assets to be the accounting areas that require the most subjective and complex judgments, and as such could be the most subject to revision as new information becomes available. Actual results could differ from those estimates. Securities The Company classifies securities as held-to-maturity or available-for-sale at the time of purchase. Held-to-maturity securities are those that the Company has the positive intent and ability to hold to maturity, and are reported at cost, adjusted for amortization of premiums and accretion of discounts. Securities not classified as held-to-maturity are classified as available-for-sale and are reported at fair value, with net unrealized gains and losses reflected as a separate component of accumulated other comprehensive income, net of taxes. None of the Company’s securities have been classified as trading securities or held-to-maturity. Gains and losses on the sale of securities are based on the specific identification method. Premiums and discounts on securities are amortized and accreted into income using the interest method over the life of the security. Securities are reviewed regularly for other than temporary impairment. Where there is other than temporary impairment, the impairment loss is recognized in the consolidated statements of income. Purchases and sales of securities are recognized on a trade-date basis. Loans and Leases Loans and leases are stated at unpaid principal balances less the allowance for credit losses, unearned interest income and net deferred loan origination fees and costs. Interest on loans is based upon the principal amount outstanding. Interest on loans is accrued except when in management’s opinion the collectability of interest is doubtful, at which time the accrual of interest on the loan is discontinued. Loan and lease origination fees and certain direct origination costs are deferred and the net amount is amortized as a yield adjustment over the life of the loan or lease. Operating leases are stated at cost of the equipment less depreciation. Equipment on operating leases is depreciated on a straight-line basis to its estimated residual value over the lease term. Operating lease income is recognized on a straight-line basis over the term of the lease. Lease financings, included in portfolio loans on the consolidated balance sheet consist of direct financing leases of commercial equipment, primarily computers and office equipment, manufacturing equipment, commercial truck and trailers, and medical equipment. Income attributable to finance leases is initially
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Table of ContentsAlliance Financial Corporation and Subsidiaries Notes to Consolidated Financial Statements
recorded as unearned income and subsequently recognized as finance income at level rates of return over the term of the leases. The recorded residual values of the Company’s leased assets are estimated at the inception of the lease to be the expected fair market value of the assets at the end of the lease term. The Company reviews commercial lease residual values at least annually and recognizes residual value impairments deemed to be other than temporary. In accordance with U.S. generally accepted accounting principles, anticipated increases in specific future residual values are not recognized before realization. Anticipated decreases in specific future residual values that are considered to be other than temporary are recognized immediately. Allowance for Credit Losses The allowance for credit losses represents management’s best estimate of probable incurred credit losses in the Company’s loan and lease portfolio. Management’s quarterly evaluation of the allowance for credit losses is a comprehensive analysis that builds a total allowance by evaluating the probable incurred losses within each loan and lease type, or pool, of similar loans and leases. The Company uses a general allocation methodology for all residential and consumer loan pools. This methodology estimates an allowance for each pool based on the average loss rate for the time period that includes the current year and two full prior years. The average loss rate is adjusted to reflect the expected impact that current trends regarding loan growth, delinquency, losses, economic conditions, loan concentrations, policy changes, experience and ability of lending personnel, and current interest rates have. For commercial loan and lease pools, the Company establishes a specific allocation for all loans and leases classified as being impaired in excess of $250,000, which have been risk rated under the Company’s risk rating system as substandard, doubtful, or loss. For all other commercial loans and leases, the Company uses the general allocation methodology that establishes an allowance to estimate the probable incurred loss for each risk-rating category. The general allocation methodology for commercial loans and leases considers the same factors that are considered when evaluating residential mortgage and consumer loan pools. The combination of using both the general and specific allocation methodologies reflects management’s best estimate of the probable incurred credit losses in the Company’s loan and lease portfolio. A loan or lease is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally discounted at the historical effective interest rate, except that all collateral-dependent loans and leases are measured for impairment based on fair value of the collateral. Large groups of smaller balance homogenous loans, such as consumer and residential real estate loans less than $250,000, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Loans are charged off when they are considered a loss regardless of the delinquency status. From a delinquency standpoint, the policy of the Company is to charge off loans when they are 120 days past due unless extenuating circumstances are documented that attest to the ability to collect the loan. Special circumstances to include fraudulent loans and loans in bankruptcy will be charged off no later than 90 days of discovery or 120 days delinquent, whichever is shorter. In lieu of charging off the entire loan balance, loans with collateral may be written down to the value of the collateral, less cost to sell, if foreclosure or repossession of collateral is assured and is in process. Directors Stock-Based Deferral Plan In accordance with EITF Number 97-14, as affected by FAS 123R the stock held in the trust is classified in equity similar to the manner in which treasury stock is classified.
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Table of ContentsAlliance Financial Corporation and Subsidiaries Notes to Consolidated Financial Statements
The amortized cost and estimated fair value of securities for the dates indicated (in thousands):
As of March 31, 2009 and December 31, 2008, mortgage-backed securities were comprised primarily of pass-through securities backed by conventional residential mortgages and guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae, which in turn, are supported by the full faith and credit of the United States government. For the periods ending March 31, 2009 and December 31, 2008, securities with a carrying value of $307.5 million and $293.1 million, respectively, were pledged as collateral for certain deposits and other purposes as required or permitted by law. The Company recognized gross gains on sales of securities of $1.0 million and $137,000 for the quarter ended March 31, 2009 and 2008, respectively. The tax provision related to these net realized gains was $393,000 and $53,000, respectively.
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Table of ContentsAlliance Financial Corporation and Subsidiaries Notes to Consolidated Financial Statements
The following table shows the securities with unrealized losses for the periods indicated, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at the dates indicated (in thousands):
Management does not believe any individual unrealized loss as of March 31, 2009 represents an other-than-temporary impairment. A total of 53 available-for-sale securities were in a continuous unrealized loss position for less than 12 months and 13 securities for 12 months or longer. The unrealized losses relate primarily to securities issued by FNMA, GNMA, FHLMC, the State of New York and various political subdivisions within the State of New York. The Company has both the intent and ability to hold the securities contained in the previous table for a time necessary to recover the amortized cost.
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Table of ContentsAlliance Financial Corporation and Subsidiaries Notes to Consolidated Financial Statements
Major classifications of loans and leases at the dates indicated (in thousands):
Nonperforming loans and leases at the dates indicated are as follows (in thousands):
As of March 31, 2009 and December 31, 2008, impaired loans and leases totaled approximately $2.4 million and $1.4 million, respectively. The related allowance for credit losses allocated to impaired loans at March 31, 2009 and December 31, 2008 was $678,000 and $193,000, respectively. The following table summarizes changes in the allowance for credit losses arising from loans and leases charged off, recoveries on loans and leases previously charged off and additions to the allowance, which have been charged to expense:
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Table of ContentsAlliance Financial Corporation and Subsidiaries Notes to Consolidated Financial Statements
Deposits consisted of the following at the periods indicated (in thousands):
The Company has stock compensation awards with non-forfeitable dividend rights which are considered participating securities. As such, earnings per share is computed using the two-class method as required by FASB Staff Position EITF 03-6-1. Basic earnings per common share is computed by dividing net income allocated to common stock by the weighted average number of common shares outstanding during the period which excludes the participating securities. Diluted earnings per common share includes the dilutive effect of additional potential common shares from stock compensation awards and warrants, but excludes awards considered participating securities. Basic and diluted net income per common share calculations are as follows:
Dividends of $25,000 and $21,000 for the quarter ending March 31, 2009 and 2008, respectively, were paid on unvested shares with non-forfeitable dividend rights. For the three months ended March 31, 2009 and 2008, 305,177 and 1,000, respectively, of anti-dilutive stock options and warrants were excluded from the diluted weighted average common share calculations.
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Table of ContentsAlliance Financial Corporation and Subsidiaries Notes to Consolidated Financial Statements
Defined Benefit Plan and Post-Retirement Benefits The Company has a noncontributory defined benefit pension plan (“Pension Plan”) which it assumed from Bridge Street Financial Inc. (“Bridge Street”). The plan covers substantially all former Bridge Street full-time employees who met eligibility requirements on October 6, 2006, at which time all benefits were frozen. Under the plan, retirement benefits are primarily a function of both the years of service and the level of compensation. The amount contributed to the plan is determined annually on the basis of (a) the maximum amount that can be deducted for federal income tax purposes, or (b) the amount certified by an actuary as necessary to avoid an accumulated funding deficiency as defined by the Employee Retirement Income Security Act of 1974. Due to recent changes in pension funding law and sharp declines in market asset values, a reasonable estimate of expected contributions cannot be determined at this time. Post-retirement medical and life insurance benefits (“Post-retirement Plan”) are available to retirees and certain active employees with more than 20 years of service to the Company in accordance with plans that existed at First National Bank of Cortland and Oneida Valley National Bank, prior to the merger of the banks in 1999. At September 30, 2007, the Company settled (the “Settlement”) the post-retirement benefits for certain active participants that met age and service criteria at that time. In addition, a negative plan amendment (“Negative Amendment”) was adopted for all other active participants who did not meet the age and service criteria. The Settlement and the Negative Amendment eliminated post-retirement benefits for all active employees. The only remaining participants in the Post-Retirement Plan after September 30, 2007 are retired participants and their spouses, if applicable. Supplemental Retirement Plans The Company has supplemental executive retirement plans (“SRP’s”) for certain current and former employees. Directors Retirement Plan In 2008, the Company established a noncontributory defined benefit plan for non-employee directors (“Directors Plan”). The Directors Plan provides for a cash benefit equivalent to 35% of their average annual director’s fees, subject to increases based on the directors’ length and extent of service, payable in a number of circumstances, including normal retirement, death or disability and a change in control. The components of all of the plans’ net periodic costs (benefit) for the three months ended March 31, 2009 and 2008 are as follows (in thousands):
Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
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Table of ContentsAlliance Financial Corporation and Subsidiaries Notes to Consolidated Financial Statements
Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2 – Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. The Company used the following methods and significant assumptions to estimate fair value: Securities – The fair values of debt securities available-for-sale are determined by obtaining matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. The fair value of mutual fund securities available-for-sale are determined by obtaining quoted prices on nationally recognized securities exchanges. Securities available-for-sale are measured at fair value on a recurring basis. At March 31, 2009, $998,000 and $328.4 million were measured using Level 1 and Level 2 inputs, respectively within the fair value hierarchy. Loans held-for-sale – The fair value of loans held-for-sale is determined, when possible, using quoted secondary-market prices. If no such quoted price exists, the fair value of a loan is determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that loan. Mortgage servicing rights – The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. The Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness. Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Real estate collateral is typically valued using independent appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace and the related non-recurring fair value measurement adjustments have generally been classified as Level 2. Estimates of fair value used for other collateral supporting commercial loans generally are not observable in the marketplace and therefore, such valuations have been classified as Level 3. Loans subject to non-recurring fair value measurement using Level 3 inputs had a gross carrying amount of $1.4 million with an associated valuation allowance of $678,000 for a fair value of $1.7 million at March 31, 2009. 8. Subsequent Event On May 8, 2009, the Company received regulatory approval to redeem all of the 26,918 shares of its Fixed Rate Cumulative Perpetual Preferred Stock (“Preferred Stock”) it sold to the U.S. Department of the Treasury (Treasury Department) on December 19, 2008 in connection with the Treasury Department’s Capital Purchase Program (“CPP”) under the Troubled Assets Relief Program (“TARP”). The Company expects the redemption transaction to close on May 13, 2009. On the redemption date, the redemption price will become due and payable on each share of the preferred stock and dividends will cease to accrue. At that time, all rights of the Treasury Department, as the holder thereof, will terminate, except the right to receive the redemption price upon surrender of the Preferred Stock certificate. The redemption price represents the $1,000 per share liquidation amount of the preferred stock, plus a pro rata accrued dividend of approximately $329,000. The redemption of the Preferred Stock will be paid primarily through a reduction of federal funds sold. The Company anticipates a reduction to undivided profits of approximately $551,000 in the second quarter of 2009 for accelerated discount accretion related to the difference between the amount at which the Preferred Stock sale was initially recorded and its redemption price (preferred stock accretion). The preferred stock dividend and the acceleration of the accretion on preferred stock will reduce the net income available to common shareholders, which is used in calculating earnings per share. The Treasury Department also received warrants to purchase 173,069 shares of the Company’s common stock with an exercise price of $23.33 per share. Subsequent to the repayment, the Company has the right to repurchase the stock warrants that were previously issued to the Treasury Department. The price for the repurchase of the warrant will be subject to negotiation and there can be no assurance that the warrants will be repurchased.
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Table of Contents
General Throughout this analysis, the term “the Company” or “Alliance” refer to the consolidated entity of Alliance Financial Corporation, its wholly-owned subsidiaries Ladd’s Agency, Inc. and Alliance Bank, N.A. (the “Bank”), and the Bank’s subsidiaries, Alliance Preferred Funding Corp. and Alliance Leasing, Inc. The Company is a New York corporation which was formed in November 1998 as a result of the merger of Cortland First Financial Corporation and Oneida Valley Bancshares, Inc. The following discussion presents material changes in the Company’s results of operations and financial condition during the three months ended March 31, 2009, which are not otherwise apparent from the consolidated financial statements included in this report. This discussion and analysis contains certain forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) with respect to the financial condition, results of operations and business of the Company. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities:
Operating results for the three months ended March 31, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. Comparison of Operating Results for the Three Months Ended March 31, 2009 and 2008 General Net income available to common shareholders for the quarter ended March 31, 2009 increased 25.2% to $2.6 million, or $0.57 per diluted share in the first quarter, compared to $2.1 million, or $0.44 per diluted share in the year-ago quarter. On a linked-quarter basis, net income available to common shareholders increased 11.2% compared with $2.3 million in the fourth quarter of 2008. The Company’s net income in the first quarter of 2009 and fourth quarter of 2008 was reduced by accrued dividends and discount accretion on preferred stock totaling $358,000 and $47,000, respectively. There was no preferred stock outstanding in the first quarter of 2008. The return on average assets and return on average common shareholders’ equity were 0.76% and 8.69%, respectively, for the three months ended March 31, 2009 compared with 0.63% and 7.15%, respectively, for the first quarter of 2008. The first quarter’s results were lifted by continued growth in net interest income which offset higher credit costs and a decline in investment management income. In addition, the Company recognized $1.0 million in pre-tax gains on the sale of securities, or $622,000 ($0.14 per diluted share) after taxes. The increase in net interest income was due primarily to a higher net interest margin, which resulted from lower funding costs and earning assets growth. Credit costs increased in the first quarter compared to the year-ago period due largely to higher loan and lease delinquencies resulting from weak economic conditions. Non-interest income decreased in the first quarter due
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Table of Contentsprimarily to lower fee income earned in the Company’s investment management business due largely to the sharp drop in the equity markets over the past year.
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Table of ContentsNet Interest Income Net interest income totaled $10.0 million in the first quarter, representing an increase of $1.3 million or 14.6% compared with the first quarter of 2008. The increase in net interest income was driven by a higher net interest margin combined with earning asset growth. Average earning assets increased $58.6 million in the first quarter compared with the year-ago quarter, due in large part to a $46.2 million or 16.6% increase in the average balance of residential mortgages. On a linked-quarter basis, net interest income increased $201,000 or 2.0% as a result of a $28.8 million increase in average earning assets which offset a modest one basis point decline in the net interest margin. The Company’s tax-equivalent net interest margin increased 27 basis points in the first quarter compared with the year-ago quarter, and was down 1 basis point compared to the fourth quarter of 2008. The net interest margin on a tax-equivalent basis was 3.42% in the first quarter of 2009, compared with 3.15% in the first quarter of 2008 and 3.43% in the fourth quarter of 2008. The increase in the Company’s net interest margin compared with the year-ago quarter was the result of a decrease in the Company’s tax-equivalent earning asset yield of 82 basis points, which was more than offset by a decrease in its cost of funds of 115 basis points over the same period. The overall net interest margin growth since the first quarter of 2008 is primarily the result of the Company’s ongoing active balance sheet management and deposit pricing strategies and the positive effects of those strategies in the interest rate environment of the past year. The rate of growth in the Company’s net interest margin slowed in the second half of 2008 and essentially leveled off in the first quarter of 2009 as interest rates on a substantial portion of the Company’s interest-bearing liabilities have adjusted to the lower rates in effect during the period. The Company experienced a decrease of 82 basis points in its tax-equivalent earning assets yield in the first quarter of 2009 compared with the year-ago period, which was more than offset by a 115 basis point decrease in its cost of funds over the same period. The yield on the Company’s interest-earning assets was 5.30% in the first quarter of 2009, compared with 6.12% in the first quarter of 2008. The Company’s cost of funds for the same periods was 2.20% and 3.35%, respectively. Since September 2007, the Federal Reserve has reduced its target fed funds rate from 5.25% to between zero and 0.25%. Over this same time period, a sharp drop in equity markets, economic recession and federal government monetary and economic stimulus efforts have contributed to a sharp decline in the yields on U.S. Treasury securities. As a result of these factors, the yields on two-year, five-year and ten-year treasury securities dropped 335 basis points, 259 basis points and 186 basis points, respectively from August 31, 2007 to March 31, 2009. Yields on commercial loans and consumer loans were most affected by these conditions, with yields on these assets down 148 basis points and 209 basis points, respectively, in the first quarter of 2009 compared with the year-ago quarter. Other earning-asset classes have experienced declines in yields, though not to the same magnitude. The commercial and consumer loan portfolios are more sensitive than the Company’s other interest-bearing assets to changes in market interest rates due to the variable rate characteristics of a portion of these portfolios and to the high levels of annual amortization in the portfolios as a result of their relatively shorter duration. Average interest-earning assets increased $58.6 million or 4.9% in the first quarter compared with the year-ago period, due primarily to growth in the residential mortgage portfolio which offset declines in the commercial loan and lease portfolios. Loans and leases comprised 72.9% of average interest-earning assets in the first quarter, compared with 75.2% in the first quarter of 2008. The Company’s cost of funds declined on a quarter over quarter basis throughout 2008 and into the first quarter of 2009 in all interest-bearing liability categories except savings accounts. The average cost of money market and time deposits dropped 118 basis points and 146 basis points, respectively in the first quarter of 2009 compared with the year-ago quarter as a result of the lower rate environment and the Company’s deposit pricing strategies. Our wholesale funding costs also dropped significantly over the same period, with the average cost of our borrowings down 70 basis points. At the same time the Company was lowering its borrowing costs due to the lower market rates over the past eighteen months, we took the opportunity to lower our overall liability-sensitive position by extending the maturity on new or renewed borrowings. The weighted average maturity of the Company’s borrowings was 2.6 years at March 31, 2009 compared with 1.1 years at December 31, 2007. The average cost on the Company’s junior subordinated obligations decreased 248 basis points in the first quarter of 2009 compared with the first quarter of 2008 due to the decline in the three-month Libor index to which these variable rate obligations are tied.
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Table of ContentsThe Company’s liability mix changed favorably during 2008 and into the first quarter of 2009 as the Company continued to focus on growing lower cost savings, demand and money market accounts (transaction accounts) and relied less on higher promotional rates to attract or retain retail time accounts. The aggregate average balance of transaction accounts was $619.0 million in the first quarter of 2009, which was an increase of $92.4 million or 17.6% from the aggregate average balances of $526.5 million in the first quarter of 2008. Average transaction account balances comprised 63.4% of total average deposits in the first quarter of 2009, compared with 56.0% in the year-ago period. Average time account balances in the first quarter of 2009 were $356.6 million or 36.6% of total average deposits, compared with $413.8 million or 44.0% in the year-ago period. The decrease in average time account balances occurred largely in the first half of 2008 as the Company’s de-emphasis on higher promotional rates allowed the Company to reduce its reliance on highly rate sensitive, short-term retail time accounts.
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Table of ContentsAverage Balance Sheet and Net Interest Analysis The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the average yields and rates thereon for the periods indicated. Interest income and yield information is adjusted for items exempt from federal income taxes (“nontaxable”) and assumes a 34% tax rate. Non-accrual loans have been included in the average balances. Securities are shown at average amortized cost.
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Table of ContentsThe following table sets forth the dollar volume of increase (decrease) in interest income and interest expense resulting from changes in the volume of earning assets and interest-bearing liabilities, and from changes in rates for the periods indicated. Volume changes are computed by multiplying the volume difference by the prior period’s rate. Rate changes are computed by multiplying the rate difference by the prior period’s balance. The change in interest income and expense due to both rate and volume has been allocated proportionally between the volume and rate variances.
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Table of ContentsAsset Quality and the Allowance for Credit Losses The following table represents a summary of delinquent loans and leases grouped by the number of days delinquent at the dates indicated:
Continuing weakness in the local, state and national economies contributed to a modest increase in nonperforming loans and leases in the first quarter, though overall delinquencies were lower at the end of the first quarter compared with the fourth quarter of 2008. Loans and leases past due 30 days or more totaled $18.0 million or 1.95% of total loans and leases at March 31, 2009, compared with $20.3 million or 2.23% of total loans and leases at December 31, 2008 and $10.9 million or 1.24% at March 31, 2008. The overall quarter-over-quarter decrease in past due loans and leases occurred as a result of payments of past due amounts, charge-offs and repossession. All of the Company’s loan portfolios showed improvements in delinquencies except for the commercial loan portfolio, which experienced an increase of $964,000 in past due loans. Approximately 50% of all delinquent loans and leases at the end of the first quarter of 2009 were past due for only one payment. The following table represents information concerning the aggregate amount of non-performing assets:
Non-performing assets, defined as non-accruing loans and leases plus loans and leases 90 days or more past due, along with other real estate owned and other repossessed assets were $6.7 million or 0.48% of total assets at March 31, 2009, compared with $5.1 million or 0.38% of total assets at December 31, 2008, and $4.8 million or 0.36% of total assets at March 31, 2008. Conventional residential mortgages comprised $1.9 million (23 loans) or 33% of nonaccrual loans and leases at March 31, 2009. Commercial loans on nonaccrual status totaled $1.9 million (21 loans) or 34% of nonaccrual loans and leases at the end of the first quarter. Leases on nonaccrual status totaled $1.7 million (26 leases) or 30% of nonaccrual loans and leases at the end of the first quarter. As a recurring part of its portfolio management program, the Company has identified approximately $12.0 million in potential problem loans at March 31, 2009 as compared to $13.3 million at December 31, 2008. The average balance of potential problem loans was $266,000 at March 31, 2009 compared with $333,000 at December 31, 2008. Potential problem loans are loans that are currently performing, but where the borrower’s operating performance or other relevant factors could result in potential credit problems, and are typically classified by our loan rating system as “substandard.” At March 31, 2009, potential problem loans primarily consisted of commercial real estate, commercial loans and leases. There can be no assurance that additional loans will not become nonperforming, require restructuring, or require increased provision for loan losses. The Bank has a loan and lease monitoring program that it believes appropriately evaluates non-performing loans and leases and the loan and lease portfolio in general. The review program continually audits the loan and lease
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Table of Contentsportfolio to confirm management’s loan and lease risk rating system, and tracks problem loans and leases to ensure compliance with loan and lease policy underwriting guidelines, and to evaluate the adequacy of the allowance for credit losses. The Bank’s policy is to place a loan or lease on non-accrual status and recognize income on a cash basis when a loan or lease is more than 90 days past due, unless in the opinion of management, the loan or lease is well secured and in the process of collection. The Bank considers a loan or lease impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally based upon the present value of future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans and leases are measured for impairment based on fair value of the collateral. As of March 31, 2009, there was $2.4 million in impaired loans for which $678,000 in related allowance for credit losses was allocated. As of December 31, 2008, there was $1.4 million in impaired loans for which $193,000 in related allowance for credit losses was allocated. The allowance for credit losses represents management’s best estimate of probable incurred credit losses in the Bank’s loan and lease portfolio. Management’s quarterly evaluation of the allowance for credit losses is a comprehensive analysis that builds a total allowance by evaluating the probable incurred credit losses within each product class. The Bank uses a general allocation methodology for all residential and consumer loan pools. This methodology estimates an allowance for each pool based on the average loss rate for the time period that includes the current year and two full prior years. The average loss rate is adjusted to reflect the expected impact that current trends regarding loan growth, delinquency, losses, economic conditions, loan concentrations, policy changes, experience and ability of lending personnel, and current interest rates have. For commercial loan and lease pools, the Bank establishes a specific allocation for all loans and leases in excess of $250,000 which are considered to be impaired and which have been risk rated under the Bank’s risk rating system as substandard, doubtful or loss. The specific allocation is based on the most recent valuation of the loan or lease collateral. For all other commercial loans and leases, the Bank uses the general allocation methodology that estimates the probable incurred loss for each risk rating category. The general allocation methodology for commercial loans and leases considers the same qualitative factors that are considered when evaluating residential mortgage and consumer loan pools. The combination of using both the general and specific allocation methodologies reflects management’s best estimate of the probable incurred credit losses in the Bank’s loan and lease portfolio. Loans and leases are charged against the allowance for credit losses, in accordance with the Bank’s loan and lease policy, when they are determined by management to be uncollectible. Recoveries on loans and leases previously charged off are credited to the allowance for credit losses when they are received. When management determines that the allowance for credit losses is less than adequate to provide for probable incurred losses, a direct charge to operating income is recorded. The provision for credit losses was $1.8 million in the first quarter, which was an increase of $384,000 compared with the first quarter of 2008, but a decrease of $226,000 compared with the fourth quarter of 2008. Net charge-offs were $1.2 million in the first quarter, compared with $1.6 million in the year-ago quarter and $1.7 million in the fourth quarter of 2008. The Company’s credit loss provisions have been somewhat elevated over the past five quarters reflecting generally higher levels of loan delinquencies and charge-offs, a higher level of classified loans, and management’s assessment of the potential impact on the Company’s portfolio of macroeconomic factors and credit market conditions affecting the financial institutions sector generally. Net charge-offs equaled 0.53% of average loans and leases in the first quarter, compared with 0.72% in the year-ago quarter and 0.74% in the fourth quarter of 2008. The provision for credit losses as a percentage of net charge-offs was 145.3% in the first quarter, compared with 85.0% in the first quarter of 2008 and 116.9% in the fourth quarter of 2008. The increase in the ratio of the provision for credit losses to net charge-offs in the first quarter of 2009 compared with the year-ago quarter was largely the result of provisions recorded by the Company in 2007 on impaired loans which were subsequently charged down to their estimated collectible amounts in the first quarter of 2008. The allowance for credit losses was $9.7 million at March 31, 2009, compared with $9.2 million at December 31, 2008 and $8.2 million at March 31, 2008. The ratio of the allowance for credit losses to total loans and leases was 1.05% at March 31, 2009, compared with 1.01% at December 31, 2008 and 0.93% at March 31, 2008. The ratio of the allowance for credit losses to nonperforming loans and leases was 164.0% at March 31, 2009, compared with 204.6% at December 31, 2008 and 176.7% at March 31, 2008.
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Table of ContentsThe following table presents certain asset quality ratios for the periods indicated:
Non-interest Income The following table sets forth certain information on non-interest income for the periods indicated, dollars in thousands:
Total non-interest income increased $175,000 or 3.4% in the first quarter of 2009 compared to the year-ago quarter. The Company recognized $1.0 million in pre-tax gains on the sale of securities in the first quarter of 2009, compared with gains of $137,000 in the first quarter of 2008. Investment management income decreased $527,000 or 23.0% in the first quarter compared with the year-ago quarter as a result of the impact of declines in equity markets on the managed investment management portfolio. Other non-interest income declined $219,000 or 43.6% in the first quarter of 2009 compared with the year-ago quarter due primarily to non-recurring income in 2008’s first quarter. Non-interest income comprised 30.2% of total revenue in the first quarter of 2009 compared with 36.3% in the year-ago quarter and 32.6% in the fourth quarter of 2008.
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Table of ContentsNon-interest Expenses The following table sets forth certain information on non-interest expenses for the periods indicated, dollars in thousands:
Non-interest expenses were $10.1 million in the first quarter, an increase of 2.8% compared to $9.8 million in the year ago quarter, but unchanged from the fourth quarter of 2008. FDIC insurance increased $320,000 compared with the year ago quarter due to an overall increase in rates assessed by the FDIC for all FDIC-insured banks, and due to the application of approximately $138,000 in credits against the Company’s first quarter 2008 assessment that are not available to the Company in 2009. Salaries and benefits decreased 6.1% and 2.0% compared with the first quarter of 2008 and the fourth quarter of 2008 due primarily to the absence of incentive compensation accruals in the first quarter of 2009. Other operating expenses increased $344,000 or 31.4% in the first quarter compared with the year-ago quarter due primarily to a non-recurring write-off of a miscellaneous asset in the first quarter of 2009. The Company’s efficiency ratio was 70.0% in the first quarter of 2009, compared with 71.1% in the year-ago quarter and 68.9% in the fourth quarter of 2008. Income Taxes The Company’s effective tax rate was 17.6% for the first quarter, compared with 25.6% in the year-ago period. The decrease in the effective tax rate is due to an increase in tax exempt income as a percentage of total taxable income. Comparison of Financial Condition at March 31, 2009 and December 31, 2008 General Total assets increased $46.0 million or 3.4% in the first quarter and were $1.4 billion at March 31, 2009. Securities available-for-sale increased $30.2 million or 10.1%, and total loans and leases, net of unearned income and deferred costs, increased $16.0 million or 1.8% in the first quarter of 2009. Securities The Company’s investment securities portfolio totaled $329.4 million at March 31, 2009, compared with $299.1 million at December 31, 2008. The Company’s portfolio is comprised entirely of investment grade securities, most of which are rated “AAA” by one or more of the nationally recognized rating agencies. The breakdown of our securities portfolio at March 31, 2009 is 64% guaranteed mortgage-backed securities, 28% municipal securities and 8% obligations of U.S. Government sponsored corporations. Mortgage-backed securities, which totaled $209.4 million at March 31, 2009, are comprised primarily of pass-through securities backed by conventional residential mortgages and guaranteed by Fannie-Mae, Freddie-Mac or Ginnie Mae, which in turn are backed by the full faith and credit of the federal government. The Company does not invest in any securities backed by sub-prime, Alt-A or other high-risk mortgages. The Company also does not hold any preferred stock, corporate debt or trust preferred securities in its investment portfolio.
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Table of ContentsThe Company had net unrealized gains of approximately $5.4 million in its securities portfolio at March 31, 2009, compared with net unrealized gains of $4.7 million at December 31, 2008. Loans and Leases Total loans and leases, net of unearned income and deferred costs, increased $16.0 million or 1.8% in the first quarter of 2009. Residential mortgages increased $25.2 million or 8.0% during the first quarter, and reached an all-time high of $339.3 million at March 31, 2009. Residential mortgage origination volume increased $18.8 million or 48% in the first quarter compared with the year-ago quarter, and was up $24.2 million or 72% compared with the fourth quarter of 2008. The increase in 2009’s first quarter originations follows an all-time high for mortgage originations of $103.2 million in 2008. Alliance has increased its market share of the residential mortgage market due largely to its focused expansion of and investment in the Company’s mortgage origination business in Central New York. The Company continues to originate only conventional residential mortgages in its local markets, and does not originate sub-prime, Alt-A, negative amortizing or other higher risk residential mortgages. The rate of growth in the Company’s mortgage portfolio is expected to slow in coming quarters as the Company plans to sell more fixed-rate mortgages in the second quarter of 2009 based on its overall asset/liability management process. Commercial loans outstanding increased $1.0 million in the first quarter of 2009, and the slow rate of growth reflects in part, the difficulty in expanding this portfolio in the perennially low-growth markets in which we operate. Until recently, opportunities for growing our commercial loan portfolio were further limited by aggressive competition predominantly from the larger commercial banks and non-bank lenders operating in our markets, some of whom had offered credit terms (such as non-recourse and high loan-to-values) against which we chose not to compete. As a result, Alliance declined many potential commercial lending opportunities due to underwriting concessions it was unwilling to make. The more recent credit market turmoil and difficulties experienced by some of the larger lenders with whom we compete is anticipated to present opportunities for Alliance to compete more effectively for sound commercial credits without compromising underwriting standards. As one of the largest community banks headquartered in Central New York, Alliance expects to play a more significant role in meeting the financing needs of credit worthy commercial customers with terms that are sound and within our standards. In the first quarter of 2009, originations of commercial loans (excluding lines of credit), totaled approximately $17.0 million, compared with approximately $10.9 million in the first quarter of 2008. Leases (net of unearned income) decreased $9.1 million or 8.7% in the first quarter of 2009 as a result of the Company’s previously announced decision to cease new lease originations. The remaining balance of the lease portfolio of $95.5 million is expected to continue to run-off at the rate of approximately $9.0 million per quarter over the next year. Indirect auto loans were unchanged at $182.8 million as of March 31, 2009. The Company originated $21.7 million of indirect auto loans in the first quarter, compared with $18.2 million in the year-ago quarter. Alliance originates auto loans through a network of reputable, well established automobile dealers located in Central and Western New York. Applications received through the Company’s indirect lending program are subject to the same comprehensive underwriting criteria and procedures as employed in its direct lending programs.
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Table of ContentsThe following table sets forth the composition of the Bank’s loan and lease portfolio at the dates indicated, dollars in thousands:
Deposits Total deposits exceeded $1.0 billion at March 31, 2009, which was an increase of $92.4 million or 9.8% compared with December 31, 2008. The deposit growth was concentrated in the Company’s lower cost transaction (checking, savings and money market) accounts, which accounted for $84.0 million or 90.9% of the total increase in deposits in the first quarter. As a result, the Company’s deposit mix continued to change favorably in the first quarter, with transaction accounts comprising 64.7% of total deposits, compared with 62.1% at December 31, 2008 and 56.7% at March 31, 2008. This growth was due largely to business development efforts focusing on these lower cost transaction accounts and to a greater awareness of the Alliance brand in our markets. The following table sets forth the composition of the Bank’s deposits by business line at the dates indicated, dollars in thousands:
Liquidity The Company’s liquidity primarily reflects the Bank’s ability to provide funds to meet loan and lease requests, to accommodate possible outflows in deposits, to take advantage of market interest rate opportunities, and to pay dividends to the company. Funding loan and lease requests, providing for liability outflows, and managing of interest rate fluctuations require continuous analysis in order to match the maturities of specific categories of short-term loans and leases and investments with specific types of deposits and borrowings. Liquidity is normally considered in terms of the nature and mix of the Bank’s sources and uses of funds. The Asset Liability Committee (“ALCO”) of the Bank is responsible for implementing the policies and guidelines for the maintenance of prudent levels of liquidity. As of March 31, 2009, liquidity as measured by the Bank is in compliance with and exceeds its policy guidelines. The Bank’s principal sources of funds for operations are cash flows generated from earnings, deposits, loan and lease repayments, borrowings from the Federal Home Loan Bank of New York (“FHLB”), and securities sold under repurchase agreements. During the three months ended March 31, 2009, cash and cash equivalents increased by $2.3 million, as net cash provided by operating and financing activities of $46.9 million exceeded net cash used in investing activities of $44.6 million. Net cash used in investing activities primarily resulted from the net increase in
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Table of Contentsloans of $17.3 million and securities purchases exceeding maturities, sales and principal repayments by $28.6 million. The net cash provided by financing activities principally reflects a $92.4 million net increase in deposits, partly reduced by a net decrease in borrowings of $47.7 million and cash dividends of $1.2 million in the three months ended March 31, 2009. Net cash from operating activities was primarily provided by net income in the amount of $3.0 million and proceeds from sale of loans and leases held-for-sale of $2.4 million, partly reduced by originations of loans held-for-sale of $1.8 million. As a member of the FHLB, the Bank is eligible to borrow up to an established credit limit against certain residential mortgage loans and investment securities that have been pledged as collateral. As of March 31, 2009, the Bank’s credit limit with the FHLB was $276.2 million. The total of the Bank’s outstanding borrowings from the FHLB on that date was $163.8 million. The Company had a $150.1 million line of credit at March 31, 2009 with the Federal Reserve Bank of New York through its Discount Window. The Company has pledged indirect loans and securities totaling $179.9 million and $6.1 million, respectively, at March 31, 2009. The Company did not draw any funds on this line of credit in 2009. At March 31, 2009, the Company also had available $35.5 million of federal funds lines of credit with other financial institutions, none of which was in use at March 31, 2009. Capital Resources Shareholders’ equity was $146.5 million at March 31, 2009, compared with $144.5 million at December 31, 2008. Shareholders’ equity increased $2.0 million during the quarter on net income available to common shareholders of $2.6 million which was partially offset by dividends declared of $1.2 million. In February 2009, the Company announced that its Board of Directors declared a quarterly dividend of $0.26 per common share. In December 2008, the Company entered into a Purchase Agreement with the U.S. Treasury Department (“Treasury Department”) under its Capital Purchase Plan (“CPP”) pursuant to which the Company has issued and sold to the Treasury Department: (i) 26,918 shares of the Series A Preferred Stock, having a liquidation amount per share equal to $1,000, for a total price of $26,918,000 (ii) and a Warrant to purchase 173,069 shares of the Company’s common stock at an exercise price per share of $23.33. The Series A Preferred Stock pays cumulative dividends at a rate of 5% per annum for the first five years and thereafter at a rate of 9% per annum. The original terms of the Purchase Agreement provided that the Company may not redeem the Series A Preferred Stock during the first three years except with the proceeds from a “qualified equity offering,” after which time, the Company had the ability, at its option, to redeem the Series A Preferred Stock at the liquidation amount plus accrued and unpaid dividends. The Series A Preferred Stock is generally non-voting. The American Recovery and Reinvestment Act (“ARRA”) now provides an opportunity for CPP recipients to immediately repay CPP financing assistance without first needing to raise any funds, subject to the approval by the Treasury Department in consultation with the appropriate federal banking agency. The nature of the consultation process is not defined under the ARRA, and banking regulators might seek to require a withdrawing CPP recipient to raise additional funds from third parties if they determine that there are not otherwise sufficient capital reserves. Prior to December 19, 2011, and unless the Company has redeemed all of the Series A Preferred Stock or the Treasury Department has transferred all of the Series A Preferred Stock to a third party, the approval of the Treasury Department will be required for the Company to increase its common stock dividend or repurchase its common stock or other equity or capital securities, other than in certain circumstances specified in the Purchase Agreement. Both the Series A Preferred Stock and Warrant will be accounted for as components of the Company’s Tier 1 capital. On May 8, 2009, the Company received regulatory approval to redeem all of the 26,918 shares of its Fixed Rate Cumulative Perpetual Preferred Stock (“Preferred Stock”) it sold to the U.S. Department of the Treasury (Treasury Department) on December 19, 2008 in connection with the Treasury Department’s Capital Purchase Program (“CPP”) under the Troubled Assets Relief Program (“TARP”). The Company expects the redemption transaction to close on May 13, 2009. On the redemption date, the redemption price will become due and payable on each share of the preferred stock and dividends will cease to accrue. At that time, all rights of the Treasury Department, as the holder thereof, will terminate, except the right to receive the redemption price upon surrender of the Preferred Stock certificate. The redemption price represents the $1,000 per share liquidation amount of the preferred stock, plus a pro rata accrued dividend of approximately $329,000. The redemption of the Preferred Stock will be paid primarily through a reduction of federal funds sold. The Company anticipates a reduction to undivided profits of approximately $551,000 in the second quarter of 2009 for accelerated discount accretion related to the difference between the amount at which the Preferred Stock sale was initially recorded and its redemption price (preferred stock accretion). The preferred stock dividend and the acceleration of the accretion on preferred stock will reduce the net income available to common shareholders, which is used in calculating earnings per share. The Treasury Department also received warrants to purchase 173,069 shares of the Company’s common stock with an exercise price of $23.33 per share. Subsequent to the repayment, the Company has the right to repurchase the stock warrants that were previously issued to the Treasury Department. The price for the repurchase of the warrant will be subject to negotiation and there can be no assurance that the warrants will be repurchased. The Company’s Tier 1 leverage ratio was 9.5% and its total risk-based capital ratio was 15.3% at the end of the first quarter, both of which exceeded the regulatory thresholds required to be classified as a well-capitalized institution, which are 5.0% and 10.0%, respectively. The Company’s Tier 1 leverage ratio and total risk-based capital ratio will decline upon redemption of the Preferred Stock. The Company’s tangible common equity capital ratio was 5.7% at March 31, 2009. The Company and its banking subsidiary 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 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,
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Table of Contentsthe Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classifications 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 its subsidiary bank to maintain minimum amounts and ratios (set forth in the following tables) of total and Tier 1 Capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 Capital (as defined) to average assets (as defined). As of December 31, 2008, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as “well-capitalized,” under the regulatory framework for prompt corrective action. To be categorized as “well-capitalized,” the Bank must maintain total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the tables below. Management believes that, as of March 31, 2009, the Company and the Bank met all capital adequacy requirements to which they were subject. The following table compares the Company’s actual capital amounts and ratios with those needed to qualify for the “well capitalized” category, which is the highest capital category as defined in the regulations.
Application of Critical Accounting Estimates The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices or are provided by other third-party sources, when available. When third party information is not available, valuation adjustments are estimated in good faith by management.
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Table of ContentsThe most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements included in the 2008 Annual Report on Form 10-K (“the Consolidated Financial Statements”). These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan and lease losses, accrued income taxes, and the fair value analysis of the intangible asset to be the accounting areas that require the most subjective and complex judgments, and as such could be the most subject to revision as new information becomes available. The allowance for credit losses represents management’s estimate of probable credit losses in the loan and lease portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogeneous loans and leases based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q describes the methodology used to determine the allowance for credit losses, and a discussion of the factors driving changes in the amount of the allowance for credit losses is included in this report. The Company accounts for income taxes using the asset and liability approach. Under this approach, deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect when such amounts are realized or settled. The Company must assess the likelihood that a portion or all of the deferred tax assets will not be realized. In doing so, judgments and estimates must be made regarding the projection of future taxable income. If necessary, a valuation allowance is established to reduce the deferred tax assets to the amount that is more likely than not to be realized. In computing the income tax provision, estimates and assumptions must be made regarding the deductibility of certain expenses. It is possible that these estimates and assumptions may be disallowed as part of an examination by the various taxing authorities that we are subject to, resulting in additional income tax expense in future periods. In addition, we maintain a reserve related to uncertain tax positions. These uncertain tax positions are evaluated each reporting period to determine the level of reserve that is appropriate. The Company utilizes significance estimates and assumptions in determining the fair value of its intangible assets for purposes of impairment testing. The valuation requires the use of assumptions, including among others, discount rates, rates of return on assets, account attrition and costs of servicing. Other Information The long-standing Oneida Indian litigation, in which the Oneida Indian nation seeks possession of land in Madison and Oneida Counties, is described in the Company’s Form 10-K for the fiscal year ended December 31, 2008. On May 21, 2007, the U.S. District Court issued a decision dismissing the possessory land claims. The Court’s decision has been appealed. Management continues to believe that this matter will be resolved without adversely affecting the Company. New Accounting Pronouncements The Company adopted FASB Staff Position EITF 03-6-1 (“FSP 03-6-1”), “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” FSP 03-6-1 requires the use of the two-class method for computing earnings per share when stock compensation awards with non-forfeitable dividend rights are present. Prior earnings per share amounts have been retrospectively adjusted to conform with the provisions of FSP 03-6-1. See Note 5 to the Company’s consolidated financial statements for disclosure of the earnings per share calculation in accordance with FSP 03-6-1. The FAS issued FASB Staff Position (“FSP”) FAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13”, and FSP FAS 157-2, “Effective Date of FASB Statement
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Table of ContentsNo. 157.” FSP FAS 157-1 excludes certain leasing transactions accounted for under FASB Statement No. 13, “Accounting for Leases”, from the scope of Statement 157. FSP FAS 157-2 defers the effective date in FASB Statement No. 157, “Fair Value Measurements”, for one year (January 1, 2009 for the Company) for certain nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The impact on the Company’s current practice of measuring fair value for these assets did not have a material effect on the financial statements. In December 2007, the FASB issued FASB Statement No. 141 (Revised 2007) “Business Combinations.” Statement 141R will significantly change the accounting for business combinations. Under Statement 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Statement 141R also includes a substantial number of new disclosure requirements. The Company will be required to apply Statement 141R to any business acquisitions completed on or after January 1, 2009. In April 2009, the FASB issued FSP 115-2 & 124-2 Recognition and Presentation of Other-Than Temporary Impairments. The FSP eliminates the requirement for the issuer to evaluate whether it has the intent and ability to hold an impaired investment until maturity. Conversely, the new FSP requires the issuer to recognize an OTTI in the event that the issuer intends to sell the impaired security or in the event that it is more likely than not that the issuer will sell the security prior to recovery. In the event that the sale of the security in question prior to its maturity is not probable but the entity does not expect to recover its amortized cost basis in that security, then the entity will be required to recognize an OTTI. In the event that the recovery of the security’s cost basis prior to maturity is not probable and an OTTI is recognized, the FSP provides that any component of the OTTI relating to a decline in the creditworthiness of the debtor should be reflected in earnings, with the remainder being recognized in Other Comprehensive Income. Conversely, in the event that the issuer intends to sell the security before the recovery of its cost basis or if it is more likely than not that the Company will have to sell the security before recovery of its cost basis, then the entire OTTI will be recognized in earnings. The FSP is effective for interim and annual reporting periods ending after June 15, 2009. The Company does not expect the adoption to have a material impact on the Company’s consolidated financial position, results of operations or cash flows. In April 2009, the FASB issued FSP 157-4 Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. The FSP provides additional guidance for determining fair value based on observable transactions. The FSP provides that if evidence suggests that an observable transaction was not executed in an orderly way that little, if any, weight should be assigned to this indication of an Asset or Liability’s fair value. Conversely, if evidence suggests that the observable transaction was executed in an orderly way, the transaction price of the observable transaction may be appropriate to use in determining the fair value of the Asset/Liability in question, with appropriate weighting given to this indication based on facts and circumstances. Finally, if there is no way for the entity to determine whether the observable transaction was executed in an orderly way, relatively less weight should be ascribed to this indicator of fair value. The FSP is effective for interim and annual reporting periods ending after June 15, 2009. The Company does not expect the adoption to have a material impact on the Company’s consolidated financial position, results of operations or cash flows. In April 2009, the FASB issued FSP 107-1 & APB 28-1 Interim Disclosures about Fair Value of Financial Instruments. The FSP provides that publicly traded companies shall provide information concerning the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. In periods after initial adoption this FSP requires comparative disclosures only for periods ending after initial adoption. The FSP is effective for interim reporting periods ending after June 15, 2009.
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Table of Contents
Qualitative Analysis. Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices, and equity rates. Interest rate risk is the primary market risk faced by the Company as other types of market risk do not arise in the normal course of our business activities. The Asset Liability Committee (“ALCO”) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk. The policies and guidelines established by ALCO are reviewed and approved by the Company’s Board of Directors. The primary tool used to assess our interest rate sensitivity is the income simulation model. Quantitative Analysis. Net Interest Income is affected by changes in the absolute level of interest rates and by changes in the shape of the yield curve. The model requires management to make assumptions about how the Bank’s balance sheet is likely to evolve through time in different rate scenarios. The model assumes loan prepayment rates, reinvestment rates and deposit decay rates based on historical experiences and current conditions. These assumptions change based on the varying rate scenarios. The following table sets forth the results of our net interest income simulation model as of March 31, 2009.
The modeled net interest income reflects a gradual increase/decrease in rates over 12 months from a flat rate scenario. The results of the income simulation show the change in net interest income that is well within the Company’s policy limit. The Company’s guideline for risk management calls for preventative measures to be taken if simulation indicates net interest income would be adversely affected by more than 15%. The net interest income table presented assumes that the composition of our interest sensitive assets and liabilities existing at the beginning of the period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Moreover, modeling changes require the making of assumptions set forth above that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. Although the net interest income table provides an indication of our interest rate risk exposure at a particular point in time, such measurement is not intended to and does not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
The management of the Company is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of March 31, 2009, an evaluation was performed under the supervision of and with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the CEO and the CFO concluded that the Company’s disclosure controls and procedures as of March 31, 2009 were effective. There has been no change in the Company’s internal control over financial reporting that occurred during the most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Table of ContentsPART II. OTHER INFORMATION
Not applicable.
There are no material changes in the risk factors disclosed in the Company’s 2008 Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
a) Not applicable b) Not applicable c) Not applicable
Not applicable.
Not applicable
Not applicable
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Table of Contents
Exhibits required by Item 601 of Regulation S-K:
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Table of ContentsSIGNATURES Pursuant to the requirements 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.
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