UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON D.C. 20549FORM 10-Q
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarterly period ended JUNE 30, 2007
Or
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 0-13888
CHEMUNG FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
New York
16-1237038
(State or other jurisdiction of incorporation or organization)
I.R.S. Employer Identification No.
One Chemung Canal Plaza, Elmira, NY
14901
(Address of principal executive offices)
(Zip Code)
(607) 737-3711 or (800) 836-3711
(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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Exchange Act Rule 12b-2):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
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 of the registrant's common stock, $.01 par value, outstanding on July 31, 2007 was 3,509,813.
CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
INDEX
PART I.
FINANCIAL INFORMATION
PAGE
Item 1:
Financial Statements - Unaudited
1
2
3
4
5
Item 2:
10
Item 3:
19
Item 4:
20
PART II.
OTHER INFORMATION
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Submission of Matters to a Vote of Security Holders
Item 6:
Exhibits
21
SIGNATURES
22
PART I. FINANCIAL INFORMATIONItem 1: Financial Statements
CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(UNAUDITED)
June 30,2007
DECEMBER 31,2006
------------
ASSETS
Cash and due from financial institutions
$ 27,661,086
$ 26,343,804
Interest-bearing deposits in other financial institutions
612,626
246,470
Total cash and cash equivalents
28,273,712
26,590,274
Securities available for sale, at estimated fair value
169,872,748
184,829,551
Securities held to maturity, estimated fair value of $6,428,599 at June30, 2007 and $6,876,509 at December 31, 2006
6,461,638
6,866,209
Federal Home Loan Bank and Federal Reserve Bank Stock, at cost
4,929,550
3,604,750
Loans, net of deferred origination fees and costs, and unearned income
529,434,792
477,663,879
Allowance for loan losses
(8,031,450)
(7,983,256)
Loans, net
521,403,342
469,680,623
Premises and equipment, net
21,606,211
21,722,094
Goodwill
1,516,666
Other intangible assets, net
6,005,368
961,156
Other assets
21,270,581
23,278,209
Total assets
$781,339,816
$739,049,532
============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest-bearing
$155,338,111
$151,600,733
Interest-bearing
441,802,749
433,491,144
Total deposits
597,140,860
585,091,877
Securities sold under agreements to repurchase
35,634,077
35,023,948
Federal Home Loan Bank term advances
20,000,000
Federal Home Loan Bank overnight advances
35,800,000
7,900,000
Accrued interest payable
1,242,111
1,323,296
Dividends payable
843,318
848,989
Other liabilities
6,750,830
6,563,161
Total liabilities
697,411,196
656,751,271
Shareholders' equity:
Common stock, $.01 par value per share, 10,000,000 shares authorized; 4,300,134 issued at June 30, 2007 and December 31, 2006
43,001
Additional-paid-in capital
22,720,788
22,652,405
Retained earnings
79,009,726
77,183,407
Treasury stock, at cost (790,321 shares at June 30, 2007; 764,420 sharesat December 31, 2006)
(20,352,226)
(19,496,106)
Accumulated other comprehensive income
2,507,331
1,915,554
Total shareholders' equity
83,928,620
82,298,261
Total liabilities and shareholders' equity
See accompanying notes to unaudited consolidated financial statements.
CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME(UNAUDITED)
Six Months Ended
Three Months Ended
-------------------
---------------------
June 30,
-----------
INTEREST
2007
2006
------
Loans, including fees
$17,219,173
$14,343,653
$ 8,863,443
$ 7,430,166
Taxable securities
3,503,156
4,350,299
1,725,283
2,092,182
Tax exempt securities
431,598
495,313
210,246
242,449
Federal funds sold
52,610
49,925
16,870
44,065
Interest-bearing deposits
7,807
8,297
4,274
4,091
Total interest and dividend income
21,214,344
19,247,487
10,820,116
9,812,953
INTEREST EXPENSE
Deposits
7,003,282
5,414,989
3,500,830
2,994,874
Borrowed funds
771,982
608,520
446,088
227,883
924,097
1,053,221
477,321
495,862
Total interest expense
8,699,361
7,076,730
4,424,239
3,718,619
Net interest income
12,514,983
12,170,757
6,395,877
6,094,334
Provision for loan losses
600,000
125,000
475,000
-
Net interest income after provision for loan losses
11,914,983
12,045,757
5,920,877
Other operating income:
Trust & investment services income
2,737,706
2,425,873
1,548,933
1,251,041
Service charges on deposit accounts
2,179,773
2,175,032
1,200,799
1,141,274
Net gain on securities transactions
9,680
Credit card merchant earnings
772,479
707,806
392,038
359,210
Gain on sale of other real estate
656,323
3,800
192,520
Other
1,705,286
1,638,087
914,204
956,393
Total other operating income
8,061,247
6,950,598
4,258,174
3,707,918
Other operating expenses:
Salaries and wages
5,988,259
5,224,886
3,030,531
2,629,767
Pension and other employee benefits
951,701
1,365,657
440,821
625,410
Net occupancy expenses
1,624,005
1,468,741
814,351
732,327
Furniture and equipment expenses
1,039,578
1,032,538
526,502
525,888
Data processing expense
1,845,400
1,810,414
950,028
911,674
Amortization of intangible assets
257,771
198,860
158,341
99,430
3,238,223
3,148,335
1,648,276
1,767,644
Total other operating expenses
14,944,937
14,249,431
7,568,850
7,292,140
Income before income tax expense
5,031,293
4,746,924
2,610,201
2,510,112
Income tax expense
1,513,504
1,353,504
792,604
713,218
Net income
$ 3,517,789
$ 3,393,420
$ 1,817,597
$ 1,796,894
===========
Weighted average shares outstanding
3,600,147
3,658,378
3,592,057
3,650,518
Basic and diluted earnings per share
$0.98
$0.93
$0.51
$0.49
CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME(UNAUDITED)
Common Stock
Additional paid-in Capital
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income
Total
--------
----------
--------------
-------------
Balances at December 31, 2005
$ 43,001
$22,787,587
$73,168,903
$(17,484,680)
$2,663,186
$81,177,997
Comprehensive Income:
3,393,420
Change in unrealized loss on securities AFS, net
(2,217,632)
Total comprehensive income
1,175,788
Restricted stock units for directors' deferredcompensation plan
- -
40,749
Cash dividends declared ($.48 per share)
(1,718,626)
Distribution of 7,963 shares of treasury stock fordirectors' compensation
(198,597)
198,597
Distribution of 1,193 shares restricted stock units fordirectors' deferred compensation plan
(26,436)
29,897
3,461
Purchase of 38,148 shares of treasury stock
(1,135,663)
---------
Balances at June 30, 2006
$22,603,303
$74,843,697
$(18,391,849))
$ 445,554
$79,543,706
=========
=============
Balances at December 31, 2006
$22,652,405
$77,183,407
$(19,496,106)
$ 1,915,554
$82,298,261
3,517,789
Change in unrealized gain on securities AFS, net
556,921
Change in funded status of Employers' Accounting forDefined Benefit Pension and Other Benefit Plans, net
34,856
4,109,566
41,777
(1,691,470)
Distribution of 7,334 shares of treasury stock fordirectors' compensation
54,265
187,017
241,282
Distribution of 1,230 shares restricted stock units fordirectors' deferred compensation plan
(27,659)
31,476
3,817
Purchase of 34,465 shares of treasury stock
(1,074,613)
Balances at June 30, 2007
$22,720,788
$79,009,726
$(20,352,226))
$ 2,507,331
$83,928,620
==============
CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
-----
Adjustments to reconcile net income to net cash provided by operatingactivities:
Depreciation and amortization of fixed assets
1,356,078
1,302,802
Amortization of premiums on securities, net
27,925
63,462
Accretion of deferred gain on sale of credit cards
(51,713)
Gain on sale of other real estate owned
(656,323)
(3,800)
(9,680)
Decrease in other assets
354,443
142,982
(Decrease) increase in accrued interest payable
(81,185)
11,870
Expense related to restricted stock units for directors' deferredcompensation plan
Increase (decrease) in other liabilities
215,785
(647,143)
Origination of student loans
(3,032,678)
(2,845,793)
Proceeds from sales of student loans
4,574,721
3,278,951
Net cash provided by operating activities
7,114,710
5,009,647
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of and principal collected on securities availablefor sale
25,926,230
31,377,201
Proceeds from maturities of and principal collected on securities held tomaturity
1,391,442
1,053,092
Purchases of securities available for sale
(10,100,000)
Purchases of securities held to maturity
(986,871)
(1,029,769)
Purchase of Federal Home Loan Bank and Federal Reserve Bank stock
(10,662,300)
(7,637,050)
Redemption of Federal Home Loan Bank and Federal Reserve Bank stock
9,337,500
9,249,150
Purchases of premises and equipment
(1,240,195)
(2,465,859)
Cash paid for purchase of trust business
(5,301,983)
Proceeds from sale of other real estate owned
2,309,508
29,842
Net increase in loans
(53,891,962)
(35,591,019)
Net cash used by investing activities
(43,218,631)
(5,014,412)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in demand deposits, NOW accounts, savings accounts,and insured money market accounts
(3,788,685)
5,378,188
Net increase in time deposits and individual retirement accounts
15,837,668
28,930,205
Net increase (decrease) in securities sold under agreements to repurchase
610,129
(24,686,480)
Proceeds from Federal Home Loan Bank overnight advances
21,000,000
Repayments of Federal Home Loan Bank overnight advances
(7,900,000)
(20,800,000)
Repayments of Federal Home Loan Bank term advances
(10,000,000)
Purchase of treasury stock
Cash dividends paid
(1,697,140)
(1,725,584)
Net cash provided (used) by financing activities
37,787,359
(3,039,334)
Net increase (decrease) in cash and cash equivalents
1,683,438
(3,044,099)
Cash and cash equivalents, beginning of period
25,558,038
Cash and cash equivalents, end of period
$28,273,712
$22,513,939
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest
$ 8,780,546
$ 7,064,860
Income Taxes
$ 30,972
$ 1,817,162
Supplemental disclosure of non-cash activity:
Transfer of loans to other real estate owned
$ 27,200
$ 1,394,854
Adjustment of securities available for sale to fair value, net of tax
$ 556,922
$(2,217,632)
Change in funded status of defined benefit pension and other benefit plans,net of tax
$ 34,856
$ -
CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
Chemung Financial Corporation (the "Corporation"), through its wholly owned subsidiaries, Chemung Canal Trust Company (the "Bank") and CFS Group, Inc., a financial services company, provides a wide range of banking, financing, fiduciary and other financial services to its local market area. The consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries. All material intercompany accounts and transactions are eliminated in consolidation.
The data in the consolidated balance sheet as of December 31, 2006 was derived from the audited consolidated financial statements in the Corporation's 2006 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 15, 2007. That data, along with the other interim financial information presented in the consolidated balance sheets, statements of income, shareholders' equity and comprehensive income, and cash flows should be read in conjunction with the audited consolidated financial statements, including the notes thereto, contained in the 2006 Annual Report on Form 10-K. As permitted by Staff Accounting Bulletin No. 108 ("SAB 108"), the December 31, 2006 balance sheet has been corrected to reflect the accrual of trust fee income which had previously been recognized on the cash basis. These differences, which are deemed to be immaterial, were identified during the second quarter of 2007. Such adjustments resulted in increases in other assets, other liabilities and sha reholders' equity in the amounts of $880 thousand, $343 thousand and $537 thousand, respectively as of December 31, 2006. Amounts in prior periods' consolidated interim financial statements are reclassified whenever necessary to conform to the current period's presentation.
The consolidated financial statements included herein reflect all adjustments which are, in the opinion of management, of a normal recurring nature and necessary to present fairly the Corporation's financial position as of June 30, 2007 and December 31, 2006, and results of operations for the three-month and six-month periods ended June 30, 2007 and 2006, and changes in shareholders' equity and cash flows for the six-month periods ended June 30, 2007 and 2006. The results for the periods presented are not necessarily indicative of results to be expected for the entire fiscal year or any other interim period.
2.Earnings Per Share
Earnings per share were computed by dividing net income by 3,600,147 and 3,658,378 weighted average shares outstanding for the six-month periods ended June 30, 2007 and 2006, respectively and 3,592,057 and 3,650,518 weighted average shares outstanding for the three-month periods ended June 30, 2007 and 2006, respectively. Issuable shares (such as those related to directors' restricted stock units and directors' stock compensation) are considered outstanding and are included in the computation of basic earnings per share as they are earned. There were no dilutive common stock equivalents during the six-month periods ended June 30, 2007 or 2006.
3. Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board ("FASB") released Financial Interpretation No. 48 ("FIN 48"). FIN 48 became effective for fiscal years beginning after December 15, 2006. FIN 48 clarified the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109 (FASB 109"). This Interpretation prescribes a recognition threshold and a measurement attribute to determine whether a tax position will ultimately be sustained. The Corporation adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes ("Fin 48"), as of January 1, 2007. A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" t est, no tax benefit is recorded. The adoption had no effect on the Corporation's financial statements.
The Corporation is no longer subject to examination by U.S. Federal income taxing authorities for years before 2003, or by New York State taxing authorities for years before 2004. We have no unrecognized tax benefits and do not anticipate any increase in unrecognized benefits during 2007 relative to any tax positions taken prior to January 1, 2007.
The Corporation recognizes interest related to income tax matters as interest expense and penalties related to income tax matters as other expense. The Corporation did not have any amounts accrued for interest or penalties at January 1, 2007.
In September 2006, FASB issued Statement No. 157, Fair Value Measurements ("FASB 157"). FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. FAS 157 is effective for fiscal years beginning after November 15, 2007. The Corporation is evaluating the potential effect FAS 157 may have on the Corporation's financial statements at this time.
In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159, "The Fair Value Option of Financial Assets and Financial Liabilities". The fair value option, established by this Statement permits entities to choose to measure eligible items at fair value at specified election dates. The Statement is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007. Early adoption is permitted under certain conditions. The Corporation is evaluating the potential effect FAS 159 may have on the Corporation's financial statements at this time.
4. Intangible Assets
The following table presents information relative to the Corporation's core deposit intangible ("CDI") related to the acquisition of deposits from the Resolution Trust Company in 1994:
At June 30, 2007
At December 31, 2006
Original core deposit intangible
$ 5,965,794
Less: Accumulated amortization
5,203,498
5,004,638
Carrying amount
$ 762,296
$ 961,156
The following table presents information relative to the Corporation's purchase of the trust business of Partners Trust Financial Group, Inc. on May 3, 2007. At that time, the Corporation acquired $351 million of trust assets under administration at fair value:
Original customer relationship intangible
$ 5,301,983
58,911
$ 5,243,072
5. Comprehensive Income
Comprehensive income or loss of the Corporation represents net income plus other comprehensive income or loss, which consists of the net change in unrealized holding gains or losses on securities available for sale and the change in the funded status of the Corporation's defined benefit pension plan and other benefit plans, net of the related tax effect. Accumulated other comprehensive income or loss represents the net unrealized holding gains or losses on securities available for sale and the change in the funded status of the Corporation's defined benefit pension plan and other benefit plans, as of the consolidated balance sheet dates, net of the related tax effect.
Comprehensive income for the three and six-month periods ended June 30, 2007 was $2,265,536 and $4,109,566, respectively. Comprehensive income for the three and six-month periods ended June 30, 2006 was $40,961 and $1,175,788, respectively.
The following summarizes the components of other comprehensive income (loss):
Other Comprehensive Income (Loss)
Three Months EndedJune 30,
Six Months EndedJune 30,
--------------------
Change in unrealized holding gains (losses) on securities available for sale
$ 690,172
$(2,876,220)
$ 897,354
$(3,632,485)
Reclassification adjustment net gains realized in net income
Net unrealized gains
680,492
(2,876,220)
887,674
(3,632,485)
Tax effect
250,054
(1,120,287)
330,753
(1,414,853)
Net of tax amount
$ 430,438
$(1,755,933)
$ 556,921
Change in funded status of defined benefit pension plan and other benefit plans
28,425
56,850
10,924
21,994
17,501
Total other comprehensive income (loss)
$ 447,939
$ 591,777
6. Commitments and Contingencies
In the normal course of operations, the Corporation engages in a variety of financial transactions that, in accordance with accounting principles generally accepted in the United States of America, are not recorded in the financial statements. The Corporation is also a party to certain financial instruments with off-balance sheet risk such as commitments under standby letters of credit, unused portions of lines of credit and commitments to fund new loans. The Corporation's policy is to record such instruments when funded. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are generally used by the Corporation to manage clients' requests for funding and other client needs.
7. Securities
Amortized cost and estimated fair value of securities available for sale are as follows:
June 30, 2007
December 31, 2006
----------------
------------------
Amortized Cost
Estimated Fair Value
---------------
Obligations of U.S. Governmentand U.S. Governmentsponsored enterprises
$ 81,743,839
$ 80,139,727
$ 81,735,482
$ 80,133,906
Mortgage-backed securities
63,903,806
61,834,558
71,427,061
69,205,540
Obligations of states and political subdivisions
13,368,141
13,270,396
17,021,991
17,083,861
Corporate bonds and notes
4,347,972
4,572,610
9,123,500
9,275,322
Corporate stocks
828,342
10,055,457
728,542
9,130,922
$164,192,100
$169,872,748
$180,036,576
$184,829,551
The composition of the loan portfolio is summarized as follows:
-----------------
Residential mortgages
$149,876,721
$133,588,409
Commercial mortgages
62,718,506
54,666,318
Commercial, financial and agricultural
141,492,621
138,342,437
Consumer loans
175,346,944
151,066,715
$529,434,792
$477,663,879
Non-accrual loans
$ 2,169,332
$ 2,859,922
Troubled debt restructurings
313,047
329,401
Accruing loans past due 90 days or more
351,103
420,515
Total non-performing loans
$ 2,833,482
$ 3,609,838
Other real estate owned
103,440
1,819,204
Total non-performing assets
$ 2,936,922
$ 5,429,042
Activity in the allowance for loan losses was as follows:
Six Months Ended June 30,
----------------------------
Balance at beginning of period
$ 7,983,256
$ 9,777,643
Provision charged to operations
Loans charged-off
(834,252)
(737,950)
Recoveries
282,446
99,732
Balance at end of period
$ 8,031,450
$ 9,264,425
At June 30, 2007 and December 31, 2006, the recorded investment in loans that are considered to be impaired totaled $2,178,867 and $2,751,400, respectively. Included in the June 30, 2007 amount are impaired loans of $284,854 for which an impairment allowance has been recognized. The related impairment allowance was $191,854. The December 31, 2006 amount includes $317,521 of impaired loans with a related impairment allowance of $224,521.
9. Components of Quarterly Net Periodic Benefit Cost
Three Months Ended June 30,
Qualified Pension
Service cost, benefits earned during the period
$ 149,400
$ 148,500
$ 298,800
$ 297,000
Interest cost on projected benefit obligation
320,325
301,000
640,650
602,000
Expected return on plan assets
(625,650)
(407,250)
(1,251,300)
(814,500)
Amortization of unrecognized transition obligation
17,475
17,500
34,950
35,000
Amortization of unrecognized prior service cost
22,200
22,500
44,400
45,000
Amortization of unrecognized net loss
26,000
52,000
Net periodic pension (benefit) expense
$(116,250)
$ 108,250
$ (232,500)
$ 216,500
==========
Supplemental Pension
$ 4,375
$ 8,750
13,375
11,450
26,750
22,900
375
362
750
724
13,500
14,755
27,000
29,510
Net periodic supplemental pension expense
$ 31,625
$ 26,567
$ 63,250
$ 53,134
Postretirement, Medical and Life
$ 6,625
$ 4,500
$ 13,250
$ 21,500
18,500
15,750
37,000
73,000
(24,250)
(25,500)
(48,500)
2,750
Amortization of unrecognized net gain
(875)
(2,500)
(1,750)
Net periodic postretirement, medical and life expense
$ (7,750)
$ 94,750
Effective July 1, 2006, all Medicare eligible retirees and spouses who live within the Central NY, geographic area may elect to continue to receive retiree medical benefits through a group sponsored plan with Blue Cross Blue Shield named Medicare Blue PPO. Blue Cross Blue Shield assumes full liability for the payment of health care benefits incurred on or after July 1, 2006. Retirees and spouses as of July 1, 2006, who live outside of the Central NY, geographic area will continue to be covered by the Bank's health care plan and therefore, remain a liability for the Bank. Employees who retire after July 1, 2006, and become Medicare eligible will only have access to the Blue Cross Blue Shield Medicare Blue PPO health insurance plan. There were no changes to medical benefits for retirees and spouses up to age 65. Effective July 1, 2006, the amount paid by retirees up to age 65 who remain covered under the Bank's health plan was increased from 40% to 50% of the cost of coverage.
As a result of these changes, the Bank received the Medicare Part D subsidy payment for January 1, 2006 through June 30, 2006 for all Medicare eligible retirees and spouses and for July 1, 2006 through December 31, 2006 for only those Medicare eligible retirees and spouses who live outside of the Central NY area. Due to the decrease in the number of retirees and spouses who will produce a federal subsidy payment for the Bank, it is not expected that the Bank will file for and receive subsidy payments after 2006.
Effective July 1, 2006, dental benefits were eliminated for all retirees.
The plan changes were recognized as a negative plan amendment in accordance with paragraph 55 of Financial Accounting Standard No. 106 (FAS 106) in the second quarter of 2006. The plan changes were communicated to retirees and plan amendments were adopted during May 2006. The obligation was remeasured using a 6.5% Discount Rate in accordance with paragraph 73 of FAS 106.
During the fourth quarter of 2006, the Corporation contributed $10 million to its defined benefit pension plan. The calculation of this contribution was based upon an actuarial interpretation of the tax deductible limit under Internal Revenue Code (IRC) section 404(a)(7), as modified by the Pension Protection Act of 2006 (PPA). In March of 2007, the Internal Revenue Service (IRS) issued IRS Notice 2007-28 providing guidance related to this calculation, portions of which appear to be inconsistent with the language and intent of the statute, and would result in a significantly reduced tax deductible limit for the Corporation. The American Academy of Actuaries has requested that the IRS modify their guidance to be in line with the general interpretation of the PPA, or to not apply their guidance to companies that had already made contributions prior to this notice. The IRS has also been requested to not assess any excise tax on non-deductible contributions for companies that in good faith made their contributions for 2006. Further clarification related to this issue is not expected until later this year, and as a result, the Corporation is unable to assess the potential impact, if any, on its financial position or results of operations. Possible outcomes could include the assessment of an excise tax if the Corporation is determined to have made excess contributions, or the requirement to withdraw excess contributions, which would increase the pension plan expense.
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
The review that follows focuses on the significant factors affecting the financial condition and results of operations of the Corporation during the three and six-month periods ended June 30, 2007, with comparisons to the comparable periods in 2006, as applicable. The following discussion and the unaudited consolidated interim financial statements and related notes included in this report, should be read in conjunction with our 2006 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 15, 2007. The results for the periods presented are not necessarily indicative of results to be expected for the entire fiscal year or any other interim period.
Forward-looking Statements
This discussion contains 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. The Corporation intends its forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in these sections. All statements regarding the Corporation's expected financial position and operating results, the Corporation's business strategy, the Corporation's financial plans, forecasted demographic and economic trends relating to the Corporation's industry and similar matters are forward-looking statements. These statements can sometimes be identified by the Corporation's use of forward-looking words such as "may," "will," "anticipate," "estimate," "expect," or "intend." The Corporation cannot promise that its expectations in such forward-looking statements will turn out to be correct. The Corporation's actual results could be materially different from expectations because of various factors, inclu ding changes in economic conditions or interest rates, credit risk, difficulties in managing our growth, competition, changes in the regulatory environment, and changes in general business and economic trends.
Critical Accounting Policies, Estimates and Risks and Uncertainties
Critical accounting policies include the areas where the Corporation has made what it considers to be particularly difficult, subjective or complex judgments in making estimates, and where these estimates can significantly affect the Corporation's financial results under different assumptions and conditions. The Corporation prepares its financial statements in conformity with accounting principles generally accepted in the United States of America. As a result, the Corporation is required to make certain estimates, judgments and assumptions that it believes are reasonable based upon the information available. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities at the date of the financial statement and the reported amounts of revenue and expenses during the periods presented. Actual results could be different from these estimates.
Management considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the inherent uncertainty in evaluating the level of the allowance required to cover probable credit losses inherent in the loan portfolio, and the material effect that such judgments can have on the Corporation's results of operations. While management's current evaluation of the allowance for loan losses indicates that the allowance is adequate, under adversely different conditions or assumptions, the allowance would need to be increased. For example, if historical loan loss experience significantly worsened or if current economic conditions significantly deteriorated, additional provisions for loan losses would be required to increase the allowance. In addition, the assumptions and estimates used in the internal reviews of the Corporation's non-performing loans and potential problem loans, and the associated evaluation of the related collateral coverage for these loans, has a sig nificant impact on the overall analysis of the adequacy of the allowance for loan losses. While management has concluded that the current evaluation of collateral values is reasonable under the circumstances, if collateral evaluations were significantly lowered, the Corporation's allowance for loan losses policy would also require additional provisions for loan losses.
Financial Condition
Consolidated assets at June 30, 2007 totaled $781.3 million, an increase of $42.3 million or 5.7% since December 31, 2006. As discussed in greater detail below, this increase is reflected primarily in a $51.8 million increase in loans, net of deferred fees and costs and unearned income, and a $5.0 million increase in intangible assets, net, offset principally by a $15.4 million decrease in investment securities.
As noted above, total loans, net of deferred fees and costs and unearned income increased $51.8 million or 10.8% from December 31, 2006 to June 30, 2007. Growth was exhibited in all segments of the loan portfolio, with total consumer loans increasing $24.3 million, residential mortgages increasing $16.3 million and commercial loans (including commercial mortgages) increasing $11.2 million. The increase in consumer loans was principally due to a $24.4 million increase in installment loans, due in large part to a significant increase in indirect auto financing originations during the second quarter of this year, driven primarily by pricing. Activity in both residential mortgages and commercial loans has been strong throughout the first half of the year, impacted in part by the Corporation's expansion into Tompkins County, with total residential mortgages and commercial loans in this market increasing $8.2 million and $7.8 million, respectively.
The available for sale segment of the securities portfolio totaled $169.9 million at June 30, 2007, down approximately $15.0 million or 8.1% from December 31, 2006. At amortized cost, the available for sale portfolio was down approximately $15.8 million, with unrealized appreciation related to the available for sale portfolio increasing $888 thousand. The decrease in this portfolio was principally due to paydowns on mortgage-backed securities totaling $7.5 million, maturities and calls of corporate bonds totaling $4.8 million, and maturities and principal reductions of municipal bonds totaling $3.7 million. Proceeds from the above were used to support the loan growth during the first six months of this year. The held to maturity portion of the portfolio, consisting primarily of local municipal obligations, was down approximately $405 thousand from $6.9 million at December 31, 2006 to $6.5 million at June 30, 2007.
A $5.0 million net increase in intangibles is due to the Corporation's acquisition on May 3, 2007 of the trust business of Partners Trust Financial Group, Inc. ("Partners Trust") at a purchase price of approximately $5.2 million or 1.49% of the fair value of the business acquired, which is being amortized over a 15 year period. At that time, the Corporation acquired $351 million of trust assets under administration at fair value.
A $1.3 million increase in Federal Home Loan Bank and Federal Reserve Bank stock is due primarily to an increase in the Corporation's ownership of Federal Home Loan Bank of New York ("FHLB") stock, which is reflective of the increase in FHLB borrowings since the end of 2006.
Since December 31, 2006, total deposits have increased $12.0 million or 2.1% from $585.1 million to $597.1 million. Non-interest bearing demand deposits increased $3.7 million due to an increase in period-end personal account balances. An $8.3 million increase in interest bearing balances was reflected primarily in a $15.8 million increase in time deposits, due in large part to an increase in municipal time deposits, offset in part by lower personal investment certificate balances. The increase in time deposits was offset to some extent by an $8.7 million decrease in insured money market accounts due to lower period-end non-personal account balances.
With loan growth during the first six months of this year exceeding funding provided through the increase in deposits and the reduction in the securities portfolio, short term borrowings under our line of credit with the FHLB have increased $27.9 million from $7.9 million at December 31, 2006 to $35.8 million at June 30, 2007.
Asset Quality
Non-performing loans at June 30, 2007 totaled $2.833 million as compared to $3.610 million at December 31, 2006, a decrease of $777 thousand, reflected primarily in a $691 thousand decrease in non-accrual loans. During the first six months of 2007, five commercial loans with outstanding balances at June 30, 2007 totaling $301 thousand were placed in non-accrual status, offset primarily by the upgrade of two commercial relationships totaling $357 thousand from non-accrual to accruing status, as well as principal reductions on other non-accruing commercial loans totaling $505 thousand and a $144 thousand decrease in non-accruing mortgages. A $70 thousand decrease in accruing loans 90 days or more past due is primarily due to lower period-end mortgage and consumer loan delinquencies. Other Real Estate Owned has decreased $1.715 million since December 31, 2006, primarily due to the sale of two commercial properties during the first six months of this year.
$ 2,169
$ 2,860
313
329
351
421
-------
$ 2,833
$ 3,610
104
1,819
$ 2,937
$ 5,429
=======
In addition to non-performing loans, as of June 30, 2007, the Corporation has identified 15 commercial loan relationships totaling $11.9 million in potential problem loans, as compared to $12.0 million (15 commercial loan relationships) at December 31, 2006. Potential problem loans are loans that are currently performing, but where known information about possible credit problems of the related borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms, and which may result in the disclosure of such loans as non-performing at some time in the future. At the Corporation, potential problem loans are typically loans that are performing but are classified in the Corporation's loan rating system as "substandard". Management cannot predict the extent to which any factors may impact borrowers and the potential problem loans. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on no n-accrual, become restructured, or require increased allowance coverage and provisions for loan losses.
Management's evaluation of the adequacy of the allowance for loan losses is performed on a periodic basis and takes into consideration such factors as the historical loan loss experience, review of specific problem loans (including evaluation of the underlying collateral), changes in the composition and volume of the loan portfolio, recent charge-off experience, overall portfolio quality, and current economic conditions that may affect the borrowers' ability to pay. While the level of non-performing loans has continued to decline, during the second quarter of this year, the Corporation charged off a commercial loan against the allowance for loan losses for which no previous allocation to the allowance had been made. This was the principal factor in the $475 thousand increase in both the second quarter and year-to-date provision when compared to the corresponding periods in 2006. At June 30, 2007, the Corporation's allowance for loan losses totaled $8.031 million, resulting in a coverage ratio of allowance to non-performing loans of 283.5%. The allowance for loan losses is an amount that management believes will be adequate to absorb probable loan losses on existing loans. Net loan charge-offs for the first six months of 2007 totaled $552 thousand as compared to $639 thousand during the first six months of 2006, this decrease primarily due to decreases in net commercial loan and consumer loan charge-offs of $63 thousand and $37 thousand, respectively. The improvement in net commercial loan charge-offs was principally the result of payments totaling $162 thousand related to the balance of a commercial loan that had been charged off during 2006. The allowance for loan losses to total loans at June 30, 2007 was 1.52% as compared to 1.67% as of December 31, 2006.
(dollars in thousands)
-----------------------------
$ 7,983
$ 9,778
Charge-offs:
(609)
(490)
(13)
(212)
(248)
(834)
(738)
Recoveries:
185
97
96
282
99
Net charge-offs
(552)
(639)
600
125
$ 8,031
$ 9,264
========
Results of Operations
Second Quarter of 2007 vs. Second Quarter of 2006
Net interest income increased $302 thousand or 5.0% from $6.094 million during the second quarter of 2006 to $6.396 million during the second quarter of 2007, with the net interest margin increasing 3 basis points from 3.66% to 3.69%. This improvement resulted from a $28.7 million or 4.3% increase in average earning assets, and a 34 basis point increase in average yield as compared to the second quarter of 2006, offset to some extent by a 38 basis point increase in the average cost of interest bearing liabilities. The increase in average earning assets was due to a $70.2 million or 15.8% increase in average loans, offset primarily by a $39.2 million or 17.9% decrease in the average securities portfolio. The increase in average loans is reflective of growth in all segments of the loan portfolio, with average mortgages increasing $37.7 million, average consumer loans increasing $29.2 million and average commercial loans increasing $3.3 million. As loans have grown, principal reductions in the securities po rtfolio have been reinvested in these higher yielding loans, a significant factor in the decrease in the average securities portfolio. The growth in average earning assets, coupled with the increase in average yield, resulted in a $1.007 million or 10.3% increase in total interest income from $9.813 million in the second quarter of 2006 to $10.820 million in the second quarter of this year.
Total average funding liabilities, including non-interest bearing demand deposits, increased $40.6 million or 6.4% compared to second quarter 2006 averages, due primarily to a $25.6 million increase in average deposits and a $14.3 million increase in total average borrowings and securities sold under agreements to repurchase funded by the FHLB. Average non-interest bearing demand deposits increased $12.8 million, with average interest bearing deposits also up $12.8 million. The increase in average interest bearing deposits was reflected primarily in higher average time deposits and insured money market deposits of $13.9 million and $4.8 million, respectively, somewhat offset primarily by a $5.7 million decrease in average savings account balances. The increase in average borrowings and securities sold under agreements to repurchase with the FHLB was directly impacted by funding requirements to support the aforementioned increase in average loans. While average interest bearing liabilities increased $27.8 million or 5.6%, interest expense increased $705 thousand or 19.0%, as the average cost of interest bearing liabilities rose 38 basis points from 3.01% to 3.39%.
As discussed more fully under the Asset Quality section of this report, the $475 thousand increase in the provision for loan losses reflects managements evaluation of the adequacy of the allowance for loan losses based upon a number of factors including an analysis of historical loss factors, the evaluation of collateral, recent charge-off experience, overall credit quality and loan growth.
Non-interest income during the second quarter of 2007 compared to the second quarter of 2006 increased $550 thousand or 14.8%. Major factors in this increase include a $298 thousand increase in Trust and Investment Center fee income, impacted to a great degree by the acquisition in May of this year of the trust department business of Partners Trust, and a $193 thousand gain recognized on the sale of a commercial property held in Other Real Estate Owned ("OREO") that had previously been acquired through foreclosure proceedings. Additionally, during the second quarter of this year, we accelerated charitable donations to non-profit organizations that we fund through the donation of appreciated stock, resulting in a $63 thousand increase in non-taxable gains associated with these donations. Management's decision to accelerate these donations was based upon an increase in the market value of SLM Corporation ("SLM") stock following the announcement early in the second quarter of the proposed sale of SLM to an investment group for $60.00 per share. Following that announcement, the market value per share of SLM rose from the mid $40 range to the mid $50 range, thereby making it advantageous to the Corporation to accelerate these donations at that time. Other significant factors included a $60 thousand increase in service charges, due primarily to an increase in fee income related to checks presented against insufficient funds, as well as increases in check card interchange fee income and credit card merchant earnings of $38 thousand and $33 thousand respectively. These increases were somewhat offset primarily by a $162 thousand decrease in revenue from the Corporation's equity investment in Cephas Capital Partners, LP ("Cephas") and a $51 thousand decrease in revenue from OREO properties. The decrease in revenue from Cephas was due primarily to a decrease in realized gains on the sale of equity positions taken in companies to which Cephas had provided financing.
Second quarter 2007 operating expenses were $277 thousand or 3.8% higher than the comparable period last year. Areas having the greatest impact on this increase include a $401 thousand increase in salaries and wages, an $82 thousand increase in net occupancy costs, a $63 thousand loss on the disposal of fixed assets, a $63 thousand increase in donation expense and a $59 thousand increase in amortization of intangible assets. The increase in salaries and wages reflects higher base pay related to additions to staff during the second half of 2006, as well as the addition of former Partners Trust employees in May of this year, merit increases effective in January of this year and an increase in incentive compensation. The net occupancy expense increase includes higher depreciation expense, real estate taxes, rent expense and buildings and grounds maintenance costs. The loss on the disposal of fixed assets resulted from the write-off of the remaining book balance of a reader-sorter that was no longer being ut ilized following our conversion to electronic branch capture for daily processing. The $63 thousand increase in donation expense is directly related to the above mentioned acceleration of donations of appreciated stock, with the $59 thousand increase in amortization expense related to the amortization of the purchased intangible associated with the acquisition of the trust department business of Partners Trust. The above mentioned increases were offset to some extent primarily by a $225 thousand decrease in costs associated with OREO and a $185 thousand decrease in pension and other employee benefits. The decrease in OREO costs was due to the sale during the first quarter of a commercial property that had previously been acquired through foreclosure proceedings, while the decrease in the cost of employee benefits is primarily due to lower pension expense accruals resulting from an increase in the expected return on plan assets associated with the Corporation's $10 million contribution to this plan in the fourth quarter of 2006.
A $79 thousand increase in income tax expense reflects an increase in income subject to federal and state income taxes as well as a reduction in the future tax benefit associated with deferred tax assets related to the decrease in the statutory New York State tax rate from 7.5% to 7.1%, resulting in an effective tax rate of 30.4% for the second quarter of this year compared to 28.4% for the second quarter of 2006.
Year-To-Date 2007 vs. Year-To-Date 2006
Net income for the six-month period ended June 30, 2007 totaled $3.518 million, an increase of 3.7% as compared to net income of $3.393 million for the six-month period ended June 30, 2006. Earnings per share were up 5.4% from $0.93 per share to $0.98 per share on 58,231 fewer average shares outstanding. Similar to second quarter results, this increase in year-to-date income resulted primarily from increases in net interest income and non-interest income, partially offset by increases in the provision for loan losses and operating expenses, as well as a higher effective tax rate.
Net interest income increased $344 thousand or 2.8% from $12.171 million for the first six months of 2006 to $12.515 million for the six months ended June 30, 2007, with the net interest margin declining 2 basis points from 3.69% to 3.67%. The improvement in net interest income resulted from a $21.2 million or 3.2% increase in average earning assets, and a 40 basis point increase in average yield from 5.83% to 6.23%, offset by a 52 basis point increase in the average cost of interest bearing liabilities. The increase in average earning assets is due to a $64.7 million or 14.8% increase in average loans, offset primarily by a $43.4 million or 19.1% decrease in the average securities portfolio. As was the case in the second quarter, the increase in average loans reflects growth in all segments of the loan portfolio, with average mortgages increasing $37.2 million, average consumer loans increasing $21.0 million and average commercial loans up $6.5 million. The decrease in the average securities portfolio h as been impacted by loan growth, with principal reductions in the securities portfolio being reinvested in higher yielding loans. The growth in average earning assets and yield resulted in a $1.967 million or 10.2% increase in total interest and dividend income from $19.247 million for the six months ended June 30, 2006 to $21.214 million for the six months ended June 30, 2007.
Total average funding liabilities, including non-interest bearing demand deposits increased $32.0 million or 5.1% when compared to the first six months of last year, the result of a $35.1 million increase in average deposits, offset primarily by lower total average borrowings and securities sold under agreements to repurchase funded through the FHLB. While average demand deposits increased $10.5 million, average interest bearing deposits increased $24.6 million. Similar to second quarter results, the increase in average interest bearing deposits was due to higher average time deposits and insured money market balances of $26.0 million and $6.7 million, respectively, offset primarily by a $7.0 million decrease in average savings balances. While average interest bearing liabilities increased $21.5 million or 4.4%, total interest expense increased $1.623 million or 22.9%, as the average cost of interest bearing liabilities increased 52 basis points to 3.40%.
A $475 thousand increase in the provision for loan losses is due to the increase during the second quarter of this year as noted above and discussed more fully under the "Asset Quality" section of this report.
Non-interest income for the first half of 2007 increased $1.111 million or 16.0% when compared to the comparable period in 2006. Similar to the second quarter results, a $653 thousand increase in gains on the sale of OREO, as well as a $312 thousand increase in Trust and Investment Center fee income, contributed significantly to this increase. The increase in gains on the sale of OREO resulted from the sale of two commercial properties during the first half of this year, while the increase in Trust and Investment Center fee income was due in large part to the purchase of the trust business from Partners Trust in May of this year. As was noted above, the acceleration of charitable donations funded with appreciated stock resulted in an increase of $69 thousand in non-taxable gains. Other areas impacting this increase included increases in credit card merchant earnings and check card interchange fee income of $65 thousand and $53 thousand, respectively. As was the case in the second quarter, and for reason s noted above, these increases were somewhat offset primarily by a $170 thousand decrease in revenue from the Corporation's equity investment in Cephas.
Operating expenses for the first six months of this year increased $696 thousand or 4.9% compared to the corresponding period in 2006. As was the case with the second quarter operating expense increase, and for reasons discussed above, areas impacting this increase include a $763 thousand increase in salaries and wages, a $155 thousand increase in net occupancy costs, a $68 thousand increase in donations expense, a $63 thousand loss on the disposal of fixed assets and a $59 thousand increase in amortization of intangible assets. These increases were somewhat offset by a $414 thousand decrease in pension and other employee benefits and a $154 thousand decrease in costs associated with OREO.
Income taxes for the first six months of 2007 were $160 thousand higher than last year, principally due to a higher level of taxable income and the aforementioned reduction in the future tax benefit associated with deferred tax assets due to the decrease in the statutory New York State tax rate, resulting in an increase in the effective tax rate from 28.5% in 2006 to 30.1% this year.
Average Consolidated Balance Sheet and Interest Analysis
Six Months EndedJune 30, 2006
Three Months EndedJune 30, 2007
Three Months EndedJune 30, 2006
Assets
Average Balance
Yield/Rate
Earning assets:
Loans
$501,281
$17,219
6.93%
$436,562
$14,344
6.63%
$514,864
$8,864
6.90%
$444,625
$7,430
6.70%
161,397
3,503
4.38%
200,409
4,351
158,212
1,725
4.37%
192,985
2,092
4.35%
Tax-exempt securities
21,917
432
3.97%
26,319
495
3.80%
21,275
210
3.96%
25,723
243
3.78%
2,023
52
5.24%
2,076
50
4.85%
1,287
17
5.26%
3,607
44
4.90%
315
8
4.99%
373
4.49%
348
4.93%
4.71%
Total earning assets
686,933
21,214
6.23%
665,739
19,248
5.83%
695,986
10,820
6.24%
667,288
9,813
5.90%
Non-earning assets:
Cash and due from banks
21,725
23,298
21,972
22,224
21,563
18,829
21,525
19,041
25,470
18,637
26,792
19,756
(8,095)
(9,834)
(8,139)
(9,770)
AFS valuation allowance
4,843
3,365
5,419
2,567
$752,439
$720,034
$763,555
$721,106
Liabilities and Shareholders'Equity
Interest-bearing liabilities:
Now and super now deposits
37,621
68
0.36%
38,776
0.50%
37,989
34
38,266
48
0.51%
Savings and insured moneymarket deposits
163,106
1,454
1.80%
163,337
1,108
1.37%
163,367
728
1.79%
164,226
603
1.47%
Time deposits
246,718
5,481
4.48%
220,752
4,210
3.85%
247,665
2,739
4.44%
233,769
2,344
4.02%
Federal Home Loan Bankadvances and securitiessold under agreements torepurchase
69,007
1,696
4.96%
72,044
1,662
4.65%
74,595
923
4.97%
59,576
4.87%
Total interest-bearingliabilities
516,452
8,699
3.40%
494,909
7,077
2.88%
523,616
4,424
3.39%
495,837
3,719
3.01%
Non-interest-bearingliabilities:
Demand deposits
146,273
135,775
149,114
136,271
7,097
8,492
7,561
8,474
669,822
639,176
680,291
640,582
Shareholders' equity
82,617
80,858
83,264
80,524
$12,515
$12,171
$6,396
$6,094
Net interest rate spread
2.83%
2.95%
2.85%
2.89%
Net interest margin
3.67%
3.69%
3.66%
The following table sets forth for the periods indicated, a summary of the changes in interest and dividends earned and interest paid resulting from changes in volume and changes in rates (in thousands of dollars):
Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006
Three Months Ended June 30, 2007 Compared to Three Months Ended June 30, 2006
Increase (Decrease) Due to (1)
Volume
Rate
Net
Interest and dividends earned on:
$2,200
$ 675
$2,875
$1,204
$ 230
$1,434
(847)
(1)
(848)
(379)
12
(367)
(86)
23
(63)
(44)
11
(33)
(30)
(27)
$ 626
$1,340
$1,966
$ 432
$ 575
$1,007
Interest paid on:
(3)
(26)
(29)
(14)
Savings and insured money marketdeposits
(2)
346
128
529
742
1,271
145
250
395
Federal Home Loan Bank advances andsecurities sold under agreementsto repurchase
(72)
106
186
13
199
Total interest-bearing liabilities
$ 319
$1,303
$1,622
$ 216
$ 489
$ 705
$ 307
$ 37
$ 344
$ 86
$ 302
Liquidity and Capital Resources
Liquidity management involves the ability to meet the cash flow requirements of deposit customers, borrowers, and the operating, investing, and financing activities of the Corporation. The Corporation uses a variety of resources to meet its liquidity needs. These include short term investments, cash flow from lending and investing activities, core deposit growth and non-core funding sources, such as time deposits of $100,000 or more, securities sold under agreements to repurchase and other borrowings.
The Corporation is a member of the Federal Home Loan Bank of New York ("FHLB") which allows it to access borrowings which enhance management's ability to satisfy future liquidity needs. At June 30, 2007, the Corporation maintained a $144.4 million line of credit with the FHLB, as compared to $141.5 million at June 30, 2006.
During the first six months of 2007, cash and cash equivalents increased $1.7 million as compared to a decrease of $3.0 million during the first six months of last year. In addition to cash provided by operating activities, other primary sources of cash during the first half of 2007 included proceeds from maturities and principal payments on securities totaling $27.3 million, a $27.9 million increase in advances from the FHLB, a $12.0 million increase in deposits and proceeds from the sale of OREO totaling $2.3 million. Proceeds from the above were used primarily to fund a $53.9 million net increase in loans, purchases of securities totaling $11.1 million, a $5.3 million purchased intangible related to the purchase of the trust business of Partners Trust, payment of cash dividends totaling $1.7 million, a $1.3 million increase in FHLB and Federal Reserve Bank stock, and the purchase of fixed assets and treasury shares totaling $1.2 million and $1.1 million, respectively.
In addition to cash provided by operating activities, other primary sources of cash during the first six months of 2006 included a $34.3 million increase in deposits, proceeds from maturities and principal payments on securities totaling $32.4 million and $1.6 million in net redemptions of FHLB and Federal Reserve Bank stock. Proceeds from the above were used primarily to fund a $35.6 million net increase in loans, a $24.7 million decrease in securities sold under agreements to repurchase, a $9.8 million reduction in FHLB advances, purchases of fixed assets totaling $2.5 million, payment of cash dividends in the amount of $1.7 million, and the purchase of treasury shares and securities totaling $1.1 million and $1.0 million, respectively.
As of June 30, 2007, the Corporation's consolidated leverage ratio was 9.84%. The Tier I and Total Risk Adjusted Capital ratios were 13.48% and 15.49%, respectively. All of the above ratios are in excess of the requirements for being considered "well capitalized" by the FDIC, the Federal Reserve and the New York State Banking Department.
During the first six months of 2007 the Corporation declared cash dividends of $0.48 per share, unchanged from the amount declared during the first half of 2006.
When shares of the Corporation become available in the market, we may purchase them after careful consideration of our capital position. On November 15, 2006, the Corporation's Board of Directors authorized the repurchase of up to 180,000 shares, or approximately 5% of its then outstanding common shares, either through open market purchases or privately negotiated transactions over a two-year period. During the first six months of 2007, the Corporation purchased 34,465 shares at an average price of $31.18 per share. As of June 30, 2007, a total of 46,265 shares had been purchased since the inception of the announced repurchase program. Additionally, during the first half of 2007, 8,564 shares were re-issued from treasury to fund the stock component of directors' 2006 compensation as well as distributions under the Corporation's directors' deferred stock plan.
Interest Rate Risk
As intermediaries between borrowers and savers, commercial banks incur both interest rate risk and liquidity risk. The Corporation's Asset/Liability Committee ("ALCO") has the strategic responsibility for setting the policy guidelines on acceptable exposure to these areas. These guidelines contain specific measures and limits regarding these risks, which are monitored on a regular basis. The ALCO is made up of the vice chairman of the board, president and chief executive officer, two executive vice presidents, chief financial officer, asset liability management officer, senior marketing officer, and others representing key functions.
The ALCO is also responsible for supervising the preparation and annual revisions of the financial segments of the annual budget, which is built upon the committee's economic and interest-rate assumptions. It is the responsibility of the ALCO to modify prudently the Corporation's asset/liability policies.
Interest rate risk is the risk that net interest income will fluctuate as a result of a change in interest rates. It is the assumption of interest rate risk, along with credit risk, that drives the net interest margin of a financial institution. For that reason, the ALCO has established tolerance limits based upon a 200-basis point change in interest rates. At June 30, 2007, it is estimated that an immediate 200-basis point decrease in interest rates would positively impact the next 12 months net interest income by 1.38% and an immediate 200-basis point increase would negatively impact the next 12 months net interest income by 6.29%. Both are within the Corporation's policy guideline of 15% established by ALCO.
A related component of interest rate risk is the expectation that the market value of our capital account will fluctuate with changes in interest rates. This component is a direct corollary to the earnings-impact component: an institution exposed to earnings erosion is also exposed to shrinkage in market value. At June 30, 2007, it is estimated that an immediate 200-basis point decrease in interest rates would negatively impact the market value of our capital account by 2.31% and an immediate 200-basis point increase in interest rates would negatively impact the market value by 7.67%. Both are within the established tolerance limit of 15%.
Management does recognize the need for certain hedging strategies during periods of anticipated higher fluctuations in interest rates and the Board-approved Funds Management Policy provides for limited use of certain derivatives in asset liability management. These strategies were not employed during the first six months of 2007.
Item 3: Quantitative and Qualitative Disclosures About Market Risk
Information required by this Item is set forth herein in Management's Discussion and Analysis of Financial Condition and Results of Operations under the heading "Interest Rate Risk."
Item 4: Controls and Procedures
The Corporation's management, under the supervision and with the participation of our President and Chief Executive Officer, who is the Corporation's principal executive officer, and our Treasurer and Chief Financial Officer, who is the Corporation's principal financial officer, has evaluated the effectiveness of the Corporation's disclosure controls and procedures as of June 30, 2007. Based upon that evaluation, the President and Chief Executive Officer and the Treasurer and Chief Financial Officer have concluded that the Corporation's disclosure controls and procedures are effective as of June 30, 2007.
There were no significant changes in the Corporation's internal control over financial reporting that occurred during the Corporation's most recent fiscal quarter that have materially affected, or that are reasonably likely to materially affect, the Corporation's internal control over financial reporting.
There have been no material changes in the risk factors set forth in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2006.
Item 2.
(c)
Issuer Purchases of Equity Securities
Period
Total number of shares purchased
Average price paid per share
Total number of shares purchased as part of publicly announced plans or programs
Maximum number of shares that may yet be purchased under the plans or programs
1/1/07-1/31/07
$ 0.00
168,200
2/1/07-2/28/07
6,908
$32.27
161,292
3/1/07-3/31/07
2,775
$31.72
158,517
Quarter ended 3/31/07
9,683======
$32.11======
158,517=======
4/1/07-4/30/07
1,270
31.72
157,247
5/1/07-5/31/07
15,484
31.16
141,763
6/1/07-6/30/07
8,028
30.01
133,735
Quarter ended 6/30/07
24,782======
$30.81======
133,735=======
Period ended 6/30/07
34,465======
$31.18======
Of the above, 8,600 shares were open-market transactions and the remaining 25,865 shares were privately negotiated transactions.
On November 16, 2006, the Corporation announced that its Board of Directors had authorized the repurchase of up to 180,000 shares, or approximately 5% of the Corporation's then outstanding common stock over a two year period, expiring November 15, 2008. Purchases will be made from time to time on the open-market or in private negotiated transactions, and will be at the discretion of management.
Item 4.
(a)
May 9, 2007-Annual Meeting
(b)
The following directors were elected at the Annual Meeting of Shareholders on May 9, 2007:
1.
To elect five directors for a term of three years expiring in 2010.
NAME
FOR
WITHHELD
Ronald M. Bentley
3,073,680
3,283
Robert H. Dalrymple
3,060,167
16,796
Clover M. Drinkwater
3,072,487
4,476
Ralph H. Meyer
3,067,821
9,142
Richard W. Swan
3,072,359
4,604
Directors serving after the meeting whose terms expire in 2009:
David J. Dalrymple
John F. Potter
William D. Eggers
Jan P. Updegraff
Directors serving after the meeting whose terms expire in 2008:
Robert E. Agan
Thomas K. Meier
Stephen M. Lounsberry III
Charles M. Streeter, Jr.
Matters voted upon (refer to b)
(d)
Not applicable
Item 6.
The Corporation files herewith the following exhibits:
31.1 Certification of President and Chief Executive Officer of the Registrant pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
31.2 Certification of Treasurer and Chief Financial Officer of the Registrant pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
32.1 Certification of President and Chief Executive Officer of the Registrant pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 19 U.S.C. 1350.
32.2 Certification of Treasurer and Chief Financial Officer of the Registrant pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 19 U.S.C. 1350.
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.
DATE:
August 8, 2007
/s/ Ronald M. Bentley
President & CEO
/s/ John R. Battersby Jr.
John R. Battersby Jr.
Treasurer & CFO
FORM 10 - Q
QUARTERLY REPORT
EXHIBIT INDEX
FOR THE PERIOD ENDING June 30, 2007
ELMIRA, NEW YORK