NBT Bancorp - 10-Q quarterly report FY

(Mark One)

For the quarterly period ended September 30, 2007.

(Exact Name of Registrant as Specified in its Charter)

 

(Address of Principal Executive Offices) (Zip Code)

Registrant's Telephone Number, Including Area Code: (607) 337-2265

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 shorter periods that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes T No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).

Yes o No T

As of October 31, 2007, there were 32,235,152 shares outstanding of the Registrant's common stock, $0.01 par value.

 

See accompanying notes to unaudited interim consolidated financial statements.

See accompanying notes to unaudited interim consolidated financial statements.

See accompanying notes to unaudited interim consolidated financial statements.

NBT Bancorp Inc. (the Registrant) is a registered financial holding company incorporated in the state of Delaware in 1986, with its principal headquarters located in Norwich, New York. The Company is the parent holding company of NBT Bank, N.A. (the Bank), NBT Financial Services, Inc. (NBT Financial), Hathaway Agency, Inc., CNBF Capital Trust I, NBT Statutory Trust I and NBT Statutory Trust II.  Through these subsidiaries, the Company operates as one segment focused on community banking operations. The Company’s primary business consists of providing commercial banking and financial services to its customers in its market area. The principal assets of the Company are all of the outstanding shares of common stock of its direct subsidiaries, and its principal sources of revenue are the management fees and dividends it receives from the Bank and NBT Financial.

The Bank is a full service commercial bank formed in 1856, which provides a broad range of financial products to individuals, corporations and municipalities throughout the central and upstate New York and northeastern Pennsylvania market area.

The accompanying unaudited interim consolidated financial statements include the accounts of NBT Bancorp Inc. and its wholly owned subsidiaries, NBT Bank, N.A., NBT Financial Services, Inc., Hathaway Agency, Inc., CNBF Capital Trust I, NBT Statutory Trust I and NBT Statutory Trust II.  Collectively, the Registrant and its subsidiaries are referred to herein as “the Company.”  All intercompany transactions have been eliminated in consolidation. Amounts in the prior period financial statements are reclassified whenever necessary to conform to current period presentation.

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements, but the application of this Statement may change current practice.  Adoption is required as of the beginning of the first fiscal year that begins after November 15, 2007. Early application of this Standard is encouraged. The Company is assessing the effect that SFAS 157 will have on our consolidated financial position, results of operations and cash flows.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities(“SFAS 159”).  SFAS 159 allows entities to voluntarily choose, at election dates, to measure many financial assets and financial liabilities (as well as certain nonfinancial instruments that are similar to financial instruments) at fair value (the “fair value option”).  The election is made on an instrument-by-instrument basis and is irrevocable.  If the fair value option is elected for an instrument, the Statement specifies that all subsequent changes in fair value for that instrument shall be reported in earnings.  The Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007.  The Company is assessing the effect that SFAS 159 will have on our consolidated financial position, results of operations and cash flows.

On February 10, 2006, the Company completed the acquisition through merger of CNB Bancorp, Inc. (“CNB”). CNB was a bank holding company for City National Bank and Trust Company (“CNB Bank”) and Hathaway Agency, Inc. (“Hathaway”), headquartered in Gloversville, NY.  CNB Bank conducted business from nine community bank offices in four upstate New York counties—Fulton, Hamilton, Montgomery and Saratoga. The stockholders of CNB received approximately $39 million in cash and 2,058,661 shares of NBT common stock. The aggregate transaction value was approximately $89.0 million. The transaction was accounted for under the purchase method of accounting. CNB had total assets of $399.0 million, loans of $197.6 million, deposits of $335.0 million and shareholders equity of $40.1 million.  As part of the merger, the Company recorded approximately $65.6 million in goodwill and identifiable intangibles.  CNB was merged with and into the Company, CNB Bank was merged with and into NBT Bank and Hathaway became a direct subsidiary of the Registrant. The results of operations are included in the consolidated financial statements from the date of acquisition, February 10, 2006.

Preparing 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, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period, as well as the disclosures provided. Actual results could differ from those estimates. Estimates associated with the allowance for loan losses, pension expense, fair values of financial instruments and status of contingencies are particularly susceptible to material change in the near term.

The allowance for loan and lease losses is the amount which, in the opinion of management, is necessary to absorb probable losses inherent in the loan and lease portfolio. The allowance is determined based upon numerous considerations, including local economic conditions, the growth and composition of the loan portfolio with respect to the mix between the various types of loans and their related risk characteristics, a review of the value of collateral supporting the loans, comprehensive reviews of the loan portfolio by the independent loan review staff and management, as well as consideration of volume and trends of delinquencies, nonperforming loans, and loan charge-offs. As a result of the test of adequacy, required additions to the allowance for loan and lease losses are made periodically by charges to the provision for loan and lease losses.

The allowance for loan and lease losses related to impaired loans is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain loans where repayment of the loan is expected to be provided solely by the underlying collateral (collateral dependent loans). The Company’s impaired loans are generally collateral dependent. The Company considers the estimated cost to sell, on a discounted basis, when determining the fair value of collateral in the measurement of impairment if those costs are expected to reduce the cash flows available to repay or otherwise satisfy the loans.

Management believes that the allowance for loan and lease losses is adequate. While management uses available information to recognize loan and lease losses, future additions to the allowance for loan and lease losses may be necessary based on changes in economic conditions or changes in the values of properties securing loans in the process of foreclosure. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan and lease losses. Such agencies may require the Company to recognize additions to the allowance for loan and lease losses based on their judgments about information available to them at the time of their examination which may not be currently available to management.

Other real estate owned (“OREO”) consists of properties acquired through foreclosure or by acceptance of a deed in lieu of foreclosure. These assets are recorded at the lower of fair value of the asset acquired less estimated costs to sell or “cost” (defined as the fair value at initial foreclosure). At the time of foreclosure, or when foreclosure occurs in-substance, the excess, if any, of the loan over the fair value of the assets received, less estimated selling costs, is charged to the allowance for loan and lease losses and any subsequent valuation write-downs are charged to other expense. Operating costs associated with the properties are charged to expense as incurred. Gains on the sale of OREO are included in income when title has passed and the sale has met the minimum down payment requirements prescribed by GAAP.

Income taxes are accounted for under the asset and liability method. The Company files consolidated tax returns on the accrual basis. Deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Realization of deferred tax assets is dependent upon the generation of future taxable income or the existence of sufficient taxable income within the available carryback period. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. Based on available evidence, gross deferred tax assets will ultimately be realized and a valuation allowance was not deemed necessary at September 30, 2007 and 2006, or December 31, 2006. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.

The Company is a party to financial instruments in the normal course of business to meet financing needs of its customers and to reduce its own exposure to fluctuating interest rates. These financial instruments include commitments to extend credit, unused lines of credit, and standby letters of credit. Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policy to make such commitments as it uses for on-balance-sheet items. Commitments to extend credit and unused lines of credit totaled $667.3 million at September 30, 2007 and $536.3 million at December 31, 2006.  Since commitments to extend credit and unused lines of credit may expire without being fully drawn upon, this amount does not necessarily represent future cash commitments. Collateral obtained upon exercise of the commitment is determined using management’s credit evaluation of the borrower and may include accounts receivable, inventory, property, land and other items.

The Company guarantees the obligations or performance of customers by issuing stand-by letters of credit to third parties. These stand-by letters of credit are frequently issued in support of third party debt, such as corporate debt issuances, industrial revenue bonds and municipal securities. The risk involved in issuing stand-by letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet products. Typically, these instruments have terms of five years or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Standby letters of credit totaled $47.4 million at September 30, 2007 and $30.8 million at December 31, 2006. As of September 30, 2007, the fair value of standby letters of credit was not significant to the Company’s consolidated financial statements.

Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity (such as the Company’s dilutive stock options).

The following is a reconciliation of basic and diluted earnings per share for the periods presented in the consolidated statements of income.

There were 1,227,585 stock options for the quarter ended September 30, 2007 and 361,379 stock options for the quarter ended September 30, 2006 that were not considered in the calculation of diluted earnings per share since the stock options’ exercise price was greater than the average market price during these periods.

There were 619,853 stock options for the nine months ended September 30, 2007 and 372,604 stock options for the nine months ended September 30, 2006 that were not considered in the calculation of diluted earnings per share since the stock options’ exercise price was greater than the average market price during these periods.

The following table sets forth information with regard to nonperforming loans:

There were no material commitments to extend further credit to borrowers with nonperforming loans. There are no loans classified as troubled debt restructures at September 30, 2007, December 31, 2006 and September 30, 2006.

Accumulated interest on the above nonaccrual loans of approximately $0.8 million and $0.5 million would have been recognized as income for the nine month periods ending September 30, 2007 and September 30, 2006, respectively, had these loans been in accrual status.  Accumulated interest on the above nonaccrual loans of approximately $0.5 million and $0.2 million would have been recognized as income for the three month periods ending at September 30, 2007 and September 30, 2006, respectively, had these loans been in accrual status.  Approximately $1.0 million and $0.6 million of interest on the above nonaccrual loans was collected for the nine month periods ending September 30, 2007 and September 30, 2006, respectively.  Approximately $0.5 million and $0.3 million of interest on the above nonaccrual loans was collected for the three month periods ending September 30, 2007 and September 30, 2006, respectively.

Loans reviewed for specific reserve allowance consist primarily of large, impaired commercial and agricultural loans.  The impaired loans subject to specific allowance allocation totaled $13.4 million at September 30, 2007, $2.2 million at December 31, 2006, and $1.7 million at September 30, 2006.  At September 30, 2007, $11.2 million of the impaired loans reviewed had a specific reserve allocation of $6.3 million, or 55.8%, and $2.2 million of the impaired loans reviewed had no specific reserve allocation.  At December 31, 2006, $1.1 million of the impaired loans reviewed had a specific reserve allocation of $0.2 million, or 19.9%, and $1.1 million of the impaired loans reviewed had no specific reserve allocation.  There was no specific reserve allocation for the impaired loans reviewed at September 30, 2006.

The following provides additional information on impaired loans for the periods presented:

The Company has a qualified, noncontributory, defined benefit pension plan covering substantially all of its employees at September 30, 2007. Benefits paid from the plan are based on age, years of service, compensation, social security benefits, and are determined in accordance with defined formulas. The Company’s policy is to fund the pension plan in accordance with ERISA standards. Assets of the plan are invested in publicly traded stocks and bonds. Prior to January 1, 2000, the Company’s plan was a traditional defined benefit plan based on final average compensation.  On January 1, 2000, the plan was converted to a cash balance plan with grandfathering provisions for existing participants.

In addition to the pension plan, the Company also provides supplemental employee retirement plans to certain current and former executives.  These supplemental employee retirement plans and the defined benefit pension plan are collectively referred to herein as “Pension Benefits.”

Also, the Company provides certain health care benefits for retired employees.  Benefits are accrued over the employees’ active service period. Only employees that were employed by NBT Bank on or before January 1, 2000 are eligible to receive postretirement health care benefits.  The plan is contributory for participating retirees, requiring participants to absorb certain deductibles and coinsurance amounts with contributions adjusted annually to reflect cost sharing provisions and benefit limitations called for in the plan.  Eligibility is contingent upon the direct transition from active employment status to retirement without any break in employment from NBT.  Employees also must be participants in the Company’s medical plan prior to their retirement.  The Company funds the cost of postretirement health care as benefits are paid. The Company elected to recognize the transition obligation on a delayed basis over twenty years.  These postretirement benefits are referred to herein as “Other Benefits.”

The Components of pension expense and postretirement expense are set forth below (in thousands):

The Company is not required to make contributions to the Plan in the remainder of 2007.  The Company recorded approximately $215,000, net of tax, as amortization of pension amounts previously recognized in Accumulated Other Comprehensive Income as of September 30, 2007.

CNBF Capital Trust I is a Delaware statutory business trust formed in 1999, for the purpose of issuing $18 million in trust preferred securities and lending the proceeds to the Company. NBT Statutory Trust I is a Delaware statutory business trust formed in 2005, for the purpose of issuing $5 million in trust preferred securities and lending the proceeds to the Company. NBT Statutory Trust II is a Delaware statutory business trust formed in 2006, for the purpose of issuing $50 million in trust preferred securities and lending the proceeds to the Company to provide funding for the acquisition of CNB Bancorp, Inc. These three statutory business trusts are collectively referred herein as “the Trusts.”  The Company guarantees, on a limited basis, payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities.  The Trusts are variable interest entities (“VIEs”) for which the Company is not the primary beneficiary, as defined in Financial Accounting Standards Board Interpretation (“FIN”) No. 46 “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (Revised December 2003) (FIN 46R).” In accordance with FIN 46R, which was implemented in the first quarter of 2004, the accounts of the Trusts are not included in the Company’s consolidated financial statements.

As of September 30, 2007, the Trusts had the following issues of trust preferred debentures, all held by the Trusts, outstanding (dollars in thousands):

* Fixed for 5 years, converts to floating at 3-month LIBOR plus 140 basis points (“bp”).

The Company owns all of the common stock of the three business trusts, which have issued trust preferred securities in conjunction with the Company issuing trust preferred debentures to the Trusts. The terms of the trust preferred debentures are substantially the same as the terms of the trust preferred securities. In February 2005, the Federal Reserve Board issued a final rule that allows the continued inclusion of trust preferred securities in the Tier 1 capital of bank holding companies. The Board’s final rule limits the aggregate amount of restricted core capital elements (which includes trust preferred securities, among other things) that may be included in the Tier 1 capital of most bank holding companies to 25% of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability. Large, internationally active bank holding companies (as defined) are subject to a 15% limitation. Amounts of restricted core capital elements in excess of these limits generally may be included in Tier 2 capital. The final rule provides a five-year transition period, ending March 31, 2009, for application of the quantitative limits. The Company does not expect that the quantitative limits will preclude it from including the trust preferred securities in Tier 1 capital. However, the trust preferred securities could be redeemed without penalty if they were no longer permitted to be included in Tier 1 capital.

The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), on January 1, 2007.  As a result of the implementation of FIN 48, the Company was not required to recognize any change in the liability for unrecognized tax benefits.  The total unrecognized tax benefits upon adoption were approximately $2.6 million.  Included in this amount is $1.2 million which would impact the effective rate if recognized or reversed and $0.4 million which would impact goodwill.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, New York State, Pennsylvania and certain other states.  The Company settled its examination of tax years 2004 and 2005 with the Internal Revenue Service during the second quarter of 2007.  The settlement of the exam did not result in a material change in the liability for unrecognized tax benefits.  All prior year federal returns are closed under the statute of limitations. The Company is also currently under examination by New York State for tax years 2000 through 2002.  It is reasonably possible that a reduction in the unrecognized tax benefits may occur; however, quantification of an estimated range cannot be made at this time.

The Company’s policy is to accrue interest and penalties as part of income tax expense. As of the date of adoption of FIN 48, the Company had accrued $0.5 million of interest.  Interest accrued as of September 30, 2007 is $0.7 million.

The purpose of this discussion and analysis is to provide the reader with a concise description of the financial condition and results of operations of NBT Bancorp Inc. (Bancorp) and its wholly owned subsidiaries, NBT Bank, N.A. (the Bank), NBT Financial Services, Inc. (NBT Financial), Hathaway Agency, Inc., CNBF Capital Trust I, NBT Statutory Trust I and NBT Statutory Trust II (collectively referred to herein as the Company). This discussion will focus on Results of Operations, Financial Position, Capital Resources and Asset/Liability Management. Reference should be made to the Company's consolidated financial statements and footnotes thereto included in this Form 10-Q as well as to the Company's 2006 Form 10-K for an understanding of the following discussion and analysis.

Certain statements in this filing and future filings by the Company with the Securities and Exchange Commission, in the Company’s press releases or other public or shareholder communications, contain forward-looking statements, as defined in the Private Securities Litigation Reform Act. These statements may be identified by the use of phrases such as “anticipate,” “believe,” “expect,” “forecasts,” “projects,” or other similar terms.   There are a number of factors, many of which are beyond the Company’s control that could cause actual results to differ materially from those contemplated by the forward looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) revenues may be lower than expected; (3) changes in the interest rate environment may affect interest margins; (4) general economic conditions, either nationally or regionally, may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and/or a reduced demand for credit; (5) legislative or regulatory changes, including changes in accounting standards or tax laws, may adversely affect the businesses in which the Company is engaged; (6) competitors may have greater financial resources and develop products that enable such competitors to compete more successfully than the Company; (7) adverse changes may occur in the securities markets or with respect to inflation; (8) acts of war or terrorism; (9) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; (10) internal control failures; and (11) the Company’s success in managing the risks involved in the foregoing.

The Company wishes to caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and to advise readers that various factors, including those described above and other factors discussed in the Company’s annual and quarterly reports previously filed with the Securities and Exchange Commission, could affect the Company’s financial performance and could cause the Company’s actual results or circumstances for future periods to differ materially from those anticipated or projected.

Unless required by law, the Company does not undertake, and specifically disclaims any obligations to publicly release the result of any revisions that may be made to any forward-looking statements to reflect statements to the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Management of the Company considers the accounting policy relating to the allowance for loan and lease losses to be a critical accounting policy given the uncertainty in evaluating the level of the allowance required to cover credit losses inherent in the loan and lease portfolio and the material effect that such judgments can have on the results of operations. While management’s current evaluation of the allowance for loan and lease 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 and lease loss experience significantly worsened or if current economic conditions significantly deteriorated, additional provisions for loan and lease losses would be required to increase the allowance. In addition, the assumptions and estimates used in the internal reviews of the Company’s nonperforming loans and potential problem loans has a significant impact on the overall analysis of the adequacy of the allowance for loan and lease losses. While management has concluded that the current evaluation of collateral values is reasonable under the circumstances, if collateral evaluations were significantly lowered, the Company’s allowance for loan and lease policy would also require additional provisions for loan and lease losses.

Management of the Company considers the accounting policy relating to pension accounting to be a critical accounting policy. Management is required to make various assumptions in valuing its pension assets and liabilities. These assumptions include the expected rate of return on plan assets, the discount rate, and the rate of increase in future compensation levels. Changes to these assumptions could impact earnings in future periods. The Company takes into account the plan asset mix, funding obligations, and expert opinions in determining the various rates used to estimate pension expense. The Company also considers the Moody’s AA and AAA corporate bond yields and other market interest rates in setting the appropriate discount rate. In addition, the Company reviews expected inflationary and merit increases to compensation in determining the rate of increase in future compensation levels.

The Company earned net income of $41.3 million ($1.22 diluted earnings per share) for the nine months ended September 30, 2007 compared to net income of $42.3 million ($1.24 diluted earnings per share) for the nine months ended September 30, 2006. The decrease in net income from 2006 to 2007 was primarily the result of a $10.7 million increase in provision for loan and lease losses compared to the same period last year.  The increase in provision for loan and lease losses was partially offset by an increase in noninterest income of $6.9 million and a decrease in noninterest expense of $2.0 million.  Although net interest margin declined by 12 bp from 3.73% for the nine months ended September 30, 2006 to 3.61% for the nine months ended September 30, 2007, net interest income remained relatively flat due to an increase in average earning assets of $202.7 million.  The Company recorded net securities gains of $1.5 million for the nine months ended September 30, 2007 compared to net securities losses of $0.9 million for the nine months ended September 30, 2006.  Excluding the effect of these securities transactions, noninterest income increased $4.5 million or 12.1% compared to the same period in 2006. The increase in noninterest income for the nine months ended September 30, 2007 resulted from increases in service charges on deposit accounts, ATM and debit card fees, retirement plan administration fees, trust administration fees, broker/dealer and insurance revenue, and bank owned life insurance income. The decrease in total noninterest expense for the nine months ended September 30, 2007 was due primarily to a decrease of $2.8 million, or 6.0%, in salaries and employee benefits.  This decrease was due primarily to a reduction in incentive compensation and pension expenses in 2007.

 

The Company earned net income of $15.1 million ($0.46 diluted earnings per share) for the three months ended September 30, 2007 compared to net income of $14.5 million ($0.43 diluted earnings per share) for the three months ended September 30, 2006. The increase in net income from 2006 to 2007 was primarily the result of a $4.0 million increase in noninterest income compared to the same period last year.  The increase in noninterest income resulted from increases in service charges on deposit accounts, ATM and debit card fees, retirement plan administration fees, trust administration fees, and gains from securities sales.  The increase in noninterest income was partially offset by an increase in the provision for loan and lease losses, which increased by $2.3 million for the three months ended September 30, 2007 compared with the three months ended September 30, 2006.   The Company recorded net securities gains of $1.5 million for the three months ended September 30, 2007 as compared to nominal gains for the three months ended September 30, 2006.  Excluding the effect of these securities transactions, noninterest income increased $2.5 million or 20.2% compared to the same period in 2006.  There was a nominal increase in net interest income from $40.9 million for the three months ended September 30, 2006 to $41.2 million for the three months ended September 30, 2007.  Although net interest margin declined by 4 bp from 3.60% for the three months ended September 30, 2006 to 3.56% for the three months ended September 30, 2007 net interest income remained relatively flat due to an increase in average earning assets of $92.9 million.

 

 

 

Net interest income is the difference between interest income on earning assets, primarily loans and securities, and interest expense on interest-bearing liabilities, primarily deposits and borrowings. Net interest income is affected by the interest rate spread, the difference between the yield on earning assets and cost of interest-bearing liabilities, as well as the volumes of such assets and liabilities. Net interest income is one of the major determining factors in a financial institution’s performance as it is the principal source of earnings.Table 2 represents an analysis of net interest income on a federal taxable equivalent basis.

FTE net interest income increased $1.5 million during the nine months ended September 30, 2007, compared to the same period of 2006. The increase in FTE net interest income resulted primarily from 4.5% growth in average earning assets. The Company’s interest rate spread declined 19 bp during the nine months ended September 30, 2007 compared to the same period in 2006.  The yield on earning assets for the period increased 20 bp, to 6.60% for the nine months ended September 30, 2007 from 6.40% for the same period in 2006. Meanwhile, the rate paid on interest-bearing liabilities increased 38 bp, to 3.54% for the nine months ended September 30, 2007 from 3.16% for the same period in 2006.

FTE net interest income increased $0.4 million during the three months ended September 30, 2007, compared to the same period of 2006. The Company’s interest rate spread declined 7 bp during the three months ended September 30, 2007 compared to the same period in 2006.  The yield on earning assets for the period increased 9 bp, to 6.56% for the three months ended September 30, 2007 from 6.47% for the same period in 2006, while average earning assets increased by 2.0%.  Meanwhile, the rate paid on interest-bearing liabilities increased 17 bp, to 3.55% for the three months ended September 30, 2007 from 3.38% for the same period in 2006.

For the nine months ended September 30, 2007, total interest income increased $17.0 million.  The rates paid on interest earning assets increased from 6.40% for the nine months ended September 30, 2006 to 6.60% for the nine months ended September 30, 2007, primarily the result of the 50 bp increase in the Federal Funds target rate since January 1, 2006.  Additionally, average interest earning assets increased $202.7 million for the nine months ended September 30, 2007 when compared to the same period in 2006, principally from growth in average loans and leases.

For the three months ended September 30, 2007, total interest income increased $2.6 million.  The rates paid on interest earning assets increased from 6.47% for the three months ended September 30, 2006 to 6.56% for the three months ended September 30, 2007.  Additionally, average interest earning assets increased $92.9 million for the three months ended September 30, 2007 when compared to the same period in 2006, principally from growth in average loans and leases.

For the nine months ended September 30, 2007, total interest expense increased $15.5 million, primarily the result of the 50 bp increase in the Federal Funds target rate since January 1, 2006, which impacts the Company’s short-term borrowing, money market account and time deposit rates. Additionally, average interest-bearing liabilities increased $170.2 million for the nine months ended September 30, 2007 when compared to the same period in 2006, principally from organic deposit growth as well as deposits assumed from the CNB transaction. Total average interest-bearing deposits increased $270.6 million for the nine months ended September 30, 2007 when compared to the same period in 2006. The rate paid on average interest-bearing deposits increased 50 bp from 2.77% for the nine months ended September 30, 2006 to 3.27% for the same period in 2007.  The increase in average interest-bearing deposits resulted from organic deposit growth as well as the previously mentioned deposits assumed from the CNB transaction.  For the nine months ended September 30, 2007, the Company experienced a shift in its deposit mix from savings accounts to money market and time deposit accounts, as interest sensitive customers shifted funds into higher paying interest bearing accounts. Savings accounts decreased approximately $50.6 million and money market and time deposit accounts collectively increased approximately $313.3 million.

For the three months ended September 30, 2007, total interest expense increased $2.2 million.  Average interest-bearing liabilities increased $57.6 million for the three months ended September 30, 2007 when compared to the same period in 2006, from organic deposit growth.  Total average interest-bearing deposits increased $112.6 million for the three months ended September 30, 2007 when compared to the same period in 2006. The rate paid on average interest-bearing deposits increased 26 bp from 3.03% for the three months ended September 30, 2006 to 3.29% for the same period in 2007.  The increase in average interest-bearing deposits resulted from organic deposit growth. For the three months ended September 30, 2007, the Company experienced a shift in its deposit mix from savings accounts to money market and time deposit accounts, as interest sensitive customers shifted funds into higher paying interest bearing accounts. Savings accounts decreased approximately $45.9 million and money market and time deposit accounts collectively increased approximately $157.1 million.

Total average borrowings, including trust preferred debentures, decreased $100.4 million for the nine months ended September 30, 2007 compared with the same period in 2006.  Average short-term borrowings decreased by $64.2 million, from $343.6 million for the nine months ended September 30, 2006 to $279.4 million for the nine months ended September 30, 2007.  Despite this 18.7% decrease, interest expense from short-term borrowings only decreased $2.0 million, or 16.7%.  The rate paid on short-term borrowings increased from 4.63% for the nine months ended September 30, 2006 to 4.73% for the same period in 2007.  Average trust preferred debentures increased $7.2 million for the nine months ended September 30, 2007, compared with the same period in 2006, primarily from the issuance of $51.5 million in trust preferred debentures in February 2006 to fund the cash portion of the CNB transaction and to provide regulatory capital.  The rate paid on trust preferred debentures increased to 6.77% for the nine months ended September 30, 2007, compared with 6.72% for the same period in 2006, driven primarily by $51.5 million in trust preferred debentures issued in February 2006 with a fixed rate of 6.195% and $18.7 million in trust preferred debentures that reprice quarterly at 3-month LIBOR plus 275 bp.

Total average borrowings, including trust preferred debentures, decreased $55.0 million for the three months ended September 30, 2007 compared with the same period in 2006.  Average short-term borrowings increased by $9.1 million, from $313.1 million for the three months ended September 30, 2006 to $322.2 million for the three months ended September 30, 2007.  Interest expense from short-term borrowings increased $0.1 million, or 1.5%.  The rate paid on short-term borrowings decreased from 4.85% for the three months ended September 30, 2006 to 4.78% for the same period in 2007.  Average trust preferred debentures remained consistent at $75.4 million for the three months ended September 30, 2007 and September 30, 2006.  The rate paid on trust preferred debentures decreased to 6.72% for the three months ended September 30, 2007, compared with 6.76% for the same period in 2006.

Another important performance measurement of net interest income is the net interest margin.  Despite a 19bp decrease in the Company’s net interest spread, the net interest margin only declined by 12 bp to 3.61% for the nine months ended September 30, 2007, compared with 3.73% for the same period in 2006. The Company thus far has mitigated some of the margin pressure by growing noninterest bearing demand deposit accounts. Average demand deposits increased $23.3 million or 3.8% for the nine months ended September 30, 2007, compared to the same period in 2006.

Despite a 7 bp decrease in the Company’s net interest spread, the net interest margin only declined by 4 bp to 3.56% for the three months ended September 30, 2007, compared with 3.60% for the same period in 2006. The Company thus far has mitigated some of the margin pressure by growing noninterest bearing demand deposit accounts. Average demand deposits increased $30.9 million or 4.9% for the three months ended September 30, 2007, compared to the same period in 2006.

The following tables include the condensed consolidated average balance sheet, an analysis of interest income/expense and average yield/rate for each major category of earning assets and interest bearing liabilities on a taxable equivalent basis. Interest income for tax-exempt securities and loans has been adjusted to a taxable-equivalent basis using the statutory Federal income tax rate of 35%.