Trustco Bank - 10-Q quarterly report FY

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

(Exact name of registrant as specified in its charter)

 

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.  xYes    oNo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

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

 

oYes   TNo

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

See accompanying notes to unaudited consolidated interim financial statements.

See accompanying notes to unaudited consolidated interim financial statements.

(Unaudited)

The unaudited Consolidated Interim Financial Statements of TrustCo Bank Corp NY (the Company) include the accounts of the subsidiaries after elimination of all significant intercompany accounts and transactions.  Prior period amounts are reclassified when necessary to conform to the current period presentation.  The net income reported for the nine months ended September 30, 2007 is not necessarily indicative of the results that may be expected for the year ending December 31, 2007, or any interim periods.

In the opinion of the management of the Company, the accompanying unaudited Consolidated Interim Financial Statements contain all adjustments necessary to present fairly the financial position as of September 30, 2007 and the results of operations for the three months and nine months ended September 30, 2007 and 2006 and cash flows for the nine months ended September 30, 2007 and 2006.  The accompanying Consolidated Interim Financial Statements should be read in conjunction with the TrustCo Bank Corp NY year-end Consolidated Financial Statements, including notes thereto, which are included in TrustCo Bank Corp NY's 2006 Annual Report to Shareholders on Form 10-K.

A reconciliation of the component parts of earnings per share (EPS) for the three and nine month periods ended September 30, 2007 and 2006 follows:

There were approximately 2.7 million and 3.2 million stock options on average for the third quarter of 2007 and for the year-to-date 2007 periods, respectively, and 1.9 million for both the quarter and year-to-date periods in 2006, which if included, would have been antidilutive in the calculation of average shares outstanding for the quarters and nine month periods ended September 30, 2007 and 2006, respectively, and were therefore excluded from the earnings per share calculations.

3.         Benefit Plans

The table below outlines the components of the Company’s net periodic expense (benefit) recognized during the three month and nine month periods ended September 30, 2007 and 2006 for its pension and other postretirement benefit plans:

 

 

The Company previously disclosed in its consolidated financial statements for the year ended December 31, 2006, that it did not expect to make any contributions to its pension and postretirement benefit plans in 2007.  As of September 30, 2007, no contributions have been made.  The Company presently anticipates that it will not make any contributions in 2007.

 

Effective January 1, 2007 TrustCo elected early adoption of Statements of Financial Accounting Standards (“SFAS”) No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” (SFAS No. 159), and No. 157 “Fair Value Measurements” (SFAS No. 157).  SFAS No. 159, which was issued in February 2007, generally permits the measurement of selected eligible financial instruments at fair value at specified election dates.  SFAS No. 157 generally establishes the definition of fair value and expands disclosures about fair value measurement.  This statement establishes a hierarchy of the levels of fair value measurement techniques.  Upon adoption of SFAS No. 159, TrustCo elected to apply the fair value option for certain U.S. government sponsored enterprises securities with lower yields, which generally had longer duration, that were classified in the available for sale portfolio totaling approximately $517 million ($502 million at fair value).  Prior to the adoption of SFAS No. 159, the Company intended to hold these securities until a market price recovery or possibly to maturity.  The Company changed its intent with respect to these securities and therefore recorded these losses directly to undivided profits rather than current income based on the transition provisions of SFAS No. 159 by electing the fair value option for these securities.  As a result, unrealized losses, net of taxes, of $8.6 million were directly recorded to undivided profits. This charge to undivided profits had no overall impact on total shareholders’ equity because the fair value adjustment had previously been included as an element of shareholders’ equity in the accumulated other comprehensive income (loss) account, net of tax.

As a result of TrustCo’s fair value measurement election for the above financial instruments, TrustCo recorded $3.4 million of pre-tax unrealized trading gains in its first quarter earnings for the change in fair value of such instruments from the effective election date of January 1, 2007 to March 31, 2007.  Additionally, TrustCo sold in the second quarter all of these securities and recognized pre-tax trading losses of $2.8 million in the second quarter.  While the proceeds from this sale were initially invested in federal funds sold, the Company re-invested these proceeds by purchasing securities, primarily U.S. government sponsored enterprises, for its trading portfolio.  As of September 30, 2007 $451 million of U.S. government sponsored enterprises securities were held in the trading portfolio.  TrustCo believes that its adoption of the standard will have a positive impact on its ability to manage its investment portfolio because it will enable the Company to sell the securities that it has elected the fair value option for without recording other-than-temporary impairment on the remainder of the available-for-sale portfolio.  Additionally, recording the unrealized losses on these securities directly to undivided profits as part of the transition adjustment will benefit future periods net income because the loss was not realized in the income statement when the security was sold.

In determining the fair value for the trading account securities the Company utilized an independent bond pricing service.

The following table presents information relative to the assets identified for the fair value option of accounting as of the initial implementation date of January 1, 2007:

The securities transferred to trading account assets as of January 1, 2007 were included previously in the available for sale portfolio as Government sponsored enterprises.

TrustCo determined that it would be appropriate to account for certain of the Government sponsored enterprises securities at fair value based upon the relatively low interest rate on these bonds.  Government sponsored enterprises bonds held by Trustco Bank in the available for sale portfolio as of January 1, 2007 under a predetermined interest rate (generally 5.45% or below) were identified as bonds to be recorded at fair value (the bonds also had an average life to maturity of approximately 9 years).  Interest on trading account securities are recorded in the Consolidated Statements of Income based upon the coupon of the underlying bond and the par value of the securities.  Unrealized gains and losses on the trading account securities are recognized based upon the fair value at period end compared to the beginning of that period.

After the adoption of SFAS 159 as of January 1, 2007 there were $232.3 million of remaining Government sponsored enterprises obligations classified as available for sale securities which had gross unrealized losses of $3.3 million.  These securities are primarily higher yielding assets and generally had shorter terms to final maturity.  It is management’s intention that Government sponsored enterprises securities that remain in the Available for Sale portfolio after the adoption of SFAS 159 will be held to generate relatively higher yields or provide liquidity in the form of maturing or called securities.  Upon adoption of SFAS 159, the yield on the securities in the available for sale portfolio ranged from 4.30% to 5.82%, and had an average term to maturity of 7 years ranging from 2007 – 2019 final maturity.

The following tables presents the financial instruments recorded at fair value by the Company as of September 30, 2007 and for the three and nine month periods ended September 30, 2007.

Assets available for sale and trading account securities are fair valued utilizing an independent bond pricing service for identical assets or significantly similar securities.  The pricing service uses a variety of techniques to arrive at fair value including market maker bids, quotes and pricing models.  Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.  Other real estate owned fair value is determined by observable comparable sales and property valuation techniques.

TrustCo adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) as of January 1, 2007.  FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return.  As a result of the Company’s adoption of FIN 48, there were no required adjustments to the Company’s consolidated financial statements.

TrustCo has implemented certain tax return positions that have not been fully recognized for financial statement purposes based upon management’s evaluation of the probability of the benefit being realized.  For 2007 the Company has recognized interest expense on the potential settlement amount as an element of other expenses and nothing for potential tax penalties.

For the nine months ended September 30, 2007 the unrecognized tax benefit and change in that benefit from the beginning of the year is as follows:

(Dollars in thousands)

If the unrecognized tax benefit were to be recognized for financial reporting purposes the impact would be to decrease total tax expense by the balance not previously recognized (as of September 30, 2007 that amount would be $2.6 million, after tax).  Interest expense of $250 thousand has been recorded during 2007 and included in accrued expenses and other liabilities (no penalties have been accrued).  The total accrual for interest expense included in the statement of financial condition is $639 thousand and is included in accrued expenses and other liabilities.

The New York State tax returns are currently under audit for the periods that the unrecognized tax return position was initiated.  Open Federal tax years are 2003, 2004 and 2005, and for NYS they are 2002 through 2005.  The 2006 state and federal tax returns were filed in the third quarter of 2007.

The Company does not issue any guarantees that would require liability-recognition or disclosure, other than its standby letters of credit.  Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  Standby letters of credit generally arise in connection with lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers.  Contingent obligations under standby letters of credit totaled approximately $3.5 million at September 30, 2007 and represent the maximum potential future payments the Company could be required to make.  Typically, these instruments have terms of twelve months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements.  Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on-balance sheet instruments.  Company policies governing loan collateral apply to standby letters of credit at the time of credit extension.  Loan-to-value ratios are generally consistent with loan-to-value requirements for other commercial loans secured by similar types of collateral. The fair value of the Company’s standby letters of credit at September 30, 2007 was insignificant.

The Board of Directors and Shareholders

TrustCo Bank Corp NY:

We have reviewed the consolidated statement of financial condition of TrustCo Bank Corp NY and subsidiaries (the Company) as of September 30, 2007, and the related consolidated statements of income for the three and nine-month periods ended September 30, 2007 and 2006 and the related changes in shareholders’ equity and cash flows for the nine-month periods ended September 30, 2007 and 2006.  These consolidated financial statements are the responsibility of the Company's management.

We conducted our review in accordance with standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.  Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 4 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” as of January 1, 2007, and Staff Accounting Bulletin No. 108 “Considering the Effects of Prior Year Misstatements when Quantifying Misstatement In Current Year Financial Statements” as of January 1, 2006.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition of TrustCo Bank Corp NY and subsidiaries as of December 31, 2006, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated February 27, 2007, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying consolidated statement of  financial condition as of December 31, 2006 is fairly stated, in all material respects, in relation to the consolidated statement of financial condition from which it has been derived.

The review that follows focuses on the factors affecting the financial condition and results of operations of TrustCo Bank Corp NY ("TrustCo" or "Company") during the three-month and nine-month periods ended September 30, 2007, with comparisons to 2006 as applicable.  Net interest margin is presented on a fully taxable equivalent basis in this discussion.  The consolidated interim financial statements and related notes, as well as the 2006 Annual Report to Shareholders should be read in conjunction with this review.  Amounts in prior period consolidated interim financial statements are reclassified whenever necessary to conform to the current period's presentation.

Statements included in this review and in future filings by TrustCo with the Securities and Exchange Commission, in TrustCo's press releases, and in oral statements made with the approval of an authorized executive officer, which are not historical or current facts, are "forward-looking statements" made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected.  TrustCo wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made.  The following important factors, among others, in some cases have affected and in the future could affect TrustCo's actual results, and could cause TrustCo's actual financial performance to differ materially from that expressed in any forward-looking statement: (1) credit risk, (2) interest rate risk, (3) competition, (4) changes in the regulatory environment, and (5) changes in market area and general business and economic trends.  The foregoing list should not be construed as exhaustive, and the Company disclaims any obligation to subsequently revise any forward-looking statements to reflect events or circumstances after the date of such statements, or to reflect the occurrence of anticipated or unanticipated events.

Following this discussion is the table "Distribution of Assets, Liabilities and Shareholders' Equity: Interest Rates and Interest Differential" which gives a detailed breakdown of TrustCo's average interest earning assets and interest bearing liabilities for the three months and nine months ended September 30, 2007 and 2006.

As a result of TrustCo’s fair value measurement election for the above financial instruments, TrustCo recorded $3.4 million of pre-tax unrealized trading gains in its first quarter earnings for the change in fair value of such instruments from the effective election date of January 1, 2007 to March 31, 2007.  Additionally, TrustCo sold in the second quarter all of these securities and recognized pre-tax trading losses of $2.7 million in the second quarter.  While the proceeds from this sale were initially invested in federal funds sold, the Company re-invested these proceeds by purchasing securities, primarily United States Government sponsored enterprises, for its trading portfolio.  As of September 30, 2007 $451 million of US Government sponsored enterprises securities were purchased for the trading portfolio.  TrustCo believes that its adoption of the standard will have a positive impact on its ability to manage its investment portfolio because it will enable the Company to sell the securities that it has elected the fair value option for without recording other-than-temporary impairment on the remainder of the available-for-sale portfolio.  Additionally, recording the unrealized losses on these securities directly to undivided profits as part of the transition adjustment will benefit net income because the loss was not realized in the income statement when the security was sold.

As already stated, the Company recorded a $8.6 million charge to undivided profits as a result of adopting SFAS No. 159 as of January 1, 2007.  Had the Company not adopted this new accounting standard and reclassified the available for sale securities to trading account assets as of that date, the charge to capital would have been recorded as a charge to net income.

In determining the fair value for the trading account securities the Company utilized an independent bond pricing service.

The following table presents information relative to the assets identified for the fair value option of accounting as of the initial implementation date of January 1, 2007:

The securities transferred to trading account assets as of January 1, 2007 were included previously in the available for sale portfolio as Government sponsored enterprises.

TrustCo determined that it would be appropriate to account for certain of the U.S. government sponsored enterprises securities at fair value based upon the relatively low interest rate on these bonds.  U.S. government sponsored enterprises bonds held by Trustco Bank in the available for sale portfolio as of January 1, 2007 under a predetermined interest rate (generally 5.45% or below) were identified as bonds to be recorded at fair value (the bonds also had an average life to maturity of approximately 9 years).  Interest on trading account securities are recorded in the Consolidated Statements of Income based upon the coupon of the underlying bond and the par value of the securities.  Unrealized gains and losses on the trading account securities are recognized based upon the fair value at period end compared to the beginning of that period.

After the adoption of SFAS 159 as of January 1, 2007 there were $232.3 million of remaining U.S. government sponsored enterprises obligations classified as available for sale securities which had gross unrealized losses of $3.3 million.  These securities are primarily higher yielding assets and generally had shorter terms to final maturity.  It is management’s intention that U.S. government sponsored enterprises securities that remain in the Available for Sale portfolio after the adoption of SFAS 159 will be held to generate relatively higher yields or provide liquidity in the form of maturing or called securities.

The following tables present the financial instruments recorded at fair value by the Company as of September 30, 2007 and for the three and nine month periods ended September 30, 2007.

Assets available for sale and trading account securities are fair valued utilizing an independent bond pricing service for identical assets or significantly similar securities.  The pricing service uses a variety of techniques to arrive at fair value including market maker bids, quotes and pricing models.  Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.  Other real estate owned fair value is determined by observable comparable sales and property valuation techniques.

TrustCo adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) as of January 1, 2007.  FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return.  As a result of the Company’s adoption of FIN 48, there were no required adjustments to the Company’s consolidated financial statements.

TrustCo has implemented certain tax return positions that have not been fully recognized for financial statement purposes based upon management’s evaluation of the probability of the benefit being realized.  For 2007 the Company has recognized interest expense on the potential settlement amount as an element of other expenses and nothing for potential tax penalties.

For the nine months ended September 30, 2007 the unrecognized tax benefit and change in that benefit from the beginning of the year is as follows:

If the unrecognized tax benefit were to be recognized for financial reporting purposes the impact would be to decrease total tax expense by the balance not previously recognized (as of September 30, 2007 that amount would be $2.6 million, after tax).  Interest expense of $250 thousand has been recorded during 2007 and included in accrued expenses and other liabilities (no penalties have been accrued).  The total accrual for interest expense included in the statement of financial condition is $639 thousand and is included in accrued expenses and other liabilities.

The New York State tax returns are currently under audit for the periods that the unrecognized tax return position was initiated.  Open Federal tax years are 2003, 2004 and 2005, and for NYS they are 2002 through 2005.  The 2006 state and federal tax returns were filed in the third quarter of 2007.

TrustCo recorded net income of $10.6 million, or $0.141 of diluted earnings per share for the three months ended September 30, 2007, as compared to net income of $11.2 million or $0.149 of diluted earnings per share in the same period in 2006.  For the nine-month period ended September 30, 2007, TrustCo recorded net income of $31.1 million, or $0.413 per diluted earnings per share as compared to $36.0 million, or $0.479 of diluted earnings per share for the comparable period in 2006.

The primary factors accounting for the year to date changes were:

The Company strives to generate its earnings capabilities through a mix of core deposits, funding a prudent mix of earning assets.  Additionally, TrustCo attempts to maintain adequate liquidity and reduce the sensitivity of net interest income to changes in interest rates to an acceptable level while enhancing profitability both on a short-term and long-term basis.

The following Management’s Discussion and Analysis for the third quarter and first nine months of 2007 compared to the comparable periods in 2006 is greatly affected by the change in interest rates in the marketplace in which TrustCo competes.  Included in the 2006 Annual Report to Shareholders is a description of the effect interest rates had on the results for the year 2006 compared to 2005.  Most of the same market factors discussed in the 2006 Annual Report also had a significant impact on the second quarter and year-to-date 2007 results.

TrustCo competes with other financial service providers based upon many factors including quality of service, convenience of operations, and rates paid on deposits and charged on loans.  The absolute level of interest rates, changes in rates and customers’ expectations with respect to the direction of interest rates have a significant impact on the volume of loan and deposit originations in any particular period.

One of the most important interest rates used to control national economic policy is the “federal funds” rate.  This is the interest rate utilized for institutions with the highest credit quality rating. The federal funds rate remained unchanged from the second quarter of 2006 until it was reduced by 50 basis points to 4.75% on September 18, 2007.  Since early 2006, the yield curve has frequently been flat or mildly inverted, as opposed to the more typical positively sloped curve.  A flat yield curve refers to an environment where market interest rates are approximately the same for short and long terms securities of the same type.  In an inverted curve, short term rates are higher than long term rates and in a positively sloped curve, long term rates are higher than short term rates.  The Federal Reserve has indicated its intention to continue to monitor economic expansion in the United States economy which may require additional changes in the federal funds rate subsequent to September 30, 2007.

These changes in interest rates have an effect on the Company relative to the interest income on loans, securities and federal funds sold as well as on interest expense on deposits and borrowings.  New originations of residential real estate loans and new purchases of longer-term investments are most affected by the changes in longer term market interest rates such as the 10 year treasury.  The federal funds sold portfolio and other short term investments along with short term securities classified as trading are affected primarily by changes in the federal funds target rate.  Deposit interest rates are most affected by the short term market interest rates.  Also, changes in interest rates have an effect on the recorded balance of the securities available for sale portfolio (with the offset to accumulated other comprehensive income) and trading portfolio (with the offset to earnings), which are recorded at fair value.

Generally as interest rates increase the fair value of these securities will decrease.

The principal loan product for TrustCo is residential real estate loans.  Interest rates on new residential real estate loan originations are influenced by the rates established by secondary market participants such as Freddie Mac and Fannie Mae.  Because TrustCo is a portfolio lender and does not typically sell loans into the secondary market, the Company establishes rates that management determines are appropriate in relation to the long-term nature of a residential real estate loan, while remaining competitive with the secondary market rates.

For the third quarter of 2007, the net interest margin decreased to 3.10% from 3.46% for the third quarter of 2006.  The quarterly results reflect the following significant factors:

During the third quarter of 2007 the Company’s strategy was to expand the loan portfolio by offering competitive interest rates as the rate environment changed.  The TrustCo residential real estate loan product is very competitive compared to local and national competitors.  The widespread disruptions in the mortgage market have not had a significant impact on TrustCo, partly because the Company has not originated the types of loans that have been responsible for many of the problems causing the disruptions.  The average balance of federal funds sold and other short-term investments increased, primarily reflecting the Company’s strong deposit growth.

The strategy on the funding side of the balance sheet continues to be to attract customers to the Company based upon a combination of service, convenience and interest rate.  The Company offered attractive long-term deposit rates as part of a strategy to lengthen deposit lives.  This strategy has been successful but has also resulted in part of the increase in the deposit costs.

The average balance of loans was $1.88 billion in the third quarter of 2007 and $1.65 billion in the comparable period in 2006.  The yield on loans increased 11 basis points to 6.58%.  The higher average balances and higher yield both contributed to an increase in the interest income on loans of $4.3 million.

For the first nine months of 2007, average loans increased $257.9 million to $1.83 billion and the average yield increased by 1 basis point to 6.51%.

Compared to the third quarter of 2006, the average balance of the loan portfolio during the third quarter of 2007 increased in all loan categories.  The average balance of residential mortgage loans was $1.18 billion in 2006 compared to $1.37 billion in 2007, an increase of 16.0%.  The average yield on residential mortgage loans increased by 3 basis points to 6.24% in 2007 compared to 2006.

TrustCo actively markets the residential loan products within its market territory.  Mortgage loan rates are affected by a number of factors including rates on treasury securities, the federal funds rate and rates set by competitors and secondary market participants.  As noted earlier, market interest rates have changed significantly as a result of national economic policy in the United States.  During this period of changing interest rates TrustCo aggressively marketed the unique aspects of its loan products thereby attempting to create a differentiation from other lenders.  These unique aspects include extremely low closing costs, fast turn around time on loan approvals, no escrow or mortgage insurance requirements and the fact that the Company typically holds these loans in portfolio and does not sell them into the secondary markets.  Assuming a rise in long-term interest rates, the Company would anticipate that the unique features of its loan product will continue to attract customers in the residential mortgage loan area.

Commercial loans, which consist primarily of loans secured by commercial real estate, increased 19.2% to an average balance of $280.4 million in the third quarter of 2007 over the prior year.  The significant increase in balances is partly due to fewer competitors focusing on this sector.  The average yield on this portfolio decreased 6 basis points to 7.58% over the same period.

The average yield on home equity credit lines of credit increased 78 basis points to 7.18% during the third quarter of 2007 compared to 2006.  The improvement in yield was the result of existing loans repricing from low initial rates to the regular indexed rate as well as a decision to significantly reduce the introductory rate discount on new loans.  The average balances of home equity lines increased 0.5% to $230.7 million in the third quarter of 2007 as compared to the prior year.

The average balance of the securities available-for-sale portfolio for the third quarter of 2007 was $544.1 million compared to $1.12 billion for the comparable period in 2006.  The average yield was 5.48% for the third quarter of 2007 and 5.32% for the third quarter of 2006.  The increase in yield is a result of the higher yielding assets in the securities available-for-sale portfolio after the transfer of assets to trading securities.  The changes in balances between the two time periods was primarily due to the transfer of bonds to the trading portfolio and to a lesser degree was due to paydowns on mortgage backed securities, and purchases, calls and maturities of bonds.

Similar to the third quarter, for the first nine months of 2007, average securities available-for-sale were $528.2 million, compared to $1.12 billion in the comparable 2006 period.  The average yield increased from 5.31% to 5.47%.

The average balance of trading securities for the third quarter of 2007 was $450.3  There were no trading securities in 2006.  The average yield was 5.22% for 2007.

For the first nine months of 2007, average trading securities were $440.5 million.  The average year-to-date yield was 5.32%.

All of the securities in this portfolio are bonds issued by Government Sponsored Enterprises (FNMA, FHLB, and Freddie Mac issued bonds).  The balances for these bonds are recorded at fair value.

As of September 30, 2007 $450.2 million of U.S. government sponsored enterprises securities were purchased for the trading portfolio.

The average balance of held-to-maturity securities for the third quarter of 2007 was $15.1 million.  There were no held-to-maturity securities in 2006.  The average yield was 5.91% for 2007.

For the first nine months of 2007, average held-to-maturity securities were $5.1 million.  The average year-to-date yield was 5.89%.

All of the securities in this portfolio are bonds issued by Government Sponsored Enterprises (FNMA, FHLB, and Freddie Mac issued bonds).  The balances for these bonds are recorded at amortized cost.

The 2007 third quarter average balance of federal funds sold and other short-term investments was $377.7 million, $227.7 million more than the $150.0 million average in 2006.  The portfolio yield decreased from 5.32% in 2006 to 5.21% in 2007.  Changes in the yield resulted from changes in the target rate set by the Federal Reserve Board for federal funds sold.  Interest income on this portfolio increased by approximately $2.9 million from $2.0 million in 2006 to $4.9 million in 2007.

For the first nine months of 2007, federal funds sold and other short-term investments averaged $388.5 million, compared to $187.1 million in the prior year.  The yield improved to 5.24% from 4.84%, reflecting the change in the fed funds target rate.

The federal funds sold and other short-term investments portfolio is utilized to generate additional interest income and liquidity as funds are waiting to be deployed into the loan and securities portfolios.

TrustCo utilizes various funding sources to support its earning asset portfolio.  The vast majority of the Company’s funding comes from traditional deposit vehicles such as savings, demand deposits, interest-bearing checking and time deposit accounts.

Total average interest-bearing deposits (which includes interest bearing checking, money market accounts, savings, and certificates of deposit) increased from $2.40 billion during the third quarter of 2006 to $2.75 billion in the third quarter of 2007, and the average rate paid increased from 2.89% for 2006 to 3.37% for 2007.  Total interest expense on these deposits increased $5.9 million to $23.3 million.

For the first nine months of 2007 average interest-bearing deposits were $2.68 billion, an increase of $319.7 million over the prior year and the cost of these funds increased to 3.32% from 2.72% over this time frame.

Average short-term borrowings for the quarter were $93.3 million in 2007 compared to $95.2 million in 2006.  The average rate decreased during this time period from 4.12% in 2006 to 4.00% in 2007.  Rates on short-term borrowings tend to change with the rates on the target Federal Funds.

For the first nine months of 2007, average short-term borrowings were $95.8 million in 2007 compared to $95.4 million in 2006.  The average rate increased during this time period from 3.82% in 2006 to 4.08% in 2007.

Net interest income was $74.6 million in the first nine months of 2007, a decline of $2.5 million versus the comparable period in 2006.  The net interest spread declined 50 basis points to 2.67%, while the net interest margin declined 46 basis points to 3.11%.

Nonperforming loans: Total nonperforming loans were $8.9 million at September 30, 2007, an increase from the $7.1 million of nonperforming loans at December 31, 2006 and the $6.3 million of nonperforming loans at September 30, 2006.  There were $7.8 million of nonaccrual loans at September 30, 2007 compared to the $5.7 million at December 31, 2006 and $5.1 million at September 30, 2006.  Restructured loans were $842 thousand at September 30, 2007 compared to the $1.2 million at both December 31, 2006 and September 30, 2006.  There were $272 thousand of loans at September 30, 2007 that were past due 90 days or more and still accruing interest, compared to $211 thousand at December 31, 2006 and $40 thousand at September 30, 2006.

Substantially all of the nonperforming loans at September 30, 2007 and 2006 are residential real estate or retail consumer loans.  Since 2000, there has been a continued shifting in the components of TrustCo’s problem loans and charge-offs from commercial and commercial real estate to the residential real estate and retail consumer loan portfolios.

TrustCo strives to identify borrowers that are experiencing financial difficulties and to work aggressively with them so as to minimize losses or exposures.

Total impaired loans at September 30, 2007 were $917 thousand, and consisted of restructured retail loans as well as one commercial mortgage.  During the third quarter of 2007, there were $167 thousand of commercial loan charge offs, $179 thousand of consumer loan charge offs and $486 thousand of residential mortgage loan charge-offs as compared with $19 thousand commercial loan charge-offs, $95 thousand of consumer loan charge-offs and $242 thousand of residential mortgage loan charge-offs in the third quarter of 2006.  Recoveries during the quarter were $478 thousand in 2007 and $691 thousand in 2006.

Allowance for loan losses: The balance of the allowance for loan losses is maintained at a level that is, in management’s judgment, representative of the amount of risk inherent in the loan portfolio.

At September 30, 2007, the allowance for loan losses was $34.7 million, which represents a decrease from the $35.6 million in the allowance at December 31, 2006.  The allowance represents 1.82% of the loan portfolio as of September 30, 2007 compared to 2.02% at December 31, 2006.  The provision for loan losses was zero for the quarter ended September 30, 2007 and for the year earlier quarter due to the continuation of the positive credit quality indicators, offset to a degree by loan growth.  The loan loss provision was also zero for the first nine months of 2007, compared to a credit $3.6 million for the first nine months of 2006.  The change in the provision/credit for loan losses is partially reflective of the change in the net charge off/ recovery from 2006 to 2007.  Net charge offs for the nine month period ended September 2007 were approximately $833 thousand compared to net recoveries of $1.4 million for the comparable period in 2006.  In deciding on the adequacy of the allowance for loan losses, management reviews the current nonperforming loan portfolio as well as loans that are past due and not yet categorized as nonperforming for reporting purposes.  Also, there are a number of other factors that are taken into consideration, including:

Management continues to monitor these factors in determining future provisions or credits for loan losses in relation to the economic environment, loan charge-offs, recoveries and the level and trends of nonperforming loans.

Total noninterest income for the third quarter was $4.8 million, compared to $3.9 million in 2006, an increase of 22.0%.  For the first nine months of 2007, noninterest income totaled $13.4 million, compared to $11.1 million in the comparable 2006 period, an increase of 20.9%.

Trust department income increased 4.7% to $1.4 million for the third quarter of 2007 compared to $1.3 million in the third quarter of 2006. Trust department assets under management were $950 million at September 30, 2007 compared to $872 million at September 30, 2006.  On a year-to-date basis, trust income was up 6.2% to $4.3 million, due primarily to higher average valuation of assets under management in the first nine months of the current year compared to the same period in 2006.

Fees for other services to customers increased by 7.0% to $2.4 million between the third quarter of 2006 and the comparable period in 2007.  The increase is the result of changes in fee policies as well as fees being charged on a larger customer base.  For the first nine months, fees were up 11.9% to $7.0 million.

The Company recognized $305 thousand of net trading gains in the third quarter of  2007.  For the first nine months of 2007, trading gains of $906 thousand were recognized, compared to zero in the same period in 2006.  On a year-to-date basis, the impact of net gains in the available for sale and trading portfolios, relative to the same period in 2006, resulted in an improvement of $1.4 million in non-interest income.

Total noninterest expense increased from $11.7 million for the three months ended September 30, 2006 to $13.6 million for the three months ended September 30, 2007, with increases in each expense category.  Salaries and employee benefits increased $615 thousand to $5.3 million for 2007.  Higher salaries and benefits are primarily due to increased staffing related to the branch expansion initiative and the impact of extended service hours.  Net occupancy expense increased $707 thousand to $2.6 million during the third quarter of 2007.  The increase is the result of new branch lease costs and the increased cost of utilities and taxes on branch locations.

In the third quarter of 2007, TrustCo recognized income tax expense of $5.1 million as compared to $5.4 million for 2006.  The effective tax rates were 32.3% and 32.5% for the third quarter of 2007 and 2006, respectively.  The tax expense on the Company’s income was different than tax expense at the statutory rate of 35%, due primarily to tax exempt income and the effect of state income taxes.

For the first nine months of 2007, income taxes were $14.9 million, compared to $17.9 million in 2006 and the tax rate declined from 33.2% to 32.4%.

Consistent with its long-term goal of operating a sound and profitable financial organization, TrustCo strives to maintain strong capital ratios.  New issues of equity securities have not been required since traditionally, most of its capital requirements are met through capital retention.

Total shareholders’ equity at September 30, 2007 was $234.8 million, a decrease from the $239.5 million at year-end 2006. TrustCo declared dividends of $0.160 per share in the third quarter of 2007.  This results in a dividend payout ratio of 113.0% in 2007. TrustCo expects to manage this ratio down.  A dividend payout ratio in excess of 100% is not sustainable indefinitely, particularly given growth in the Company’s asset base.

The Company achieved the following ratios as of September 30, 2007 and 2006: