UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
Amendment No.1
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-26481
[LOGO] Financial Institutions, Inc.
(Exact Name of Registrant as specified in its charter)
NEW YORK 16-0816610
(State of Incorporation) (I.R.S. Employer Identification Number)
220 Liberty Street Warsaw, NY 14569
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number Including Area Code:
(585) 786-1100
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant to Section 12(g) of the Act: Title of Class:
COMMON STOCK, PAR VALUE $.01 PER SHARE
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 twelve 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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
YES |X| NO |_|
Aggregate market value of common stock held by non-affiliates of the registrant,
computed by reference to the closing price as of close of business on June 30,
2003 was $181,724,967.
As of March 1, 2004 there were issued and outstanding, exclusive of treasury
shares, 11,172,673 shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's proxy statement to be filed with the Securities and
Exchange Commission in connection with the 2004 Annual Meeting of Shareholders
are incorporated by reference in Part III of this Annual Report on Form 10-K.
Explanatory Note
This Form 10-K/A is being filed solely to correct typographical errors generated
during the edgarization process in Item 8 of Financial Institutions Inc.'s
Annual Report on Form 10-K for the year ended December 31, 2003, filed with the
Securities and Exchange Commission on March 12, 2004. Specifically, in the
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive
Income on page 53, data in the line items associated with the purchase of
preferred stock in 2001 and 2003 were inadvertently shifted to the wrong column.
The amendment conforms the Form 10-K as filed to the version that was certified
by Financial Institution Inc.'s Chief Executive Officer and Chief Financial
Officer, pursuant to Rules 13a-14(a) and 13a-14(b) under the Securities Exchange
Act of 1934, as amended (Exchange Act). No other changes are being made by means
of this filing.
FINANCIAL INSTITUTIONS, INC.
2003 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
Item 1. Business 3
Item 2. Properties 25
Item 3. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters 26
Item 6. Selected Financial Data 27
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 29
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 48
Item 8. Financial Statements and Supplementary Data 51
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 83
Item 9A. Controls and Procedures 83
PART III
Item 10. Directors and Executive Officers of the Registrant 83
Item 11. Executive Compensation 84
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 84
Item 13. Certain Relationships and Related Transactions 85
Item 14. Principal Accountant Fees and Services 86
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 86
2
PART I
Item I. Business
Forward Looking Statements
This Annual Report on Form 10-K contains forward-looking statements, which can
be identified by the use of such words as estimate, project, believe, intend,
anticipate, plan, seek, expect and similar expressions. These statements are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995 and may include:
o statements regarding our business plans, and prospects;
o statements of our goals, intentions and expectations;
o statements regarding our growth and operating strategies;
o statements regarding the quality of our loan and investment
portfolios; and
o estimates of our risks and future costs and benefits.
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In order to comply with the terms of the safe
harbor, the Company notes that a variety of factors could cause the Company's
actual results and experience to differ materially from the anticipated results
or other expectations expressed in the Company's forward-looking statements.
Some of the risks and uncertainties that may affect the operations, performance,
development and results of the Company's business, the interest rate sensitivity
of its assets and liabilities, and the adequacy of its allowance for loan
losses, include but are not limited to the following:
o significantly increased competition among depository and other
financial institutions;
o changes in the interest rate environment that reduces our margins or
the fair value of financial instruments;
o general economic conditions, either nationally or in our market
areas, that are worse than expected;
o declines in the value of real estate, equipment, livestock and other
assets serving as collateral for our loans outstanding;
o legislative or regulatory changes that adversely affect our
business;
o changes in consumer spending, borrowing and savings habits; and
o changes in accounting policies and practices, as generally accepted
in the United States of America.
The Company cautions readers not to place undue reliance on any forward-looking
statements, which speak only as of the date made, and advises readers that
various factors, including those described above, 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.
Except as required by law, the Company does not undertake, and specifically
disclaims any obligation, to publicly release any revisions to any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
3
General
Financial Institutions, Inc. (the "Company" or "FII") is a bank holding company
headquartered in Warsaw, New York, which is located 45 miles southwest of
Rochester and 45 miles southeast of Buffalo. The Company operates a
super-community bank holding company - a bank holding company that owns multiple
community banks that are separately managed.
The Company owns four commercial banks that provide consumer, commercial and
agricultural banking services in Western and Central New York State: Wyoming
County Bank ("WCB"), National Bank of Geneva ("NBG"), First Tier Bank & Trust
("FTB") and Bath National Bank ("BNB"), collectively referred to as the "Banks".
During 2002, the Company completed a geographic realignment of the subsidiary
banks, which involved the merger of the subsidiary formerly known as The
Pavilion State Bank ("PSB") into NBG and transfer of other branch offices
between subsidiary banks. In September 2003 the Boards of Directors of the
Company's two national bank subsidiaries, NBG and BNB entered into formal
agreements with their primary regulator, the Office of the Comptroller of the
Currency ("OCC"). Under the terms of the agreements, NBG and BNB, without
admitting any violations agreed to take various actions to reduce the level of
credit risk in the banks, including reviewing loan policies, charge-off policies
for nonaccrual loans, real property appraisal standards, insider lending and
overdraft policies and affiliate transactions, and adopting capital plans to
ensure levels of risk-based capital at higher than minimum levels. Pursuant to
these agreements, the banks have taken actions required by the agreements to
ensure that their operations are in accordance with applicable laws and
regulations.
The Company formerly qualified as financial holding company under the
Gramm-Leach-Bliley Act (see discussion beginning on page 19), which allowed FII
to expand business operations to include financial services businesses. The
Company currently has two financial services subsidiaries: The FI Group, Inc.
("FIGI") and Burke Group, Inc. ("BGI"), collectively referred to as the
"Financial Services Group" ("FSG"). FIGI is a brokerage subsidiary that
commenced operations as a start-up company in March 2000. BGI is an employee
benefits and compensation consulting firm acquired by the Company in October
2001. During 2003, the Company terminated its financial holding company status
and now operates as a bank holding company. The change in status did not affect
the non-financial subsidiaries or activities being conducted by the Company,
although future acquisitions or expansions of non-financial activities may
require prior Federal Reserve Board approval and will be limited to those that
are permissible for bank holding companies.
In February 2001, the Company formed FISI Statutory Trust I ("FISI" or "Trust")
(100% owned) and capitalized the trust with a $502,000 investment in FISI's
common securities. The Trust was formed to accommodate the private placement of
$16.2 million in capital securities ("trust preferred securities"), the proceeds
of which were utilized to partially fund the acquisition of BNB. Effective
December 31, 2003, the provisions of FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities," resulted in the deconsolidation of the Company's
wholly-owned Trust. The deconsolidation resulted in the derecognition of the
$16.2 million in trust preferred securities and the recognition of $16.7 million
in junior subordinated debentures and a $502,000 investment in the subsidiary
trust recorded in other assets in the Company's 2003 consolidated statement of
financial position.
As a super-community bank holding company, the Company's strategy has been to
manage its bank subsidiaries on a decentralized basis. This strategy provides
the Banks the flexibility to efficiently serve their markets and respond to
local customer needs. While generally operating on a decentralized basis, the
Company has consolidated selected lines of business, operations and support
functions in order to achieve economies of scale, greater efficiency and
operational consistency. In furtherance of this objective, in September 2002,
the Company added a Credit Administration Department at the holding company to
review company-wide credit policies and strengthen overall credit
administration.
4
Available Information
This annual report, including the exhibits and schedules filed as part of the
annual report, may be inspected at the public reference facility maintained by
the Securities and Exchange Commission ("SEC") at its public reference room at
450 Fifth Street, NW, Washington, DC 20549 and copies of all or any part thereof
may be obtained from that office upon payment of the prescribed fees. You may
call the SEC at 1-800-SEC-0330 for further information on the operation of the
public reference room and you can request copies of the documents upon payment
of a duplicating fee, by writing to the SEC. In addition, the SEC maintains a
website that contains reports, proxy and information statements and other
information regarding registrants, including us, that file electronically with
the SEC which can be accessed at www.sec.gov.
The Company also makes available, free of charge through its website at
www.fiiwarsaw.com, all reports filed with the SEC, including our Annual Report
on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as
well as any amendments to those reports, as soon as reasonably practicable after
those documents are filed with, or furnished to, the SEC. Information available
on our website is not a part of, and should not be incorporated into, this
annual report on Form 10-K.
Market Area and Competition
The Company provides a wide range of consumer and commercial banking and
financial services to individuals, municipalities and businesses through a
network of 48 branches and 69 ATMs in fifteen contiguous counties of Western and
Central New York State: Allegany, Cattaraugus, Cayuga, Chautauqua, Chemung,
Erie, Genesee, Livingston, Monroe, Ontario, Schuyler, Seneca, Steuben, Wyoming
and Yates Counties.
The Company's market area is geographically and economically diversified in that
it serves both rural markets and, increasingly, the larger more affluent markets
of suburban Rochester and suburban Buffalo. Rochester and Buffalo are the two
largest cities in New York State outside of New York City, with combined
metropolitan area populations of over two million people. The Company
anticipates increasing its presence in the markets around these two cities.
The Company faces significant competition in both making loans and attracting
deposits, as Western and Central New York have a high density of financial
institutions. The Company's competition for loans comes principally from
commercial banks, savings banks, savings and loan associations, mortgage banking
companies, credit unions, insurance companies and other financial service
companies. Its most direct competition for deposits has historically come from
savings and loan associations, savings banks, commercial banks and credit
unions. The Company faces additional competition for deposits from
non-depository competitors such as the mutual fund industry, securities and
brokerage firms and insurance companies.
Operating Segments
The relative asset size, profitability and average number of full-time
equivalent employees ("FTEs") of the Company's operating segments as of or for
the year ended December 31, 2003, are depicted in the following table:
(Dollars in thousands)
Percent Net Income Percent Average Percent
Subsidiary Assets of Total (Loss) of Total FTEs of Total
-----------------------------------------------------------------------------------------------------
Wyoming County Bank $ 754,639 35% $ 9,042 63% 168 23%
National Bank of Geneva 721,374 33 151 1 190 27
Bath National Bank 462,113 21 4,108 29 133 19
First Tier Bank & Trust 225,080 11 2,117 15 67 9
Financial Services Group 5,135 -- (115) (1) 50 7
Parent and eliminations, net 5,391 (1,056) (7) 106 15
---------- -------- -------- -------- -------- --------
Total $2,173,732 100% $ 14,247 100% 714 100%
========== ======== ======== ======== ======== ========
5
Mergers and Acquisitions
On December 13, 2002, BNB acquired two Chemung County branch offices of BSB Bank
& Trust Company of Binghamton, New York. The two offices purchased, located in
Elmira and Elmira Heights, had deposit liabilities totaling $44.2 million at the
time of acquisition. The acquisition was accounted for as a business combination
using the purchase method of accounting, and accordingly, the excess of the
purchase price over the fair value of identifiable tangible and intangible
assets acquired, less liabilities assumed, of approximately $1.5 million has
been recorded as goodwill. In accordance with Statement of Financial Accounting
Standard (SFAS) No. 142, "Goodwill and Other Intangible Assets," the Company is
not required to amortize goodwill recognized in this acquisition. The Company
also recorded a $2.0 million intangible asset attributable to core deposits,
which is being amortized using the straight-line method over seven years.
On May 1, 2002, FII acquired all of the common stock of the Bank of Avoca
("BOA") in exchange for 47,036 shares of FII common stock. BOA was a community
bank with its main office located in Avoca, New York, as well as a branch office
in Cohocton, New York. Subsequent to the acquisition, BOA was merged with BNB.
The acquisition was accounted for as a business combination using the purchase
method of accounting, and accordingly, the excess of the purchase price ($1.5
million) over the fair value of identifiable tangible and intangible assets
acquired ($18.4 million), less liabilities assumed ($17.3 million), of
approximately $0.4 million has been recorded as goodwill. In accordance with
SFAS No. 142, the Company is not required to amortize goodwill recognized in
this acquisition. The Company recorded a $146,000 core deposit intangible asset,
which is being amortized using the straight-line method over seven years. The
results of operations for BOA are included in the income statements from the
date of acquisition (May 1, 2002).
On October 22, 2001, the Company acquired the Burke Group, Inc. ("BGI"); an
employee benefits administration and compensation consulting firm, with offices
in Honeoye Falls and Syracuse, New York. BGI's expertise includes design and
consulting for retirement and employee welfare plans, administrative services
for defined contribution and benefit plans, actuarial services and post
employment benefits. Under the terms of the agreement, BGI shareholders received
primarily common stock as consideration for their ownership in BGI. The
acquisition was accounted for as a business combination using the purchase
method of accounting, and accordingly, the excess of the purchase price ($3.3
million including earned amounts and contingent amounts to date, see Note 2 of
the notes to consolidated financial statements for additional discussion
regarding the merger consideration) over the fair value of identifiable tangible
and intangible assets acquired ($1.7 million), less liabilities assumed ($1.7
million), of approximately $3.3 million has been recorded as goodwill. In
accordance with SFAS No. 142, the Company is not required to amortize goodwill
recognized in this acquisition. The Company also recorded a $500,000 intangible
asset for a customer list that is being amortized using the straight-line method
over five years. The results of operations for BGI are included in the income
statements from the date of acquisition (October 22, 2001).
On May 1, 2001, FII acquired all of the common stock of BNC, and its wholly
owned subsidiary bank, BNB. BNB is a full service community bank headquartered
in Bath, New York, which had 9 branch locations in Steuben, Yates, Ontario and
Schuyler Counties. The Company paid $48.00 per share in cash for each of the
outstanding shares of BNC common stock with an aggregate purchase price of
approximately $62.6 million. The acquisition was accounted for under the
purchase method of accounting, and accordingly, the excess of the purchase price
($62.6 million) over the fair value of identifiable tangible and intangible
assets acquired ($295.4 million), less liabilities assumed ($269.9 million), of
approximately $37.1 million has been recorded as goodwill. Goodwill was
amortized in 2001 using the straight-line method over 15 years, since the
transaction was consummated prior to June 30, 2001, the effective date of SFAS
No. 142. However, in accordance with SFAS No. 142, the Company ceased goodwill
amortization on January 1, 2002. The results of operations for BNB are included
in the income statements from the date of acquisition (May 1, 2001).
6
Lending Activities
General. The Company, through its banking subsidiaries, offers a broad range of
loans including commercial and agricultural working capital and revolving lines
of credit, commercial and agricultural mortgages, equipment loans, crop and
livestock loans, residential mortgage loans and home equity lines of credit,
home improvement loans, student loans, automobile loans, personal loans and
credit cards. Under the Company's decentralized management philosophy, each of
the banks determines individually which loans are sold and which are retained
for the portfolio. However, most newly originated fixed rate residential
mortgage loans are sold in the secondary market. The Company retains the
servicing rights on most mortgage loans it sells and realizes monthly service
fee income.
Underwriting Standards. During 2003, the Company expanded the role of the
position formerly known as Chief Credit Officer to Chief Risk Officer in an
effort to better manage overall corporate risk. The Credit Administration
Department, which falls under the supervision of the Chief Risk Officer, was
given the responsibility of reviewing company-wide credit policies with the goal
of developing and implementing stronger and more standardized underwriting and
credit administration policies. This process included a thorough evaluation and
update of the Company's loan policy and the adoption of enhanced risk rating
guidelines company-wide. The revisions to the loan policy included a focus on
the Company's lending philosophy and credit objectives.
The key elements of the Company's lending philosophy include the following:
o to ensure consistent underwriting, all employees must share a common
view of the risks inherent in lending to businesses as well as the
standards to be applied in underwriting and managing specific credit
exposures;
o pricing of credit products should be risk-based;
o the loan portfolio must be diversified to limit the potential impact
of negative events; and
o careful, timely exposure monitoring through dynamic use of our risk
rating system, is required to provide early warning and assure
proactive management of potential problems.
The Company's credit objectives are as follows:
o service the legitimate credit needs of small businesses within
target markets of our subsidiary banks;
o compete effectively as a high volume producer of credit to
commercial and agricultural business within our markets;
o maintain our banks' reputations for superior quality and timely
delivery of products and services to our customers;
o continue to provide competitive pricing that reflects the entire
relationship and is commensurate with the risk profiles of our
borrowers;
o retain, develop and acquire profitable, multi-product, value added
relationships with high quality businesses;
o continue the focus on government guaranteed lending and establish a
specialization in this area to meet the needs of the small
businesses in our communities; and
o comply with the relevant laws and regulations.
The loan policy establishes the lending authority of individual loan officers as
well as the loan authority of the banks' loan committees. The policy limits
exposure to any one borrower or affiliated group of borrowers to a limit of
$8,000,000 unless the amount above that number has liquid collateral pledged as
security or has a U.S. Government agency guarantee. The Senior Loan
Administrators and Commercial Team Leaders can approve loans up to $500,000
jointly. The subsidiary bank CEOs and Senior Loan Administrators can approve
loans up to $1,000,000 jointly. Each bank has an External Loan Committee that
consists of up to three lending officers and at least two outside bank
directors. The External Loan Committee may approve loans up to $2,000,000. Loans
of $2,000,000 and over require the approval of
7
the Company's Executive Loan Committee. The Executive Loan Committee consists of
the Company's CEO, the FII Chief Risk Officer (non-voting), the FII Risk
Manager, the FII Loan Administration Manager, each subsidiary bank CEO, and each
subsidiary bank Senior Loan Administrator.
Commercial Loans. The Company, through its banking subsidiaries, originates
commercial loans in its primary market areas and underwrites them based on the
borrower's ability to service the loan from operating income. The Company,
through its banking subsidiaries, offers a broad range of commercial lending
products, including term loans and lines of credit. Short and medium-term
commercial loans, primarily collateralized, are made available to businesses for
working capital (including inventory and receivables), business expansion
(including acquisition of real estate, expansion and improvements) and the
purchase of equipment. As a general practice, a collateral lien is placed on any
available real estate, equipment or other assets owned by the borrower and a
personal guarantee of the borrower is obtained. At December 31, 2003, $32
million, or 12.9%, of the aggregate commercial loan portfolio was at fixed rates
while $216 million, or 87.1%, was at variable rates. The Company also utilizes
government loan guarantee programs offered by the Small Business Administration
(or "SBA") and Rural Economic and Community Development (or "RECD") when
appropriate. See "Government Guarantee Programs" below.
Commercial Real Estate Loans. In addition to commercial loans secured by real
estate, the Company, through its banking subsidiaries, makes commercial real
estate loans to finance the purchase of real property which generally consists
of real estate with completed structures. Commercial real estate loans are
secured by first liens on the real estate, typically have variable interest
rates and are amortized over a 10 to 20 year period. The underwriting analysis
includes credit verification, appraisals and a review of the borrower's
financial condition. At December 31, 2003, $46 million, or 12.5%, of the
aggregate commercial real estate loan portfolio was at fixed rates while $324
million, or 87.5%, was at variable rates.
Agricultural Loans. Agricultural loans are offered for short-term crop
production, farm equipment and livestock financing and agricultural real estate
financing, including term loans and lines of credit. Short and medium-term
agricultural loans, primarily collateralized, are made available for working
capital (crops and livestock), business expansion (including acquisition of real
estate, expansion and improvement) and the purchase of equipment. The Banks also
closely monitor commodity prices and inventory build-up in various commodity
categories to better anticipate price changes in key agricultural products that
could adversely affect the borrowers' ability to repay their loans. At December
31, 2003 the Company had $119 million in loans to the dairy industry, which
represents 8.9% of the total loan portfolio. The dairy industry is under stress
from an extended period of low milk prices. The Company routinely evaluates the
effect of those price changes on the cash flow of borrowers and the values of
collateral supporting those loans. Borrower cash flows in the dairy industry
have recently improved due to some stabilization and upward movement in milk
prices. At December 31, 2003, $21 million, or 9.1%, of the agricultural loan
portfolio was at fixed rates while $214 million, or 90.9%, was at variable
rates. The Banks utilize government loan guarantee programs offered by the SBA
and the Farm Service Agency (or "FSA") of the United States Department of
Agriculture where available and appropriate. See "Government Guarantee Programs"
below.
Residential Real Estate Loans. The Banks originate fixed and variable rate
one-to-four family residential real estate loans collateralized by
owner-occupied properties located in its market areas. A variety of real estate
loan products, which generally are amortized over five to 30 years, are offered.
Loans collateralized by one-to-four family residential real estate generally
have been originated in amounts of no more than 80% of appraised value or have
mortgage insurance. Mortgage title insurance and hazard insurance are normally
required. The Company sells most newly originated fixed rate one-to-four family
residential mortgages on the secondary mortgage market and retains the rights to
service the mortgages. To assure maximum salability of the residential loan
products for possible resale, the Company has formally adopted the underwriting,
appraisal, and servicing guidelines of the Federal Home Loan Mortgage
Corporation ("Freddie Mac") as part of its standard loan policy. At December 31,
2003, the residential mortgage servicing portfolio totaled $386 million, the
majority of which have been sold to Freddie Mac. At December 31, 2003, $197
million, or 78.5%, of residential real estate loans retained in portfolio were
at fixed rates while $54 million, or 21.5%, were at variable rates.
8
Consumer and Home Equity Loans. The Banks originate direct and indirect credit
automobile loans, recreational vehicle loans, boat loans, home improvement
loans, fixed and open-ended home equity loans, personal loans (collateralized
and uncollateralized), student loans and deposit account collateralized loans.
Visa cards that provide consumer credit lines are also issued. The terms of
these loans typically range from 12 to 120 months and vary based upon the nature
of the collateral and the size of loan. The majority of the consumer lending
program is underwritten on a secured basis using the customer's home or the
financed automobile, mobile home, boat or recreational vehicle as collateral. At
December 31, 2003, $139 million, or 57.7%, of consumer and home equity loans
were at fixed rates while $102 million, or 42.3%, were at variable rates.
Government Guarantee Programs. The Banks participate in government loan
guarantee programs offered by the SBA, RECD and FSA. At December 31, 2003, the
Banks had loans with an aggregate principal balance of $45.9 million that were
covered by guarantees under these programs. The guarantees only cover a certain
percentage of these loans. By participating in these programs, the Banks are
able to broaden their base of borrowers while minimizing credit risk.
Delinquencies and Nonperforming Assets. The Banks have several procedures in
place to assist in maintaining the overall quality of the Company's loan
portfolio. Standardized underwriting guidelines have been established for
subsidiary bank lending officers. The Company requires each bank subsidiary to
report delinquencies on a monthly basis, and the Chief Risk Officer monitors
these levels to identify adverse trends.
Loans are generally placed on nonaccrual status and cease accruing interest when
the payment of principal or interest is delinquent for 90 days, or earlier in
some cases, unless the loan is in the process of collection and the underlying
collateral further supports the carrying value of the loan.
Classification of Assets. As previously indicated, the Company adopted enhanced
risk rating guidelines company-wide during 2003. Risk ratings are assigned to
loans in the commercial, commercial real estate and agricultural portfolios. The
risk ratings are specifically used as follows:
o profile banks' risk and exposure in the loan portfolio and identify
developing trends and relative levels of risk;
o guide polices which control individual exposure with regard to
degree of risk;
o identify deteriorating credits which may become criticized according
to regulatory definitions; and
o reflect the probability that a given customer may default on its
obligations to pay in a timely fashion.
Through the underwriting and loan review process, the Banks maintain internally
classified loan lists which, along with delinquency reporting, helps management
assess the overall quality of the loan portfolio and the allowance for loan
losses.
Loans classified as "watch" are basically satisfactory, but a higher degree of
risk is evident. Loans classified as "warning" or "special mention" have
potential weaknesses that may, if not corrected, weaken the loan or inadequately
protect the banks' credit position.
"Substandard" loans are those with clear and well-defined weaknesses such as a
higher leveraged position, unfavorable financial ratios, uncertain repayment
sources or poor financial condition, which may jeopardize the full collection of
the debt. Substandard loans may be placed on nonaccrual status and may have
specific loss allowances assigned. Once a loan is identified as substandard, the
credit relationship is assigned to the Credit Administration Department's Loan
Workout Group. The Loan Workout Group performs a detailed analysis of each
substandard credit, which includes evaluating the borrower's paying capacity and
assessing the collateral supporting the loans outstanding. Various forms of
collateral including receivables, inventory, livestock, equipment, real property
and other assets, secure the majority of the substandard credits. The Loan
Workout Group also quantifies credit loss exposure by determining specific loss
allowances where appropriate.
9
Loans classified as "doubtful" have characteristics similar to substandard with
the added characteristic that the weaknesses make collection or liquidation in
full, on the basis of currently existing facts, conditions, and values, highly
questionable and improbable. Due to the high probability of loss, nonaccrual
accounting treatment is required for all assets listed as doubtful.
Assets are classified as "loss" when considered to be uncollectible and of such
little value that their continuance as bankable assets is not warranted. This
classification does not mean that the asset has absolutely no recovery or
salvage value, but rather, that it is not practical or desirable to defer
write-off even though partial recovery may be achieved in the future.
Allowance for Loan Losses. The allowance for loan losses is established through
charges to earnings in the form of a provision for loan losses. The allowance
reflects management's estimate of the amount of probable loan losses in the
portfolio, based on the following factors:
o historical charge-off experience;
o the evaluation of the loan portfolio by the loan review function;
o levels and trends in delinquencies and non-accruals;
o trends in volume and terms;
o collateral values;
o effects of changes in lending policy;
o experience, ability and depth of management;
o national and local economic trends and conditions; and
o concentration of credit.
Subsidiary Bank management presents a quarterly review of the allowance for loan
losses to each subsidiary Bank's Board of Directors as well as to the Company's
Board of Directors, indicating any change in the allowance since the last review
and any recommendations as to adjustments in the allowance. In order to
determine the allowance for loan losses, the risk classification and delinquency
status of loans and other factors are considered, such as collateral value,
government guarantees, portfolio composition, trends in economic conditions and
the financial strength of borrowers. Specific allowances for loans, which have
been individually evaluated for impairment, are established when required. An
allowance is also established for groups of loans with similar risk
characteristics, based upon average historical charge-off experience taking into
account levels and trends in delinquencies, loan volumes, economic and industry
trends and concentrations of credit.
Investment Activities
General. The Company's investment securities policy is contained within the
overall Asset-Liability Management and Investment Policy. This policy dictates
that investment decisions will be made based on the safety of the investment,
liquidity requirements, potential returns, cash flow targets, need for
collateral and desired risk parameters. In pursuing these objectives, the
Company considers the ability of an investment to provide earnings consistent
with factors of quality, maturity, marketability and risk diversification. The
Board of each subsidiary bank adopts an asset/liability policy containing an
investment securities policy within the parameters of the Company's overall
asset/liability policy. The FII Treasurer, guided by the separate ALCO
Committees of each subsidiary bank, is responsible for securities portfolio
decisions within the established policies.
10
The Company's investment securities strategy centers on providing liquidity to
meet loan demand and redeeming liabilities, meeting pledging requirements,
managing overall interest rate risk and maximizing portfolio yield. The Company
policy generally limits security purchases to the following:
o U.S. treasury securities;
o U.S. government agency and government sponsored agency securities;
o mortgage-backed pass-through securities and collateralized mortgage
obligations ("CMOs") issued by the Federal National Mortgage
Association ("FNMA"), the Government National Mortgage Association
("GNMA") and Federal Home Loan Mortgage Corporation ("Freddie Mac");
o investment grade municipal securities, including tax, revenue and
bond anticipation notes and general obligation and revenue notes and
bonds;
o certain creditworthy un-rated securities issued by municipalities;
and investment grade corporate debt.
Additionally, the Company's investment policy limits investments in corporate
bonds to no more than 10% of total investments and to bonds rated as Baa or
better by Moody's Investor Services, Inc. or BBB or better by Standard & Poor's
Ratings Services at the time of purchase.
Sources of Funds
General. Deposits and borrowed funds are the primary sources of the Company's
funds for use in lending, investing and for other general purposes. In addition,
repayments on loans, proceeds from sales of loans and securities, and cash flows
from operations provide additional sources of funds.
Deposits. The Company, through its banking subsidiaries, offers a variety of
deposit account products with a range of interest rates and terms. The deposit
accounts consist of savings, interest-bearing checking accounts, checking
accounts, money market accounts, savings, club accounts and certificates of
deposit. The Company offers certificates of deposit with balances in excess of
$100,000 at preferential rates (jumbo certificates) to local municipalities,
businesses, and individuals as well as Individual Retirement Accounts ("IRAs")
and other qualified plan accounts. To enhance its deposit product offerings, the
Company provides commercial checking accounts for small to moderately sized
commercial businesses, as well as a low-cost checking account service for
low-income customers. The flow of deposits is influenced significantly by
general economic conditions, changes in money market rates, prevailing interest
rates and competition. The Banks' deposits are obtained predominantly from the
areas in which the Banks' branch offices are located. The Banks rely primarily
on competitive pricing of their deposit products, customer service and
long-standing relationships with customers to attract and retain these deposits.
On a secondary basis, the Company utilizes time deposit sales in the national
brokered market ("brokered deposits") as a wholesale funding source.
Borrowed Funds. Borrowings consist mainly of advances entered into with the
Federal Home Loan Bank ("FHLB"), a debt agreement with a commercial bank and
sweep repurchase agreements.
Junior Subordinated Debentures Issued to Unconsolidated Subsidiary Trust. The
Company formed a trust in February 2001 to accommodate the private placement of
capital securities, the proceeds of which were utilized to partially fund the
acquisition of BNC.
Risk Factors
Asset Quality. A significant source of risk for the Company arises from the
possibility that losses will be sustained because borrowers, guarantors and
related parties may fail to perform in accordance with the terms of their loans.
Most loans originated by the Company are secured, but loans may be unsecured
depending on the nature of the loan. With respect to secured loans, the
collateral securing the repayment of these loans includes a wide variety of
diverse real and personal property that may be insufficient to cover the
obligations owed under such loans. Collateral values may be adversely affected
by changes in prevailing economic, environmental and other conditions, including
declines in the value of real estate, changes in interest rates, changes in
monetary and fiscal policies of the federal government, wide-spread
11
disease, terrorist activity, environmental contamination and other external
events. In addition, collateral appraisals that are out of date or that do not
meet M.A.I. or other recognized standards may create the impression that a loan
is adequately collateralized when in fact it is not. The Company has adopted
underwriting and credit monitoring procedures and policies, including the
establishment and review of the allowance for loan losses and regular review of
appraisals and borrower financial statements, that management believes are
appropriate to mitigate the risk of loss by assessing the likelihood of
nonperformance and the value of available collateral, monitoring loan
performance and diversifying the Company's credit portfolio. Such policies and
procedures, however, may not prevent unexpected losses that could have a
material adverse effect on the Company's business, financial condition, results
of operations or liquidity. See "Lending Activities" for further discussion on
underwriting standards.
Interest Rate Risk. The bank industry earnings depend largely on the
relationship between the yield on earning assets, primarily loans and
investments, and the cost of funds, primarily deposits and borrowings. This
relationship, known as the interest rate spread, is subject to fluctuation and
is affected by economic and competitive factors which influence interest rates,
the volume and mix of interest earning assets and interest bearing liabilities
and the level of non-performing assets. Fluctuations in interest rates affect
the demand of customers for the Company's products and services. The Company is
subject to interest rate risk to the degree that its interest bearing
liabilities reprice or mature more slowly or more rapidly or on a different
basis than its interest earning assets. Significant fluctuations in interest
rates could have a material adverse effect on the Company's business, financial
condition, results of operations or liquidity. For additional information
regarding interest rate risk, see Part II, Item 7A, "Quantitative and
Qualitative Disclosures About Market Risk."
Changes in the Value of Goodwill and Other Intangible Assets. The Company had
goodwill of $40.6 million and other intangible assets of $2.7 million as of
December 31, 2003. Under current accounting standards, the Company is not
required to amortize goodwill but rather must evaluate goodwill for impairment
at least annually. If deemed impaired at any point in the future, an impairment
charge representing all or a portion of goodwill will be recorded to current
earnings in the period in which the impairment occurred. The capitalized value
of other intangible assets is amortized to earnings over their estimated lives.
Other intangible assets are also subject to periodic impairment reviews. If
these assets are deemed impaired at any point in the future, an impairment
charge will be recorded to current earnings in the period in which the
impairment occurred. For additional information regarding goodwill and other
intangible assets, see Note 6 of the notes to consolidated financial statements.
Breach of Information Security and Technology Dependence. The Company depends
upon data processing, software, communication and information exchange on a
variety of computing platforms and networks and over the internet. Despite
instituted safeguards, the Company cannot be certain that all of its systems are
entirely free from vulnerability to attack or other technological difficulties
or failures. The Company relies on the services of a variety of vendors to meet
its data processing and communication needs. If information security is breached
or other technology difficulties or failures occur, information may be lost or
misappropriated, services and operations may be interrupted and the Company
could be exposed to claims from customers. Any of these results could have a
material adverse effect on the Company's business, financial condition, results
of operations or liquidity.
Economic Conditions, Limited Geographic Diversification. The Company's banking
operations are located in Western and Central New York State. Because of the
geographic concentration of its operations, the Company's results depend largely
upon economic conditions in this area, which include depressed wholesale milk
prices, losses of manufacturing jobs in Rochester and Buffalo, and minimal
population growth throughout the region. Further deterioration in economic
conditions could adversely affect the quality of the Company's loan portfolio
and the demand for its products and services, and accordingly, could have a
material adverse effect on the Company's business, financial condition, results
of operations or liquidity. See also "Market Area and Competition."
Ability of the Company to Execute Its Business Strategy. The financial
performance and profitability of the Company will depend on its ability to
execute its strategic plan and manage its future growth. Although the Company
believes that it has substantially integrated recently acquired banks into the
12
Company's operations, there can be no assurance that unforeseen issues relating
to the assimilation or prior operations of these banks, including the emergence
of any material undisclosed liabilities, will not materially adversely affect
the Company. In addition, the effect of the formal agreements entered into by
NBG and BNB has been to increase the capital needs at those banks, and to
increase staffing and loan administration expense. It is unlikely that either of
these banks will be able to grow significantly through loan growth or
acquisitions while the formal agreements remain in place. The Company has
incurred, and may continue to incur, additional operating costs in connection
with compliance with the formal agreements including, among others, incremental
staff and continued higher legal, accounting and consulting expenses. Further,
the reputational risk created by the formal agreements could have an impact on
such matters as business generation and retention, the ability to attract and
retain management at the banks, liquidity and funding. The Company's financial
performance will also depend on the Company's ability to maintain profitable
operations through implementing its strategic plan. Moreover, the Company's
future performance is subject to a number of factors beyond its control,
including when the formal agreements are lifted at BNB and NBG, pending and
future federal and state banking legislation, regulatory changes, unforeseen
litigation outcomes, inflation, lending and deposit rate changes, interest rate
fluctuations, increased competition and economic conditions. Accordingly, these
issues could have a material adverse effect on the Company's business, financial
condition, results of operations or liquidity.
Dependence on Key Personnel. The Company's success depends to a significant
extent on the management skills of its existing executive officers and
directors, many of whom have held officer and director positions with the
Company for many years. The loss or unavailability of any of its key executives
or directors, including Peter G. Humphrey, Chairman of the Board of Directors,
President and Chief Executive Officer, Ronald M. Miller, Senior Vice President
and Chief Financial Officer, or Thomas D. Grover, Senior Vice President and
Chief Risk Officer, could have a material adverse effect on the Company's
business, financial condition, results of operations or liquidity. See also Part
III, Item 10, "Directors and Executive Officers of Registrant."
Competition. National competitors are much larger in total assets and
capitalization, have greater access to capital markets and offer a broader array
of financial services than the Company. There can be no assurance that the
Company will be able to compete effectively in its markets. Furthermore,
developments increasing the nature or level of competition could have a material
adverse effect on the Company's business, financial condition, results of
operations or liquidity. See also "Market Area and Competition" and "Supervision
and Regulation."
Government Regulation and Monetary Policy. The Company and the banking industry
are subject to extensive regulation and supervision under federal and state laws
and regulations. The restrictions imposed by such laws and regulations limit the
manner in which the Company conducts its banking business, undertakes new
investments and activities and obtains financing. These regulations are designed
primarily for the protection of the deposit insurance funds and consumers and
not to benefit holders of the Company's securities. Financial institution
regulation has been the subject of significant legislation in recent years and
may be the subject of further significant legislation in the future, none of
which is in the control of the Company. Significant new laws or changes in, or
repeals of, existing laws could have a material adverse effect on the Company's
business, financial condition, results of operations or liquidity. Further,
federal monetary policy, particularly as implemented through the Federal Reserve
System, significantly affects credit conditions for the Company, and any
unfavorable change in these conditions could have a material adverse effect on
the Company's business, financial condition, results of operations or liquidity.
See also "Supervision and Regulation."
Supervision and Regulation
The supervision and regulation of financial and bank holding companies and their
subsidiaries is intended primarily for the protection of depositors, the deposit
insurance funds regulated by the FDIC and the banking system as a whole, and not
for the protection of shareholders or creditors of bank holding companies. The
various bank regulatory agencies have broad enforcement power over bank holding
companies and banks, including the power to impose substantial fines,
operational restrictions and other penalties for violations of laws and
regulations.
13
The following description summarizes some of the laws to which the Company and
its subsidiaries are subject. References to applicable statutes and regulations
are brief summaries and do not claim to be complete. They are qualified in their
entirety by reference to such statutes and regulations. Management believes the
Company is in compliance in all material respects with these laws and
regulations. Changes in the laws, regulations or policies that impact the
Company cannot necessarily be predicted, but they may have a material effect on
the business and earnings of the Company.
The Company
The Company is a bank holding company registered under the Bank Holding Company
Act of 1956, as amended, and is subject to supervision, regulation and
examination by the Federal Reserve Board. During 2003, the Company terminated
its financial holding company status and now operates as a bank holding company.
The change in status did not affect any non-financial subsidiaries or activities
being conducted by the Company, although future acquisitions or expansions of
non-financial activities may require prior Federal Reserve Board approval and
will be limited to those that are permissible for bank holding companies. The
Bank Holding Company Act and other federal laws subject bank holding companies
to particular restrictions on the types of activities in which they may engage,
and to a range of supervisory requirements and activities, including regulatory
enforcement actions for violations of laws and regulations.
Regulatory Restrictions on Dividends; Source of Strength. It is the policy of
the Federal Reserve Board that bank holding companies should pay cash dividends
on common stock only out of income available over the past year, and only if
prospective earnings retention is consistent with the holding company's expected
future needs and financial condition. The policy provides that bank holding
companies should not maintain a level of cash dividends that undermines the bank
holding company's ability to serve as a source of strength to its banking
subsidiaries.
Under Federal Reserve Board policy, a bank holding company is expected to act as
a source of financial strength to each of its banking subsidiaries and commit
resources to their support. Such support may be required at times when, absent
this Federal Reserve Board policy, a holding company may not be inclined to
provide it. As discussed below, a bank holding company in certain circumstances
could be required to guarantee the capital plan of an undercapitalized banking
subsidiary.
Safe and Sound Banking Practices. Bank holding companies are not permitted to
engage in unsafe and unsound banking practices. The Federal Reserve Board's
Regulation Y, for example, generally requires a holding company to give the
Federal Reserve Board prior notice of any redemption or repurchase of its own
equity securities, if the consideration to be paid, together with the
consideration paid for any repurchases or redemptions in the preceding year, is
equal to 10% or more of the company's consolidated net worth. The Federal
Reserve Board may oppose the transaction if it believes that the transaction
would constitute an unsafe or unsound practice or would violate any law or
regulation. Depending upon the circumstances, the Federal Reserve Board could
take the position that paying a dividend would constitute an unsafe or unsound
banking practice.
The Federal Reserve Board has broad authority to prohibit activities of bank
holding companies and their non-banking subsidiaries which represent unsafe and
unsound banking practices or which constitute violations of laws or regulations,
and can assess civil money penalties for certain activities conducted on a
knowing and reckless basis, if those activities caused a substantial loss to a
depository institution. The penalties can be as high as $1,000,000 for each day
the activity continues.
Anti-Tying Restrictions. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates. In
late 2002, the Federal Reserve Board adopted Regulation W, a comprehensive
synthesis of prior opinions and interpretations under Sections 23A and 23B of
the Federal Reserve Act. Regulation W contains an extensive discussion of tying
arrangements, which could impact the way banks and bank holding companies
transact business with affiliates.
14
Capital Adequacy Requirements. The Federal Reserve Board has adopted a system
using risk-based capital guidelines to evaluate the capital adequacy of bank
holding companies. Under the guidelines, specific categories of assets are
assigned different risk weights, based generally on the perceived credit risk of
the asset. These risk weights are multiplied by corresponding asset balances to
determine a "risk-weighted" asset base. The guidelines require a minimum total
risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist
of Tier 1 capital elements). Total capital is the sum of Tier 1 and Tier 2
capital. As of December 31, 2003, the Company's ratio of Tier 1 capital to total
risk-weighted assets was 10.18% and the ratio of total capital to total
risk-weighted assets was 11.44%. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Financial Condition-Capital
Resources."
In addition to the risk-based capital guidelines, the Federal Reserve Board uses
a leverage ratio as an additional tool to evaluate the capital adequacy of bank
holding companies. The leverage ratio is a company's Tier 1 capital divided by
three-month average consolidated assets. Certain highly rated bank holding
companies may maintain a minimum leverage ratio of 3.0%, but other bank holding
companies may be required to maintain a leverage ratio of up to 200 basis points
above the regulatory minimum. As of December 31, 2003, the Company's leverage
ratio was 7.03%.
The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
Federal Reserve Board guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets.
Imposition of Liability for Undercapitalized Subsidiaries. Bank regulators are
required to take "prompt corrective action" to resolve problems associated with
insured depository institutions whose capital declines below certain levels. In
the event an institution becomes "undercapitalized," it must submit a capital
restoration plan. The capital restoration plan will not be accepted by the
regulators unless each company having control of the undercapitalized
institution guarantees the subsidiary's compliance with the capital restoration
plan up to a certain specified amount. Any such guarantee from a depository
institutions holding company is entitled to a priority of payment in bankruptcy.
The aggregate liability of the holding company of an undercapitalized bank is
limited to the lesser of 5% of the institution's assets at the time it became
undercapitalized or the amount necessary to cause the institution to be
"adequately capitalized." The bank regulators have greater power in situations
where an institution becomes "significantly" or "critically" undercapitalized or
fails to submit a capital restoration plan. For example, a bank holding company
controlling such an institution can be required to obtain prior Federal Reserve
Board approval of proposed dividends, or might be required to consent to a
consolidation or to divest the troubled institution or other affiliates.
Acquisitions by Bank Holding Companies. The Bank Holding Company Act requires
every bank holding company to obtain the prior approval of the Federal Reserve
Board before it may acquire all or substantially all of the assets of any bank,
or ownership or control of any voting shares of any bank, if after such
acquisition it would own or control, directly or indirectly, more than 5% of the
voting shares of such bank. In approving bank acquisitions by bank holding
companies, the Federal Reserve Board is required to consider the financial and
managerial resources and future prospects of the bank holding company and the
banks concerned, the convenience and needs of the communities to be served, and
various competitive factors.
Control Acquisitions. The Change in Bank Control Act prohibits a person or group
of persons from acquiring "control" of a bank holding company unless the Federal
Reserve Board has been notified and has not objected to the transaction. Under a
rebuttable presumption established by the Federal Reserve Board, the acquisition
of 10% or more of a class of voting stock of a bank holding company with a class
of
15
securities registered under Section 12 of the Exchange Act, would, under the
circumstances set forth in the presumption, constitute acquisition of control of
the Company.
In addition, any entity is required to obtain the approval of the Federal
Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the
case of an acquirer that is a bank holding company) or more of the Company's
outstanding common stock, or otherwise obtaining control or a "controlling
influence" over the Company.
The Banks
Wyoming County Bank ("WCB") and First Tier Bank & Trust ("FTB") are New York
State-chartered banks. National Bank of Geneva ("NBG") and Bath National Bank
("BNB") are national banks chartered by the Office of the Comptroller of
Currency. The FDIC through the Bank Insurance Fund insures all of the deposits
of the four subsidiary banks. FTB is a member of the Federal Reserve System. The
Banks are subject to supervision and regulation that subject them to special
restrictions, requirements, potential enforcement actions and periodic
examination by the FDIC, the Federal Reserve Board and the New York State
Banking Department (in the case of the state-chartered banks) and the Office of
the Comptroller of Currency (in the case of the national banks). Because the
Federal Reserve Board regulates the bank holding company parent of the Banks,
the Federal Reserve Board also has supervisory authority, which directly affects
the banks.
Restrictions on Transactions with Affiliates and Insiders. Transactions between
the holding company and its subsidiaries, including the Banks, are subject to
Section 23A of the Federal Reserve Act, and to the requirements of Regulation W.
In general, Section 23A imposes limits on the amount of such transactions, and
also requires certain levels of collateral for loans to affiliated parties. It
also limits the amount of advances to third parties, which are collateralized by
the securities, or obligations of the Company or its subsidiaries.
Affiliate transactions are also subject to Section 23B of the Federal Reserve
Act, and to the requirements of Regulation W which generally requires that
certain transactions between the holding company and its affiliates be on terms
substantially the same, or at least as favorable to the banks, as those
prevailing at the time for comparable transactions with or involving other
nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O apply to all
insured institutions and their subsidiaries and holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such a loan can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the FDIC may determine
that a lesser amount is appropriate. Insiders are subject to enforcement actions
for knowingly accepting loans in violation of applicable restrictions.
Restrictions on Distribution of Subsidiary Bank Dividends and Assets. Dividends
paid by the Banks have provided a substantial part of the Company's operating
funds and, for the foreseeable future, it is anticipated that dividends paid by
the Banks will continue to be its principal source of operating funds. Capital
adequacy requirements serve to limit the amount of dividends that may be paid by
the subsidiaries. Under federal law, the subsidiaries cannot pay a dividend if,
after paying the dividend, a particular subsidiary will be "undercapitalized."
The FDIC may declare a dividend payment to be unsafe and unsound even though the
bank would continue to meet its capital requirements after the dividend. Neither
of the formal agreements entered into by NBG or BNB restrict the ability of the
banks to pay dividends to the Company, provided the minimum capital requirements
set forth in the agreements are met.
Because the Company is a legal entity separate and distinct from its
subsidiaries, the Company's right to participate in the distribution of assets
of any subsidiary upon the subsidiary's liquidation or reorganization will be
subject to the prior claims of the subsidiary's creditors. In the event of a
liquidation or other resolution of an insured depository institution, the claims
of depositors and other general or subordinated
16
creditors are entitled to a priority of payment over the claims of holders of
any obligation of the institution to its shareholders, including any depository
bank holding company (such as the Company) or any shareholder or creditor
thereof.
Examinations. The New York State Banking Department (in the case of WCB and
FTB), the Office of the Comptroller of the Currency (in the case of NBG and
BNB), the Federal Reserve Board and the FDIC periodically examine and evaluate
the Banks. Based upon such examinations, the appropriate regulator may revalue
the assets of the institution and require that it establish specific reserves to
compensate for the difference between what the regulator determines the value to
be and the book value of such assets.
Audit Reports. Insured institutions with total assets of $500 million or more at
the beginning of a fiscal year must submit annual audit reports prepared by
independent auditors to federal and state regulators. In some instances, the
audit report of the institution's holding company can be used to satisfy this
requirement. Auditors must receive examination reports, supervisory agreements
and reports of enforcement actions. In addition, financial statements prepared
in accordance with generally accepted accounting principles, management's
certifications concerning responsibility for the financial statements, internal
controls and compliance with legal requirements designated by the FDIC, and an
attestation by the auditor regarding the statements of management relating to
the internal controls must be submitted. The FDIC Improvement Act of 1991
requires that independent audit committees be formed, consisting of outside
directors only. The committees of institutions with assets of more than $3
billion must include members with experience in banking or financial management
must have access to outside counsel and must not include representatives of
large customers.
Capital Adequacy Requirements. The FDIC has adopted regulations establishing
minimum requirements for the capital adequacy of insured institutions. The FDIC
may establish higher minimum requirements if, for example, a bank has previously
received special attention or has a high susceptibility to interest rate risk.
The FDIC's risk-based capital guidelines generally require banks to have a
minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and a
ratio of total capital to total risk-weighted assets of 8.0%. The capital
categories have the same definitions for the Company. As of December 31, 2003,
the ratio of Tier 1 capital to total risk-weighted assets for the Banks was
8.91% for WCB, 11.15% for NBG, 13.69% for BNB, and 10.90% for FTB, and the ratio
of total capital to total risk-weighted assets was 10.16% for WCB, 12.41% for
NBG, 14.94% for BNB, and 12.16% for FTB. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
The FDIC's leverage guidelines require banks to maintain Tier 1 capital of no
less than 4.0% of average total assets, except in the case of certain highly
rated banks for which the requirement is 3.0% of average total assets. As of
December 31, 2003, the ratio of Tier 1 capital to average total assets (leverage
ratio) was 6.71% for WCB, 8.04% for NBG, 8.02% for BNB, and 6.09% for FTB. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
As part of the agreements in place with their primary regulator, NBG and BNB
were required to develop capital plans enabling them to achieve, by March 31,
2004, Tier 1 leverage capital equal to 8% of risk-weighted assets, Tier 1
risk-based capital equal to 10% of risk-weighted assets, and total risk-based
capital of 12% of risk-weighted assets. Each of the banks meets the required
levels at December 31, 2003.
Corrective Measures for Capital Deficiencies. The federal banking regulators are
required to take "prompt corrective action" with respect to capital-deficient
institutions. Agency regulations define, for each capital category, the levels
at which institutions are "well-capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." A "well-capitalized" bank has a total risk-based capital
ratio of 10.0% or higher; a Tier 1 risk-based capital ratio of 6.0% or higher; a
leverage ratio of 5.0% or higher; and is not subject to any written agreement,
order or directive requiring it to maintain a specific capital level for any
capital measure. An "adequately capitalized" bank
17
has a total risk-based capital ratio of 8.0% or higher; a Tier 1 risk-based
capital ratio of 4.0% or higher; a leverage ratio of 4.0% or higher (3.0% or
higher if the bank was rated a composite 1 in its most recent examination report
and is not experiencing significant growth); and does not meet the criteria for
a well-capitalized bank. A bank is "undercapitalized" if it fails to meet any
one of the "adequately capitalized" ratios.
In addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations contain broad restrictions on certain
activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from paying
management fees to control persons if the institution would be undercapitalized
after any such distribution or payment.
As an institution's capital decreases, the FDIC's enforcement powers become more
severe. A significantly undercapitalized institution is subject to mandated
capital raising activities, restrictions on interest rates paid and transactions
with affiliates, removal of management and other restrictions. The FDIC has only
very limited discretion in dealing with a critically undercapitalized
institution and is virtually required to appoint a receiver or conservator.
Banks with risk-based capital and leverage ratios below the required minimums
may also be subject to certain administrative actions, including the termination
of deposit insurance upon notice and hearing, or a temporary suspension of
insurance without a hearing in the event the institution has no tangible
capital.
Deposit Insurance Assessments. The bank subsidiaries must pay assessments to the
FDIC for federal deposit insurance protection. The FDIC has adopted a risk-based
assessment system as required by the FDIC Improvement Act. Under this system,
FDIC-insured depository institutions pay insurance premiums at rates based on
their risk classification. Institutions assigned to higher risk classifications
(that is, institutions that pose a greater risk of loss to their respective
deposit insurance funds) pay assessments at higher rates than institutions that
pose a lower risk. An institution's risk classification is assigned based on its
capital levels and the level of supervisory concern the institution poses to the
regulators. In addition, the FDIC can impose special assessments in certain
instances.
The FDIC maintains a process for raising or lowering all rates for insured
institutions semi-annually if conditions warrant a change. Under this system,
the FDIC has the flexibility to adjust the assessment rate schedule twice a year
without seeking prior public comment, but only within a range of five cents per
$100 above or below the premium schedule adopted. The FDIC can make changes in
the rate schedule outside the five-cent range above or below the current
schedule only after a full rulemaking with opportunity for public comment.
The Deposit Insurance Fund Act of 1996 contained a comprehensive approach to
recapitalizing the Savings Association Insurance Fund and to assuring the
payment of the Financing Corporation's bond obligations. Under this law, banks
insured under the Bank Insurance Fund are required to pay a portion of the
interest due on bonds that were issued by the Financing Corporation in 1987 to
help shore up the ailing Federal Savings and Loan Insurance Corporation.
Enforcement Powers. The FDIC and the other federal banking agencies have broad
enforcement powers, including the power to terminate deposit insurance, impose
substantial fines and other civil and criminal penalties and appoint a
conservator or receiver. Failure to comply with applicable laws, regulations and
supervisory agreements could subject the Company or its banking subsidiaries, as
well as the officers, directors and other institution-affiliated parties of
these organizations, to administrative sanctions and potentially substantial
civil money penalties.
Brokered Deposit Restrictions. Adequately capitalized institutions cannot
accept, renew or roll over brokered deposits except with a waiver from the FDIC,
and are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew or roll over
18
brokered deposits. The Company's NBG and BNB subsidiaries for purposes of
brokered deposit restrictions are deemed to be adequately capitalized
institutions.
Cross-Guarantee Provisions. The Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") contains a "cross-guarantee" provision which
generally makes commonly controlled insured depository institutions liable to
the FDIC for any losses incurred in connection with the failure of a commonly
controlled depository institution.
Community Reinvestment Act. The Community Reinvestment Act of 1977 ("CRA") and
the regulations issued hereunder are intended to encourage banks to help meet
the credit needs of their service area, including low and moderate income
neighborhoods, consistent with the safe and sound operations of the banks. These
regulations also provide for regulatory assessment of a bank's record in meeting
the needs of its service area when considering applications regarding
establishing branches, mergers or other bank or branch acquisitions. FIRREA
requires federal banking agencies to make public a rating of a bank's
performance under the CRA. In the case of a bank holding company, the CRA
performance record of the banks involved in the transaction are reviewed in
connection with the filing of an application to acquire ownership or control of
shares or assets of a bank or to merge with any other bank holding company. An
unsatisfactory record can substantially delay or block the transaction.
Consumer Laws and Regulations. In addition to the laws and regulations discussed
herein, the subsidiary banks are also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include, among others, the Truth in Lending Act, the Truth in Savings Act, the
Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal
Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act,
the Real Estate Settlement Procedures Act, and the "Check 21" Act. These laws
and regulations mandate certain disclosure requirements and regulate the manner
in which financial institutions must deal with customers when taking deposits or
making loans to such customers. The Banks must comply with the applicable
provisions of these consumer protection laws and regulations as part of their
ongoing customer relations.
Changing Regulatory Structure
Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act ("Gramm-Leach") was signed into law on November 12,
1999. Gramm-Leach permits, subject to certain conditions, combinations among
banks, securities firms and insurance companies beginning March 11, 2000. Under
Gramm-Leach, bank holding companies are permitted to offer their customers
virtually any type of financial service including banking, securities
underwriting, insurance (both underwriting and agency), and merchant banking. In
order to engage in these additional financial activities, a bank holding company
must qualify and register with the Board of Governors of the Federal Reserve
System as a "financial holding company" by demonstrating that each of its bank
subsidiaries is "well capitalized," "well managed," and has at least a
"satisfactory" rating under the CRA. On May 12, 2000 the Company received
approval from the Federal Reserve Bank of New York to become a financial holding
company resulting in the eventual formation of FIGI and acquisition of BGI as
previously discussed. During 2003, the Company terminated its financial holding
company status and now operates as a bank holding company. The change in status
did not affect the non-financial subsidiaries or activities being conducted by
the Company, although future acquisitions or expansions of non-financial
activities may require prior Federal Reserve Board approval and will be limited
to those that are permissible for bank holding companies. Gramm-Leach
establishes that the federal banking agencies will regulate the banking
activities of financial holding companies and banks' financial subsidiaries, the
U.S. Securities and Exchange Commission will regulate their securities
activities and state insurance regulators will regulate their insurance
activities. Gramm-Leach also provides new protections against the transfer and
use by financial institutions of consumers' nonpublic, personal information.
The major provisions of Gramm-Leach are:
19
Financial Holding Companies and Financial Activities. Title I establishes a
comprehensive framework to permit affiliations among commercial banks, insurance
companies, securities firms, and other financial service providers by revising
and expanding the Bank Holding Company Act framework to permit a holding company
system to engage in a full range of financial activities through qualification
as a new entity known as a financial holding company. A bank holding company
that qualifies as a financial holding company can expand into a wide variety of
services that are financial in nature, if its subsidiary depository institutions
are well-managed, well-capitalized and have received at least a "satisfactory"
rating on their last CRA examination. Services that have been deemed to be
financial in nature include securities underwriting, dealing and market making,
sponsoring mutual funds and investment companies, insurance underwriting and
agency activities and merchant banking.
Title I also required the FDIC to adopt regulations implementing Section 121 of
Title I, regarding permissible activities and investments of insured state
banks. Final regulations adopted by the FDIC in January 2001, in the form of
amendments to Part 362 of the FDIC rules and regulations, provide the framework
for subsidiaries of state nonmember banks to engage in financial activities that
Gramm-Leach permits national banks to conduct through a financial subsidiary.
The regulations require that prior to commencing such financial activities, a
state nonmember bank must notify the FDIC of its intent to do so, and must
certify that it is well-managed and that it and all of its subsidiary insured
depository institutions are well-capitalized after deducting its investment in
the new subsidiary. Furthermore, the regulations require that the notifying bank
must, and must continue to, (i) disclose the capital deduction in published
financial statements, and (ii) comply with sections 23A and 23B of the Federal
Reserve Act and (iii) comply with all required financial and operational
safeguards.
Activities permissible for financial subsidiaries of national banks, and,
pursuant to Section 362 of the FDIC rules and regulations, also permissible for
financial subsidiaries of state nonmember banks, include, but are not limited
to, the following: (a) Lending, exchanging, transferring, investing for others,
or safeguarding money or securities; (b) Insuring, guaranteeing, or indemnifying
against loss, harm, damage, illness, disability, or death, or providing and
issuing annuities, and acting as principal, agent, or broker for purposes of the
foregoing, in any State; (c) Providing financial, investment, or economic
advisory services, including advising an investment company; (d) Issuing or
selling instruments representing interests in pools of assets permissible for a
bank to hold directly; and (e) Underwriting, dealing in, or making a market in
securities.
Securities Activities. Title II narrows the exemptions from the securities laws
previously enjoyed by banks, requires the Federal Reserve Board and the SEC to
work together to draft rules governing certain securities activities of banks
and creates a new, voluntary investment bank holding company.
Insurance Activities. Title III restates the proposition that the states are the
functional regulators for all insurance activities, including the insurance
activities of federally-chartered banks, and bars the states from prohibiting
insurance activities by depository institutions. The law encourages the states
to develop uniform or reciprocal rules for the licensing of insurance agents.
Privacy. Under Title V, federal banking regulators were required to adopt rules
that have limited the ability of banks and other financial institutions to
disclose non-public information about consumers to nonaffiliated third parties.
These limitations require disclosure of privacy policies to consumers and, in
some circumstances, allow consumers to prevent disclosure of certain personal
information to a nonaffiliated third party. Federal banking regulators issued
final rules on May 10, 2000 to implement the privacy provisions of Title V.
Under the rules, financial institutions must provide:
o initial notices to customers about their privacy policies,
describing the conditions under which they may disclose nonpublic
personal information to nonaffiliated third parties and affiliates;
o annual notices of their privacy policies to current customers; and
o a reasonable method for customers to "opt out" of disclosures to
nonaffiliated third parties.
Compliance with the rules is mandatory after July 1, 2001. The Company and the
banks were in full compliance with the rules as of or prior to their respective
effective dates.
20
Safeguarding Confidential Customer Information. Under Title V, federal banking
regulators are required to adopt rules requiring financial institutions to
implement a program to protect confidential customer information. In January
2000, the federal banking agencies adopted guidelines requiring financial
institutions to establish an information security program to:
o identify and assess the risks that may threaten customer
information;
o develop a written plan containing policies and procedures to manage
and control these risks;
o implement and test the plan; and
o adjust the plan on a continuing basis to account for changes in
technology, the sensitivity of customer information and internal or
external threats to information security.
The Banks' approved security programs appropriate to their size and complexity
and the nature and scope of their operations prior to the July 1, 2001 effective
date of the regulatory guidelines. The implementation of the programs is an
ongoing process.
Community Reinvestment Act Sunshine Requirements. In February 2001, the federal
banking agencies adopted final regulations implementing Section 711 of Title
VII, the CRA Sunshine Requirements. The regulations require nongovernmental
entities or persons and insured depository institutions and affiliates that are
parties to written agreements made in connection with the fulfillment of the
institution's CRA obligations to make available to the public and the federal
banking agencies a copy of each agreement. The regulations impose annual
reporting requirements concerning the disbursement, receipt and use of funds or
other resources under these agreements. The effective date of the regulations
was April 1, 2001. Neither the Company nor the banks is a party to any agreement
that would be the subject of reporting pursuant to the CRA Sunshine
Requirements.
The Company continues to evaluate the strategic opportunities presented by the
broad powers granted to bank holding companies that elect to be treated as
financial holding companies. In the event that the Company determines that
access to the broader powers of a financial holding company is in the best
interests of the Company, its shareholders and the banks, the Company will file
the appropriate election with the Federal Reserve Board.
USA Patriot Act
As part of the Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001 ("USA Patriot Act"),
signed into law on October 26, 2001, Congress adopted the International Money
Laundering Abatement and Financial Anti-Terrorism Act of 2001 ("IMLAFATA").
IMLAFATA authorizes the Secretary of the Treasury, in consultation with the
heads of other government agencies, to adopt special measures applicable to
banks, bank holding companies, or other financial institutions. During 2002, the
Department of Treasury issued a number of regulations relating to enhanced
recordkeeping and reporting requirements for certain financial transactions that
are of primary money laundering concern, due diligence requirements concerning
the beneficial ownership of certain types of accounts, and restrictions or
prohibitions on certain types of accounts with foreign financial institutions.
Covered financial institutions also are barred from dealing with foreign "shell"
banks. In addition, IMLAFATA expands the circumstances under which funds in a
bank account may be forfeited and requires covered financial institutions to
respond under certain circumstances to requests for information from federal
banking agencies within 120 hours.
Regulations were also adopted during 2002 to implement minimum standards to
verify customer identity, to encourage cooperation among financial institutions,
federal banking agencies, and law enforcement authorities regarding possible
money laundering or terrorist activities, to prohibit the anonymous use of
"concentration accounts," and to require all covered financial institutions to
have in place a Bank Secrecy Act compliance program. IMLAFATA also amends the
Bank Holding Company Act and the Bank Merger Act to require the federal banking
agencies to consider the effectiveness of a financial institution's anti-money
laundering activities when reviewing an application under these acts.
21
The Banks have in place a Bank Secrecy Act compliance program, and they engage
in very few transactions of any kind with foreign financial institutions or
foreign persons.
Sarbanes-Oxley Act
On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002
(the "Act") implementing legislative reforms intended to address corporate and
accounting fraud. In addition to the establishment of a new accounting oversight
board that enforces auditing, quality control and independence standards and is
funded by fees from all publicly traded companies, the law restricts provision
of both auditing and consulting services by accounting firms. To ensure auditor
independence, any non-audit services being provided to an audit client requires
pre-approval by the issuer's audit committee members. In addition, the audit
partners must be rotated. The Act requires chief executive officers and chief
financial officers, or their equivalent, to certify to the accuracy of periodic
reports filed with the SEC, subject to civil and criminal penalties if they
knowingly or willfully violate this certification requirement. In addition,
under the Act, legal counsel is required to report evidence of a material
violation of the securities laws or a breach of fiduciary duty by a company to
its chief executive officer or its chief legal officer, and, if such officer
does not appropriately respond, to report such evidence to the audit committee
or other similar committee of the board of directors or the board itself.
Longer prison terms and increased penalties are also applied to corporate
executives who violate federal securities laws, the period during which certain
types of suits can be brought against a company or its officers has been
extended, and bonuses issued to top executives prior to restatement of a
company's financial statements are subject to disgorgement if such restatement
was due to corporate misconduct. Executives are also prohibited from insider
trading during retirement plan "blackout" periods, and loans to company
executives are restricted. The Act accelerates the time frame for disclosures by
public companies, as they must immediately disclose any material changes in
their financial condition or operations. Directors and executive officers must
also provide information for most changes in ownership in a company's securities
within two business days of the change.
The Act also prohibits any officer or director of a company or any other person
acting under their direction from taking any action to fraudulently influence,
coerce, manipulate or mislead any independent public or certified accountant
engaged in the audit of the company's financial statements for the purpose of
rendering the financial statement's materially misleading. The Act also requires
the SEC to prescribe rules requiring inclusion of an internal control report and
assessment by management in the annual report to stockholders. In addition, the
Act requires that each financial report required to be prepared in accordance
with (or reconciled to) accounting principles generally accepted in the United
States of America and filed with the SEC reflect all material correcting
adjustments that are identified by a "registered public accounting firm" in
accordance with accounting principles generally accepted in the United States of
America and the rules and regulations of the SEC.
Effective August 29, 2002, as directed by Section 302(a) of the Act, the
Company's chief executive officer and chief financial officer are each required
to certify that the Company's quarterly and annual reports do not contain any
untrue statement of a material fact. The Act imposes several requirements,
including having these officers certify that: they are responsible for
establishing, maintaining and regularly evaluating the effectiveness of the
Company's internal controls; they have made certain disclosures to the Company's
auditors and the audit committee of the Board of Directors about the Company's
internal controls; and they have included information in the Company's quarterly
and annual reports about their evaluation and whether there have been
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls during the last quarter.
Fair Credit Reporting Act
In 1970, the U. S. Congress enacted the Fair Credit Reporting Act (the "FCRA")
in order to ensure the confidentiality, accuracy, relevancy and proper
utilization of consumer credit report information. Under the framework of the
FCRA, the United States has developed a highly advanced and efficient credit
reporting system. The information contained in that broad system is used by
financial institutions, retailers and other creditors of every size in making a
wide variety of decisions regarding financial transactions. Employers, and law
enforcement agencies have also made wide use of the information
22
collected and maintained in databases made possible by the FCRA. The FCRA
affirmatively preempts state law in a number of areas, including the ability of
entities affiliated by common ownership to share and exchange information
freely, the requirements on credit bureaus to reinvestigate the contents of
reports in response to consumer complaints, among others. By its terms, the
preemption provisions of the FCRA were to terminate as of December 31, 2003.
With the enactment of the Fair and Accurate Transactions Act (FACT Act) in late
2003, the preemption provisions of FCRA were extended, although the FACT Act
imposes additional requirements on entities that gather and share consumer
credit information. The FACT Act requires the Federal Reserve Board and the
Federal Trade Commission to issue final regulations within nine months of the
effective date of the Act. The provisions of these implementing regulations, and
their effect on the Company's banks, cannot be determined at this time.
Expanding Enforcement Authority
The Federal Reserve Board, the Office of the Comptroller of Currency, the New
York State Superintendent of Banks and the FDIC possess extensive authority to
police unsafe or unsound practices and violations of applicable laws and
regulations by depository institutions and their holding companies. For example,
the FDIC may terminate the deposit insurance of any institution, which it
determines has engaged in an unsafe or unsound practice. The agencies can also
assess civil money penalties, issue cease and desist or removal orders, seek
injunctions, and publicly disclose such actions. The OCC has indicated, in the
case of NBG, that it is considering whether civil money penalties should be
imposed for certain of the violations of law identified in its Report of
Examination for the period ended September 30, 2002.
Effect On Economic Environment
The policies of regulatory authorities, including the monetary policy of the
Federal Reserve Board, have a significant effect on the operating results of
bank holding companies and their subsidiaries. Among the means available to the
Federal Reserve Board to affect the money supply are open market operations in
U.S. Government securities, changes in the discount rate on member bank
borrowings and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth and
distribution of bank loans, investments and deposits, and their use may affect
interest rates charged on loans or paid for deposits. Federal Reserve Board
monetary policies have materially affected the operating results of commercial
banks in the past and are expected to continue to do so in the future.
2003 Regulatory Developments
On September 4, 2003, the boards of NBG and BNB entered into formal agreements
with their primary regulator, the OCC. Under the terms of the agreements, NBG
and BNB, without admitting any violations, agreed to take certain actions
designed to assure that their operations are in accordance with applicable laws
and regulations. The agreements require them, among other things, to: appoint a
Compliance Committee of the Board; develop, implement and ensure compliance with
a written plan outlining actions to be taken to address regulatory
recommendations set forth in the reports of examination, review and assess the
capabilities of management; develop various policies and programs to reduce
credit risk and identify problem loans and to adopt policies that will permit
them to declare dividends only when they are in compliance with their approved
capital plans and applicable laws, and upon prior written notice to (but not
with the consent of) the OCC. The boards of both banks have taken, or are in the
process of taking, the actions required by the agreements, and the Company has
implemented a compliance monitoring program to track and monitor compliance
within each bank of each requirement in the formal agreements.
Both banks were required to develop capital plans that will enable them to
achieve, by March 31, 2004, Tier 1 leverage capital equal to 8% of risk-weighted
assets, Tier 1 risk-based capital equal to 10% of risk-weighted assets, and
total risk-based capital of 12% of risk-weighted assets. Interim levels, to be
achieved by December 31, 2003, were also established, at 6.25%, 9.0% and 11.0%,
respectively, for Bath, and 7.0%, 9.0% and 10.5%, respectively, for NBG.
Following the closing of the credit facility with M&T Bank in December 2003,
loan proceeds were downstreamed to NBG and BNB so that the capital levels
required to be achieved by March 31, 2004 were met by December 31, 2003.
23
The NBG agreement also requires its board of directors to adopt, implement and
ensure adherence to a written policy on extensions of overdraft credit and limit
the circumstances under which NBG will be permitted to extend credit to its
affiliates, and requires the bank to engage an independent appraiser to provide
updated real estate appraisals where required.
The BNB agreement also requires its board of directors to adopt, implement and
ensure adherence to a written action plan outlining proposed corrective action
addressing issues in the pre-existing Matters Requiring Attention pertaining to
interest rate risk measurement and monitoring systems.
Also on September 4, 2003, in a letter to the Federal Reserve Bank of New York,
the Company's primary regulator, the Company terminated its financial holding
company status and began operating instead as a bank holding company. The change
in status will not affect any non-financial subsidiaries or activities currently
being conducted by the Company, although it will mean that future acquisitions
or expansions of non-financial activities may require prior Federal Reserve
Board approval and will be limited to those that are permissible for bank
holding companies.
The Company believes that it has made substantial progress to date in enhancing
its risk management and governance practices while working with management and
Boards of NBG and BNB to address the various requirements set forth in the
formal agreements. There can be no assurance, however, as to the precise timing
for determining that all required corrective actions have been taken to the
appropriate satisfaction of the OCC. The Board and senior management team are
committed to the goal of establishing and maintaining "best practices" at both
the Company and the bank level in the areas of governance, corporate conduct,
risk management and regulatory compliance, and to meeting all of the banks'
commitments to their regulators. While the Company believes that substantial
progress has been made in this pursuit to date, the Company also recognizes that
this remains an important ongoing effort requiring dedication and a commitment
of resources at all levels of the holding company and the banks.
24
Item 2. Properties
The Company's headquarters and operations center is located in Warsaw, New York.
This facility is leased for a nominal rent from the Wyoming County Industrial
Development Agency for local tax reasons and the Company has the right to
purchase it for nominal consideration beginning in November 2006. The following
table lists the properties of each of the Company's subsidiaries:
TYPE OF LEASED OR EXPIRATION
ENTITY \ LOCATION FACILITY OWNED OF LEASE
----------------- -------- ----- --------
Wyoming County Bank
Warsaw............................. Main Office Own --
Attica............................. Branch Own --
Batavia............................ Branch Lease September 2011
Batavia (In-Store)................. Branch Lease August 2009
Dansville.......................... Branch Lease March 2014
East Aurora........................ Branch Lease March 2013
Geneseo............................ Branch Own --
Lakeville.......................... Branch Own --
Mount Morris....................... Branch Own --
North Java......................... Branch Own --
North Warsaw....................... Branch Own --
Orchard Park....................... Branch Ground Lease January 2019
Pavilion........................... Branch Own --
Strykersville...................... Branch Own --
Williamsville...................... Branch Lease May 2005
Wyoming............................ Branch Own --
Yorkshire.......................... Branch Lease November 2007
National Bank of Geneva
Geneva............................. Main Office Own --
Geneva............................. Drive-up Branch Own --
Geneva (Plaza)..................... Branch Ground Lease January 2016
Caledonia.......................... Branch Lease April 2006
Canandaigua........................ Branch Own --
Honeoye Falls...................... Branch Lease September 2017
Leroy.............................. Branch Own --
North Chili........................ Branch Own --
Ovid............................... Branch Own --
Penn Yan........................... Branch Own --
Victor............................. Branch Own --
Waterloo........................... Branch Own --
Bath National Bank
Bath............................... Main Office Own --
Bath............................... Drive-up Branch Own --
Avoca.............................. Branch Own --
Avoca.............................. Drive-up Branch Lease September 2004
Cohocton........................... Closed Branch Lease August 2005
Dundee............................. Branch Own --
Elmira............................. Branch Own --
Elmira Heights..................... Branch Lease August 2009
Erwin.............................. Branch Lease August 2004
Hammondsport....................... Branch Own --
Hornell............................ Branch Own --
Horseheads......................... Branch Lease October 2012
Naples............................. Branch Own --
Wayland............................ Branch Own --
First Tier Bank & Trust
Olean.............................. Main Office Own --
Olean.............................. Drive-up Branch Own --
Allegany........................... Branch Own --
Cuba............................... Branch Own --
Ellicottville...................... Branch Own --
Lakewood........................... Branch Own --
Salamanca.......................... Branch Own --
Burke Group
Honeoye Falls...................... Main Office Lease December 2018
Syracuse........................... Branch Lease April 2005
25
Item 3. Legal Proceedings
From time to time the Company and its subsidiaries are parties to or otherwise
involved in legal proceedings arising in the normal course of business.
Management does not believe that there is any pending or threatened proceeding
against the Company or its subsidiaries, which, if determined adversely, would
have a material effect on the Company's business, results of operations or
financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted during the fourth quarter of the year ended December
31, 2003 to a vote of security holders.
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
The common stock of the Company is traded under the symbol of FISI on the Nasdaq
National Market. At March 1, 2004, the Company had 11,172,673 shares of common
stock outstanding (exclusive of treasury shares) and approximately 2,400
shareholders of record. The following chart lists prices of actual sales
transactions as reported by Nasdaq, as well as the Company's cash dividends
declared.
Sales Price Cash Dividends
High Low Close Declared
-------------------------------------------------
2003
First Quarter $ 29.75 $ 19.05 $ 19.82 $ 0.16
Second Quarter 27.23 18.94 23.53 0.16
Third Quarter 27.20 21.80 21.92 0.16
Fourth Quarter 29.40 22.00 28.23 0.16
2002
First Quarter $ 30.00 $ 23.33 $ 29.11 $ 0.13
Second Quarter 38.85 28.74 37.86 0.14
Third Quarter 38.25 24.35 27.15 0.15
Fourth Quarter 32.04 25.05 29.36 0.16
The Company pays regular quarterly cash dividends on its common stock, and the
Board of Directors presently intends to continue the payment of regular
quarterly cash dividends, subject to the need for those funds for debt service
and other purposes. However, because substantially all of the funds available
for the payment of dividends are derived from the Banks, future dividends will
depend upon the earnings of the Banks', their financial condition and need for
funds. Furthermore, there are a number of federal banking policies and
regulations that restrict the Company's ability to pay dividends. For further
discussion on dividend restrictions, please refer to page 14, as these
restrictions may have the effect of reducing the amount of dividends that the
Company can declare to its shareholders.
26
Item 6. Selected Financial Data
(Dollars in thousands) December 31
--------------------------------------------------------------
2003 2002 2001 2000 1999
--------------------------------------------------------------
Selected Financial Condition Data
Total assets $2,173,732 $2,105,034 $1,794,296 $1,289,327 $1,136,460
Loans 1,345,347 1,321,892 1,166,050 887,145 763,745
Allowance for loan losses 29,064 21,660 19,074 13,883 11,421
Securities available for sale 604,964 596,862 428,423 257,823 197,134
Securities held to maturity 47,131 47,125 61,281 76,947 81,356
Deposits 1,818,891 1,708,523 1,433,658 1,078,111 949,531
Borrowed funds 154,247 195,479 190,389 62,384 56,336
Shareholders' equity 183,103 178,294 149,187 131,618 117,539
(Dollars in thousands) For the years ended December 31
--------------------------------------------------------------
2003 2002 2001 2000 1999
--------------------------------------------------------------
Selected Results of Operations
Data
Interest income $ 111,450 $ 118,439 $ 114,468 $ 96,467 $ 78,692
Interest expense 35,949 42,585 49,694 43,605 31,883
--------------------------------------------------------------
Net interest income 75,501 75,854 64,774 52,862 46,809
Provision for loan losses 22,526 6,119 4,958 4,211 3,062
--------------------------------------------------------------
Net interest income after
Provision for loan loss 52,975 69,735 59,816 48,651 43,747
Noninterest income 26,072 22,189 15,782 9,409 8,055
Noninterest expense (3) 60,823 53,049 43,352 30,156 27,032
--------------------------------------------------------------
Income before income taxes 18,224 38,875 32,246 27,904 24,770
Income taxes 3,977 12,419 11,033 9,804 8,813
--------------------------------------------------------------
Net income $ 14,247 $ 26,456 $ 21,213 $ 18,100 $ 15,957
==============================================================
At or for the years ended December 31
----------------------------------------------
2003 2002 2001 2000 1999
----------------------------------------------
Per Common Share Data
Net income - basic $ 1.14 $ 2.26 $ 1.79 $ 1.51 $ 1.38
Net income - diluted 1.13 2.23 1.77 1.51 1.38
Cash dividends declared on common stock 0.64 0.58 0.48 0.42 0.31
Book value 14.81 14.46 11.93 10.36 9.05
Market value 28.23 29.36 23.40 13.61 12.12
Selected Financial Ratios and Other Data
Performance Ratios:
Return on common equity 7.65% 17.01% 15.84% 15.78% 16.16%
Return on assets 0.66 1.35 1.34 1.51 1.54
Common dividend payout 56.14 25.66 26.82 27.81 22.46
Net interest rate spread 3.62 3.96 3.96 3.98 4.19
Net interest margin (1) 3.95 4.37 4.62 4.87 5.00
Efficiency ratio 55.73 50.62 48.49 45.19 45.55
Noninterest income to average total assets (2) 1.16 1.11 0.96 0.76 0.75
Noninterest expenses to average total assets 2.82 2.70 2.73 2.52 2.61
Average interest-earning assets to average interest
bearing liabilities 118.62 117.82 119.67 123.25 124.86
Asset Quality Ratios:
Non-performing loans to total loans 3.82% 2.81% 0.86% 0.80% 0.75%
Non-performing assets to total loans and other real 3.87 2.90 0.94 0.91 0.88
estate
Allowance for loan losses to non-performing loans 56 58 190 195 199
Allowance for loan losses to total loans 2.16 1.64 1.64 1.56 1.50
Net charge-offs during the period to average loans
outstanding during the year 1.11 0.30 0.23 0.21 0.17
Capital ratios:
Equity to total assets 8.42% 8.47% 8.31% 10.21% 10.34%
Average common equity to average assets 7.74 7.47 7.84 8.78 8.63
Other Data:
Number of full-service offices 48 47 41 32 29
Loans serviced for others (in millions) $439.5 $356.4 $302.3 $205.2 $200.2
Full time equivalent employees 744 685 608 441 411
(1) Net interest income divided by average interest earning assets. A
tax-equivalent adjustment to interest earned from tax-exempt securities
has been computed using a federal tax rate of 35%.
(2) Noninterest income excludes net gain (loss) on sale of securities
available for sale.
(3) Noninterest expense includes goodwill amortization, which amounted to
$1,653,000 for 2001 compared to zero in all other years presented.
27
----------------------------------------------
(Dollars in thousands) First Second Third Fourth
Quarter Quarter Quarter Quarter
----------------------------------------------
Selected Quarterly Financial Information
2003
Results of operations data:
Interest income $28,527 $28,764 $27,310 $26,849
Interest expense 9,686 9,571 8,770 7,922
Net interest income 18,841 19,193 18,540 18,927
Provision for loan losses 3,298 5,311 5,590 8,327
Net interest income after provision for loan losses 15,543 13,882 12,950 10,600
Noninterest income 6,102 6,160 7,059 6,751
Noninterest expense 15,576 14,947 14,896 15,404
Income before income taxes 6,069 5,095 5,113 1,947
Income taxes 1,773 1,445 1,058 (299)
Net income 4,296 3,650 4,055 2,246
Per common share data:
Net income - basic $0.35 $0.29 $0.33 $0.17
Net income - diluted 0.35 0.29 0.33 0.17
Cash dividends declared 0.16 0.16 0.16 0.16
Book value 14.57 15.11 14.78 14.81
Market value 19.82 23.53 21.92 28.23
----------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------------------------------------------
2002
Results of operations data:
Interest income $28,560 $29,927 $30,343 $29,609
Interest expense 10,483 10,941 10,810 10,351
Net interest income 18,077 18,986 19,533 19,258
Provision for loan losses 1,007 1,181 1,452 2,479
Net interest income after provision for loan losses 17,070 17,805 18,081 16,779
Noninterest income 4,937 5,157 5,687 6,408
Noninterest expense 12,100 13,093 13,418 14,438
Income before income taxes 9,907 9,869 10,350 8,749
Income taxes 3,250 3,225 3,466 2,478
Net income 6,657 6,644 6,884 6,271
Per common share data:
Net income - basic $0.57 $0.57 $0.59 $0.53
Net income - diluted 0.56 0.56 0.58 0.53
Cash dividends declared 0.13 0.14 0.15 0.16
Book value 12.26 13.23 14.03 14.46
Market value 29.11 37.86 27.15 29.36
28
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
GENERAL
The principal objective of this discussion is to provide an overview of the
financial condition and results of operations of the Company during the year
ended December 31, 2003 and the preceding two years. This discussion and tabular
presentations should be read in conjunction with the accompanying consolidated
financial statements and accompanying notes.
Income. The Company's results of operations are dependent primarily on net
interest income, which is the difference between the income earned on loans and
securities and the cost of funds, consisting of the interest paid on deposits
and borrowings. Results of operations are also affected by the provision for
loan losses, service charges on deposits, financial services group fees and
commissions, mortgage banking activities, gain or loss on the sale or call of
investment securities and other miscellaneous income.
Expenses. The Company's expenses primarily consist of salaries and employee
benefits, occupancy and equipment, supplies and postage, amortization of
intangible assets, computer and data processing, professional fees, other
miscellaneous expense and income tax expense. Results of operations are also
significantly affected by general economic and competitive conditions,
particularly changes in interest rates, government policies and the actions of
regulatory authorities.
OVERVIEW
Net income was $14.2 million, $26.5 million and $21.2 million for 2003, 2002 and
2001, respectively. Diluted earnings per share for the year ended December 31,
2003 was $1.13, compared to $2.23 in 2002 and $1.77 in 2001. The return on
average common equity in 2003 was 7.65%, compared to 17.01% in 2002 and 15.84%
in 2001. The return on average assets in 2003 was 0.66%, compared to 1.35% in
2002 and 1.34% in 2001.
Net interest income, the principal source of the Company's earnings, was $75.5
million in 2003 comparable to $75.9 million in 2002. Net interest margin was
3.95% for the year ended December 31, 2003, a drop of 42 basis points from the
4.37% level for last year.
The most significant item affecting 2003 financial results was the provision for
loan losses, which totaled $22.5 million in 2003, an increase of $16.4 million
over the $6.1 million provision for loan losses in 2002. Credit quality issues
made 2003 a challenging year for the Company. High levels of nonperforming loans
with associated charge-offs and increases to the allowance for loan losses
significantly impacted financial results. Nonperforming assets increased to $52
million at December 31, 2003 compared to $38 million at December 31, 2002.
Nonperforming agricultural credits, principally dairy farms, have increased $10
million since December 31, 2002. Total nonperforming agricultural loans were $22
million at December 31, 2003 or 9.40% of total agricultural loans. Borrower cash
flows in the dairy industry have recently improved due to some stabilization and
upward movement in milk prices. Net loan charge-offs were $15 million, or 1.11%
of average loans, for the year ended December 31, 2003 compared to $4 million,
or 0.30% of average loans for 2002. Commercial and commercial mortgage loans
represented $11 million of net charge-offs in 2003.
During 2003, increased regulatory oversight was put in place in the form of
formal agreements at the two national banks, NBG and BNB. In addition, the
Company's management placed a renewed focus on risk management, from both a
corporate and credit perspective. This included expansion of the position
formerly known as Chief Credit Officer to Chief Risk Officer. The Company has
committed substantial resources to credit administration and underwriting
functions with the goal of increasing consistency among subsidiary banks in
reporting and grading loans, and strengthening the review and oversight of
subsidiary bank lending and credit administration at the holding company level.
The Company's future challenges include managing existing credit quality issues
as well as continuing to strengthen and standardize the current loan
underwriting process. Significant resources have been invested in building an
infrastructure necessary to manage the current credit issues and to support
future
29
growth. Management is now faced with the challenge of leveraging that
infrastructure to grow revenues by investing in quality assets.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States and are consistent
with predominant practices in the financial services industry. Application of
critical accounting policies, which are those policies that Management believes
are the most important to the Company's financial position and results, requires
Management to make estimates, assumptions, and judgments that affect the amounts
reported in the consolidated financial statements and accompanying notes and are
based on information available as of the date of the financial statements.
Future changes in information may affect these estimates, assumptions and
judgments, which, in turn, may affect amounts reported in the financial
statements.
The Company has numerous accounting policies, of which the most significant are
presented in Note 1 of the notes to consolidated financial statements. These
policies, along with the disclosures presented in the other financial statement
notes and in this discussion, provide information on how significant assets,
liabilities, revenues and expenses are reported in the consolidated financial
statements and how those reported amounts are determined. Based on the
sensitivity of financial statement amounts to the methods, assumptions, and
estimates underlying those amounts, Management has determined that the
accounting policies with respect to the allowance for loan losses and goodwill
require particularly subjective or complex judgments important to the Company's
financial position and results of operations, and, as such, are considered to be
critical accounting policies as discussed below.
Allowance for Loan Losses: The allowance for loan losses represents management's
estimate of probable credit losses inherent in the loan portfolio. Determining
the amount of the allowance for loan losses is considered a critical accounting
estimate because it requires significant judgment and the use of subjective
measurements including management's assessment of the internal risk
classifications of loans, changes in the nature of the loan portfolio, industry
concentrations and the impact of current local, regional and national economic
factors on the quality of the loan portfolio. Changes in these estimates and
assumptions are reasonably possible and may have a material impact on the
Company's consolidated financial statements, results of operations or liquidity.
For additional discussion related to the Company's accounting policies for the
allowance for loan losses, see Note 1 of the notes to consolidated financial
statements.
Goodwill: Statement of Financial Accounting Standard (SFAS) No. 142, "Goodwill
and Other Intangible Assets" prescribes the accounting for goodwill and
intangible assets subsequent to initial recognition. The provisions of SFAS No.
142 discontinue the amortization of goodwill and intangible assets with
indefinite lives. Instead, these assets are subject to at least an annual
impairment review, and more frequently if certain impairment indicators are in
evidence. Changes in the estimates and assumptions used to evaluate impairment
may have a material impact on the Company's consolidated financial statements,
results of operations or liquidity. During 2003, the Company evaluated goodwill
for impairment using a discounted cash flow analysis and determined no
impairment existed. For additional discussion related to the Company's
accounting policy for goodwill and other intangible assets, see Note 1 of the
notes to the consolidated financial statements.
30
NET INCOME ANALYSIS
Average Balance Sheet
The following table sets forth certain information relating to the Company's
consolidated statements of financial condition and reflects the average yields
earned on interest-earning assets, as well as the average rates paid on
interest-bearing liabilities for the years indicated. Such yields and rates were
derived by dividing interest income or expense by the average balances of
interest-earning assets or interest-bearing liabilities, respectively, for the
years shown. Tax equivalent adjustments have been made. All average balances are
average daily balances. Nonaccrual loans are included in the yield calculations
in this table.
Year ended December 31
----------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------- ----------------------------- --------------------------------
Average Interest Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
(Dollars in thousands) Balance Paid Rate Balance Paid Rate Balance Paid Rate
----------------------------------------------------------------------------------------------
Interest-earning assets:
Federal funds sold and
interest bearing deposits $ 45,361 $ 505 1.11% $ 28,889 $ 494 1.71% $ 8,634 $ 358 4.15%
Investment securities (1):
Taxable 387,799 16,073 4.14 364,356 19,109 5.24 251,794 15,288 6.07
Non-taxable 231,529 12,794 5.53 211,358 13,109 6.20 170,151 11,279 6.63
---------- -------- ------- ---------- -------- ------- ---------- -------- -------
Total investment securities 619,328 28,867 4.66 575,714 32,218 5.59 421,945 26,567 6.30
Loans (2):
Commercial and agricultural 859,709 51,196 5.96 766,818 52,177 6.80 611,866 51,244 8.38
Residential real estate 255,429 18,340 7.18 234,813 19,362 8.25 227,784 20,193 8.86
Consumer and home equity 242,491 17,020 7.02 233,173 18,776 8.05 217,070 20,045 9.23
---------- -------- ------- ---------- -------- ------- ---------- -------- -------
Total loans 1,357,629 86,556 6.38 1,234,804 90,315 7.31 1,056,720 91,482 8.66
Total interest-earning
assets 2,022,318 115,928 5.73 1,839,407 123,027 6.69 1,487,299 118,407 7.96
Allowance for loan losses (25,135) (20,030) (16,825)
Other non-interest earning assets 158,554 145,639 117,698
---------- ---------- ----------
Total assets $2,155,737 $1,965,016 $1,588,172
========== ========== =========
Interest-bearing liabilities:
Savings and money market $ 411,587 $ 3,958 0.96% $ 366,708 $ 5,768 1.57% $ 253,128 $ 5,244 2.07%
Interest-bearing checking 389,267 3,547 0.91 354,687 5,059 1.43 172,022 2,110 1.23
Certificates of deposit 744,022 21,758 2.92 655,737 24,340 3.71 696,230 36,060 5.18
Borrowed funds 143,749 5,009 3.48 167,883 5,741 3.42 107,530 4,840 4.50
Guaranteed preferred
beneficial interests in
corporations junior
subordinated debentures 16,200 1,677 10.35 16,200 1,677 10.35 13,892 1,440 10.37
---------- -------- ------- ---------- -------- ------- ---------- -------- -------
Total interest-bearing
liabilities 1,704,825 35,949 2.11 1,561,215 42,585 2.73 1,242,802 49,694 4.00
---------- -------- ------- ---------- -------- ------- ---------- -------- -------
Non-interest bearing demand
deposits 245,234 219,028 181,831
---------- ---------- ----------
Other non-interest-bearing
liabilities 21,165 20,306 21,318
---------- ---------- ----------
Total liabilities 1,971,224 1,800,549 1,445,951
Stockholders' equity (3) 184,513 164,467 142,221
---------- ---------- ----------
Total liabilities
and stockholders'
equity $2,155,737 $1,965,016 $1,588,172
========== ========== ==========
Net interest income $ 79,979 $ 80,442 $ 68,713
======== ======== ========
Net interest rate spread 3.62% 3.96% 3.96%
======= ======= =======
Net earning assets $ 317,493 $ 278,192 $ 244,497
========== ========== ==========
Net interest income as a
percentage of average
interest-earning assets 3.95% 4.37% 4.62%
======= ======= =======
Ratio of average interest-earning
assets to average
interest-bearing liabilities 118.62% 117.82% 119.67%
======= ======= =======
(1) Amounts shown are amortized cost for held to maturity securities and fair
value for available for sale securities. In order to make pre-tax income
and resultant yields on tax-exempt securities comparable to those on
taxable securities and loans, a tax-equivalent adjustment to interest
earned from tax-exempt securities has been computed using a federal tax
rate of 35%.
(2) Net of deferred loan fees and costs, and loan discounts and premiums.
(3) Includes unrealized gains/(losses) on securities available for sale.
31
Net Interest Income
Net interest income, the principal source of the Company's earnings, was $75.5
million in 2003 comparable to $75.9 million in 2002. Net interest margin was
3.95% for the year ended December 31, 2003, a drop of 42 basis points from the
4.37% level for the same period last year. Growth in average earning assets of
$183 million, or 10%, served to partially offset the fall in net interest
margin. The growth in average earning assets is comprised of average increases
of $123 million and $60 million in loans and investment securities,
respectively. The Company's yield on average earning assets was 5.73% for 2003,
down 96 basis points from 6.69% from 2002. The Company's loan portfolio yield
was 6.38% and tax-equivalent investment yield was 4.66% for 2003, each down 93
basis point from 2002. The decline in both categories is partially due to the
historically low interest rate environment, which has led to repricing of
variable rate loans and prepayments of higher yielding investment securities and
redeployment of those funds at current market rates. Lost interest on the higher
levels of nonaccrual loans has also contributed to the decline in loan portfolio
yield.
Total average interest-bearing liabilities were $1.705 billion for the year
ended December 31, 2003 representing a $144 million increase over 2002 and
represented approximately 80% of the average increased funding required to
support the growth in average earning assets. The principal funding source for
the average earning asset growth was deposits, with the average for the year
ended December 31, 2003 increasing $194 million or 12% over the average for the
same period in 2002. Net interest margin declined in 2003, as general market
interest rates declined to historically low levels. As overall interest rates
have continued to remain low, the Company's yields on earning assets declined in
2003 more rapidly than the cost of funds.
The Company's cost of interest bearing liabilities was 2.11% for 2003, a drop of
62 basis points from 2002. Interest bearing liabilities represented
approximately 85% of the funding sources for earning assets in 2003 and 2002
with the balance of earning assets being funded by net noninterest bearing
funding sources. Net noninterest bearing funding sources represent the amount of
zero interest cost funds such as demand deposits and equity that are available
to fund earning assets after funding non-interest earning assets. Coupling the
zero interest funding sources with interest bearing liabilities results in a
total cost of funds for the Company in 2003 of 1.78%, down 54 basis points from
the 2002 total cost of funds of 2.32%.
Net interest income was $75.9 million in 2002 compared with $64.8 million in
2001, an increase of $11.1 million or 17%. Average earning assets grew by $352
million to $1.839 billion in 2002, or 24% over 2001, which offset the effects of
a 25 basis point decline in the net interest margin from 4.62% in 2001 to 4.37%
in 2002. Total average interest-bearing liabilities were $1.561 billion for the
year ended December 31, 2002, representing a $318 million increase over 2001 and
90% of the average increased funding required to support the growth in average
earning assets.
32
Rate/Volume Analysis
The following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to: (i) changes attributable to changes in volume (changes in volume
multiplied by current year rate); (ii) changes attributable to changes in rate
(changes in rate multiplied by prior volume); and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
Year ended December 31
----------------------------------------------------------------
2003 vs. 2002 2002 vs. 2001
----------------------------------------------------------------
Increase/(Decrease) Total Increase/(Decrease) Total
Due To Increase/ Due To Increase/
(Dollars in thousands) Volume Rate (Decrease) Volume Rate (Decrease)
---------------------------------------------------------------
Interest-earning assets:
Federal funds sold and
interest-bearing deposits $ 200 $ (189) $ 11 $ 349 $ (213) $ 136
Investment securities:
Taxable 971 (4,007) (3,036) 5,957 (2,136) 3,821
Non-taxable 1,165 (1,480) (315) 2,565 (735) 1,830
-------- -------- -------- -------- -------- --------
Total investment securities 2,136 (5,487) (3,351) 8,522 (2,871) 5,651
Loans:
Commercial and agricultural 5,965 (6,946) (981) 11,249 (10,316) 933
Residential real estate 1,466 (2,488) (1,022) 595 (1,426) (831)
Consumer and home equity 657 (2,413) (1,756) 1,300 (2,569) (1,269)
-------- -------- -------- -------- -------- --------
Total loans 8,088 (11,847) (3,759) 13,144 (14,311) (1,167)
-------- -------- -------- -------- -------- --------
Total interest-earning assets 10,424 (17,523) (7,099) 22,015 (17,395) 4,620
======== ======== ======== ======== ======== ========
Interest-bearing liabilities:
Savings and money market 432 (2,242) (1,810) 1,807 (1,283) 524
Interest-bearing checking 311 (1,823) (1,512) 2,606 343 2,949
Certificates of deposit 2,557 (5,138) (2,581) (1,500) (10,220) (11,720)
Borrowed funds (833) 100 (733) 2,059 (1,158) 901
Junior subordinated debentures
issued to unconsolidated
subsidiary trust -- -- -- 240 (3) 237
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities 2,467 (9,103) (6,636) 5,212 (12,321) (7,109)
======== ======== ======== ======== ======== ========
Net interest income $ 7,957 $ (8,420) $ (463) $ 16,803 $ (5,074) $ 11,729
======== ======== ======== ======== ======== ========
Provision for Loan Losses
The provision for loan losses represents management's estimate of the expense
necessary to maintain the allowance for loan losses at a level representative of
losses in the portfolio. The provision for loan losses was $22.5 million in
2003, compared to $6.1 million in 2002 and $5.0 million in 2001. The significant
increase in the provision for loan losses during 2003 primarily relates to
higher levels of nonperforming loans and charge-offs. Nonperforming loans
increased to $51.5 million at December 31, 2003 compared to $37.1 million at
December 31, 2002. Nonperforming agricultural credits, principally dairy farms,
have increased $10 million since December 31, 2002 after a long period of
depressed milk prices. Total nonperforming agricultural loans were $22 million
at December 31, 2003 or 9.40% of total agricultural loans. Borrower cash flows
in the dairy industry have recently improved due to some stabilization and
upward movement in milk prices. Net loan charge-offs were $15 million, or 1.11%
of average loans, for the year ended December 31, 2003 compared to $4 million,
or 0.30% of average loans for 2002. Commercial and commercial mortgage loans
represented $11 million of net charge-offs in 2003. The ratio of the allowance
for loan losses to nonperforming loans was 56% at December 31, 2003 versus 58%
at December 31, 2002. The ratio of allowance for loan losses to total loans was
2.16% and 1.64% at December 31, 2003 and 2002, respectively. See "Lending
Activities" section for further discussion.
33
Noninterest Income
The following table presents the major categories of noninterest income during
the years indicated:
Year Ended December 31
--------------------------------------------
(Dollars in thousands) 2003 2002 2001
---- ---- ----
Service charges on deposits.......................... $ 11,461 $ 10,603 $ 7,653
Financial services group fees and commissions........ 5,692 5,629 2,690
Mortgage banking activities.......................... 4,036 2,279 2,190
Gain on sale or call of securities................... 1,041 285 531
Other................................................ 3,842 3,393 2,718
--------- --------- ---------
Total noninterest income........................... $ 26,072 $ 22,189 $ 15,782
========= ========= =========
Noninterest income increased 17% to $26.1 million in 2003 compared to $22.2
million in 2002. The increase in noninterest income is partially attributed to
the growth in deposits and related service fees. The increase in mortgage
banking activities, which includes gains and losses from the sale of loans,
mortgage servicing income and the amortization and impairment of mortgage
servicing rights, corresponds with the increase in residential mortgage
refinancing activity resulting from the historically low interest rate
environment during 2003. Gains and losses from the sale of loans, the largest
component of mortgage banking activities, totaled $3.2 million and $1.5 million
in 2003 and 2002, respectively. The Company sells most fixed rate newly
originated and refinanced mortgage loans in the secondary market and retains the
servicing rights. The Company's loan servicing portfolio was $439 million at
December 31, 2003 compared to $356 million at December 31, 2002.
Noninterest income increased 41% to $22.2 million in 2002 compared to $15.8
million in 2001. The increase in noninterest income is partially attributed to
the growth in deposits and related service fees. In addition, the increase in
financial services group fees and commissions reflects the ongoing expansion of
the financial services line of business. In comparison to 2001, the year ended
December 31, 2002 reflects a full year of fees and commissions generated by the
Company's employee benefits administration and compensation consulting firm,
BGI, acquired during the fourth quarter of 2001.
Noninterest Expense
The following table presents the major categories of noninterest expense during
the years indicated:
Year Ended December 31
--------------------------------------------
(Dollars in thousands) 2003 2002 2001
---- ---- ----
Salaries and employee benefits....................... $ 33,825 $ 30,093 $ 22,958
Occupancy and equipment.............................. 8,270 7,285 6,050
Supplies and postage................................. 2,468 2,371 1,953
Amortization of goodwill............................. -- -- 1,653
Amortization of other intangible assets.............. 1,226 898 728
Computer and data processing......................... 1,829 1,759 1,501
Professional fees.................................... 1,881 1,612 1,326
Other................................................ 11,324 9,031 7,183
--------- --------- ---------
Total noninterest expense.......................... $ 60,823 $ 53,049 $ 43,352
========= ========= =========
Noninterest expense was $60.8 million compared to $53.0 million in 2002. The
overall increase in noninterest expense is generally attributed to higher credit
collection costs, costs of opening new branch offices and costs for additional
lending and credit administration staff. The Company's largest component of
noninterest expense, salaries and employee benefits, increased 13% in 2003,
primarily a reflection of staffing additions as previously indicated. Included
in 2003 other expenses are the following items which increased substantially
from the prior year: $1.1 million of other real estate expense, $683,000 of
commercial loan expense and $544,000 of limited partnership expense. The
additional noninterest expenses, coupled with a slowing of revenue growth, are
the principal factors in an increase in the
34
Company's efficiency ratio to 55.7% for the year ended December 31, 2003,
compared to 50.6% and 48.5% in 2002 and 2001, respectively.
Noninterest expense increased 22% to $53.0 million in 2002 compared to $43.4
million in 2001. The Company's largest component of noninterest expense,
salaries and employee benefits, increased 31% in 2002, a reflection of staffing
additions from acquisitions and other additions necessary to support the
Company's growth. The increase also results from overhead coupled with
integrating the newly acquired companies, expenditures associated with
maintaining the Company's investment in technology and costs connected with
opening new branch offices. In contrast, goodwill amortization expense
recognized on the BNB acquisition, which amounted to $1.7 million in 2001,
ceased on January 1, 2002 with the adoption of SFAS No. 142.
Income Tax Expense
The provision for income taxes provides for Federal and New York State income
taxes, which amounted to $4.0 million, $12.4 million and $11.0 million for the
years ended December 31, 2003, 2002 and 2001, respectively. The fluctuation in
the provision for income taxes corresponds in general with taxable income levels
for each year. The effective tax rate for 2003 was 21.8%, compared to 31.9% in
2002 and 34.2% in 2001. The lower effective tax rate in 2003 is primarily
attributable to tax exempt interest income constituting a larger proportion of
net income before income taxes.
Segment Information
In accordance with the provisions of SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information," the Company's reportable segments are
comprised of WCB, NBG, BNB, FTB and FSG as the Company evaluates performance on
an individual bank basis. During 2002 the Company completed a geographic
realignment of the subsidiary banks, which involved the merger of the subsidiary
formerly known as PSB into NBG and subsequent transfer of branches between NBG
and WCB. Accordingly, the Company restated segment results to reflect the merger
and transfers for each of the years presented. Financial information related to
the Company's segments is presented in Note 17 of the notes to consolidated
financial statements.
FINANCIAL CONDITION
At December 31, 2003 the Company had total assets of $2.174 billion, an increase
of 3% from $2.105 billion at December 31, 2002. Total deposits were $1.819
billion at year-end 2003, compared with $1.709 billion a year earlier. Book
value per common share at December 31, 2003 was $14.81, an increase of 2% from
$14.46 at December 31, 2002.
At December 31, 2003 the Company's total shareholders' equity was $183 million
compared to $178 million a year earlier. During the fourth quarter of 2003 the
Company completed a debt-financing plan that raised $25 million. Approximately
$15 million of the financing proceeds were contributed as capital to the
Company's NBG and BNB subsidiaries allowing those banks to meet higher capital
ratios required in agreements imposed by their regulator. See Note 15 of the
notes to consolidated financial statements.
35
Lending Activities
Set forth below is selected information concerning the composition of the
Company's loan portfolio.
At December 31
---------------------------------------------------------------
(Dollars in thousands) 2003 2002 2001 2000 1999
---------------------------------------------------------------
Commercial $ 248,313 $ 262,630 $ 232,379 $ 169,832 $ 140,376
Commercial real estate 369,712 332,134 274,702 166,041 137,648
Agricultural 235,199 233,769 186,623 165,367 151,534
Residential real estate 251,502 251,898 240,141 201,160 189,149
Consumer and home equity 240,591 241,461 232,205 184,745 145,038
----------- ----------- ----------- --------- ---------
Total loans, gross 1,345,317 1,321,892 1,166,050 887,145 763,745
Allowance for loan losses (29,064) (21,660) (19,074) (13,883) (11,421)
----------- ----------- ----------- --------- ---------
Total loans, net $ 1,316,253 $ 1,300,232 $ 1,146,976 $ 873,262 $ 752,324
=========== =========== =========== ========= =========
Gross loans increased slightly to $1.345 billion at December 31, 2003 from
$1.322 billion at December 31, 2002, an increase of $23 million or 1.8%.
Commercial loans decreased $14 million or 5.5%, while commercial real estate
loans increased by $38 million or 11.3%. At December 31, 2003, commercial loans
totaled $248 million, representing 18.5% of total loans, and commercial real
estate loans totaled $370 million, representing 27.5% of total loans. At
December 31, 2003, agricultural loans, which include agricultural real estate
loans, totaled $235 million, representing 17.5% of the total loan portfolio.
As of December 31, 2003 and 2002, residential real estate loans remained flat at
$252 million or 18.7% of total loans in 2003. Although the residential real
estate loans portfolio remained flat year-over-year, the Company processed a
significant number of mortgage applications during 2003 because of the
historically low interest rate environment during 2003. The Company sells most
qualifying newly originated and refinanced residential real estate mortgages on
the secondary market. The sold and serviced residential real estate loan
portfolio increased to $386 million at December 31, 2003 from $301 million at
December 31, 2002. During 2003 and 2002, the Company sold residential real
estate loans totaling $192 million and $139 million, respectively.
Gross loans increased to $1.322 billion at December 31, 2002 from $1.166 billion
at December 31, 2001, an increase of $156 million or 13.4%, principally from
continued expansion of the commercial, commercial real estate and agricultural
loan portfolios. Commercial loans increased $30 million or 13.0%, while
commercial real estate loans increased by $57 million or 20.9%. At December 31,
2002, commercial loans totaled $263 million, representing 19.9% of total loans,
and commercial real estate loans totaled $332 million, representing 25.1% of
total loans. At December 31, 2002, agricultural loans increased by $47 million
or 25.3%, to $234 million, represented 17.7% of the total loan portfolio. The
2002 increases in commercial, commercial real estate and agricultural loans
reflect the Company's expanded business development efforts.
As of December 31, 2002, residential real estate loans grew by $12 million or
4.9% from December 31, 2001, and totaled $252 million or 19.1% of total loans.
The relatively small percentage increase in residential real estate loans in
comparison to commercial loan types corresponds with the Company's trend towards
selling newly originated residential real estate mortgages, which is evidenced
by the increase in the sold and serviced loan portfolio to $301 million at
December 31, 2002 from $246 million at December 31, 2001. During 2002 and 2001,
the Company sold residential real estate loans totaling $139 million and $117
million, respectively.
The Company also offers a broad range of consumer loan products. Consumer and
home equity loans totaled $241 million at December 31, 2003 and 2002,
representing 17.9% of the total loan portfolio at year-end 2003. The flat
consumer portfolio is a reflection of an increase in home equity lines of credit
offset by a decline in the Company's indirect lending program, which resulted
from an increase in competition for automobile financing.
36
Nonaccrual Loans and Nonperforming Assets
During 2003, the Company's credit quality declined further, particularly in the
agricultural sector. Nonperforming loans increased to $51.5 million at December
31, 2003 compared to $37.1 million at December 31, 2002. Nonperforming
agricultural credits, principally dairy farms, have increased $10 million since
December 31, 2002 after a long period of depressed milk prices. Total
nonperforming agricultural loans were $22 million at December 31, 2003 or 9.40%
of total agricultural loans. Net loan charge-offs were $15 million, or 1.11% of
average loans, for the year ended December 31, 2003 compared to $4 million, or
0.30% of average loans for 2002. Commercial and commercial mortgage loans
represented $11 million of net charge-offs in 2003.
The Company has performed a comprehensive analysis of each impaired loan over
$250,000, including the borrower's paying capacity; assessed the collateral
supporting the loans outstanding and made appropriate allocations of loss
allowances. Various forms of collateral including receivables, inventory,
livestock, equipment, real property and other assets, secure the majority of the
nonperforming loans.
The following table sets forth information regarding nonaccrual loans and other
nonperforming assets.
At December 31
----------------------------------------------------
(Dollars in thousands) 2003 2002 2001 2000 1999
----------------------------------------------------
Nonaccrual loans (1)
Commercial $ 12,983 $ 12,760 $ 2,623 $ 1,044 $ 1,159
Commercial real estate 11,745 8,407 3,344 1,619 1,373
Agricultural 18,870 8,739 1,529 2,881 1,455
Residential real estate 2,496 1,065 921 835 413
Consumer and home equity 578 915 541 217 375
-------- -------- -------- -------- --------
Total nonaccrual loans 46,672 31,886 8,958 6,596 4,775
Restructured loans 3,069 4,129 -- -- --
Accruing loans 90 days or more delinquent 1,709 1,091 1,064 521 969
-------- -------- -------- -------- --------
Total nonperforming loans 51,450 37,106 10,022 7,117 5,744
Other real estate owned 653 1,251 947 932 969
-------- -------- -------- -------- --------
Total nonperforming assets $ 52,103 $ 38,357 $ 10,969 $ 8,049 $ 6,713
======== ======== ======== ======== ========
Total nonperforming loans to total loans 3.82% 2.81% 0.86% 0.80% 0.75%
Total nonperforming assets to total loans
and other real estate 3.87% 2.90% 0.94% 0.91% 0.88%
(1) Although loans are generally placed on nonaccrual status when they become
90 days or more past due they may be placed on nonaccrual status earlier
if they have been identified by the Company as presenting uncertainty with
respect to the collectibility of interest or principal.
37
Analysis of the Allowance for Loan Losses
The allowance for loan losses represents the estimated amount of probable credit
losses in the Company's loan portfolio. The Company performs periodic,
systematic reviews of its Banks' portfolios to identify these probable losses,
and to assess the overall collectibility of these portfolios. These reviews
result in the identification and quantification of loss factors, which are used
in determining the amount of the allowance for loan losses. In addition, the
Company periodically evaluates prevailing economic and business conditions,
industry concentrations, changes in the size and characteristics of the
portfolio and other pertinent factors. The allowance for loan losses is
allocated to cover the estimated losses in each loan category based on the
results of this detailed review. The process used by the Company to determine
the overall allowance for loan losses is based on this analysis, taking into
consideration management's judgment. Allowance methodology is reviewed on a
periodic basis and modified as appropriate. Based on this analysis, the Company
believes that the allowance for loan losses is fairly stated at December 31,
2003.
The following table sets forth an analysis of the activity in the allowance for
loan losses for the periods indicated.
Years Ended December 31
----------------------------------------------------
(Dollars in thousands) 2003 2002 2001 2000 1999
----------------------------------------------------
Balance at beginning of year $ 21,660 $ 19,074 $ 13,883 $ 11,421 $ 9,570
Addition resulting from acquisitions -- 174 2,686 -- --
Charge-offs:
Commercial 8,891 1,771 1,003 466 312
Commercial real estate 2,953 944 394 629 139
Agricultural 1,876 106 58 85 12
Residential real estate 215 98 178 113 461
Consumer and home equity 2,107 1,499 1,319 905 663
-------- -------- -------- -------- --------
Total charge-offs 16,042 4,418 2,952 2,198 1,587
Recoveries:
Commercial 525 210 58 206 88
Commercial real estate 35 69 23 22 23
Agricultural 3 36 -- 1 --
Residential real estate 11 67 19 5 163
Consumer and home equity 346 329 399 215 102
-------- -------- -------- -------- --------
Total recoveries 920 711 499 449 376
Net charge-offs 15,122 3,707 2,453 1,749 1,211
Provision for loan losses 22,526 6,119 4,958 4,211 3,062
-------- -------- -------- -------- --------
Balance at end of year $29,064 $ 21,660 $ 19,074 $ 13,883 $ 11,421
======== ======== ======== ======== ========
Ratio of net charge-offs during the year to
average loans outstanding during the year 1.11% 0.30% 0.23% 0.21% 0.17%
Ratio of allowance for loan losses to total loans 2.16% 1.64% 1.64% 1.56% 1.50%
Ratio of allowance for loan losses to
nonperforming loans 56% 58% 190% 195% 199%
At December 31, 2003, the Company's allowance for loan losses totaled $29
million, an increase of $7 million over the previous year-end. The allowance as
a percentage of total loans was 2.16% and 1.64% at December 31, 2003 and 2002,
respectively. The ratio of allowance for loan losses to nonperforming loans
declined slightly to 56% at December 31, 2003 versus 58% at December 31, 2002.
The allowance for loan losses at December 31, 2003 represents the estimated
probable losses in the loan portfolio
38
based on the Company's comprehensive assessment of collateral values and
borrower paying capacity on impaired loans in excess of $250,000 together with
the Company's assessment of current economic conditions in the Company's market
area. The results of these assessments showed that a provision for loan losses
of $22.5 million was required and recorded during 2003.
The increase in commercial loan charge-offs to $8.9 million at December 31, 2003
from $1.8 million at December 31, 2002 related primarily to NBG, as the NBG
subsidiary accounted for approximately 90% of the Company's increase in
commercial loan charge-offs. In addition, over 60%, or $4.6 million of NBG's
commercial loan charge-offs were attributed to four credit relationships.
The following table summarizes the loan delinquencies (excluding past due
nonaccrual loans) in the loan portfolio as of December 31, 2003:
Accruing
Loans
60-89 90 Days
(Dollars in thousands) Days or More
---- -------
Commercial $ 1,426 $ 1,219
Commercial real estate 519 --
Agricultural 284 178
Residential real estate 524 106
Consumer and home equity 508 206
-------- --------
Total $ 3,261 $ 1,709
======== ========
Allocation of Allowance for Loan Losses
The following table sets forth the allocation of the allowance for loan losses
by loan category at the dates indicated. The allocation is made for analytical
purposes and is not necessarily indicative of the categories in which actual
losses may occur. The total allowance is available to absorb losses from any
segment of the loan portfolio.
At December 31
-----------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
-----------------------------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
of of Loans of of Loans of of Loans of of Loans of of Loans
Allowance in Each Allowance in Each Allowance in Each Allowance in Each Allowance in Each
for Category for Category for Category for Category for Category
Loan to Total Loan to Total Loan to Total Loan to Total Loan to Total
(Dollars in thousands) Losses Loans Losses Loans Losses Loans Losses Loans Losses Loans
-----------------------------------------------------------------------------------------------------------
Commercial $ 7,739 18.4% $ 5,321 19.9% $ 4,376 19.9% $ 2,924 19.1% $ 1,909 18.4%
Commercial real
estate 5,354 27.5 4,725 25.1 3,611 23.6 1,902 18.7 2,071 18.0
Agricultural 6,078 17.5 3,711 17.7 2,341 16.0 2,270 18.7 1,443 19.8
Residential real
estate 1,447 18.7 1,414 19.1 1,700 20.6 1,186 22.7 914 24.8
Consumer and home
equity 2,161 17.9 2,007 18.2 2,578 19.9 1,818 20.8 1,270 19.0
Unallocated 6,285 -- 4,482 -- 4,468 -- 3,783 -- 3,814 --
--------- -------- --------- -------- --------- -------- --------- -------- --------- --------
Total $ 29,064 100% $ 21,660 100% $ 19,074 100% $ 13,883 100% $ 11,421 100%
========= ======== ========= ======== ========= ======== ========= ======== ========= ========
39
Loan Maturity and Repricing Schedule
The following table sets forth certain information as of December 31, 2003,
regarding the amount of loans maturing or repricing in the portfolio. Demand
loans having no stated schedule of repayment or maturity and overdrafts are
reported as due in one year or less. Adjustable and floating-rate loans are
included in the period in which interest rates are next scheduled to adjust
rather than the period in which they contractually mature, and fixed-rate loans
are included in the period in which the final contractual repayment is due.
At December 31, 2003
----------------------------------------------------
One
Within Through After
One Five Five
(Dollars in thousands) Year Years Years Total
---------- ---------- ---------- ----------
Commercial $ 121,226 $ 75,081 $ 52,006 $ 248,313
Commercial real estate 10,534 40,525 318,653 369,712
Agricultural 59,990 48,113 127,096 235,199
Residential real estate 12,064 18,256 221,182 251,502
Consumer and home equity 9,759 109,802 121,030 240,591
---------- ---------- ---------- ----------
Total loans $ 213,573 $ 291,777 $ 839,967 $1,345,317
========== ========== ========== ==========
Loans maturing after one year:
With a predetermined interest rate $ 171,158 $ 236,295
With a floating or adjustable rate 120,619 603,672
---------- ----------
$ 291,777 $ 839,967
========== ==========
Investing Activities
U.S. Treasury and Agency Securities. At December 31, 2003, the U.S. Treasury and
agency securities portfolio totaled $211.9 million, all of which was classified
as available for sale. The portfolio consisted entirely of U.S. federal agency
securities. The U.S. agency security portfolio consists of primarily callable
securities, as callable securities provide higher yields than similar securities
without call features. During 2003 the Company also utilized U.S. agency
discount notes as a short-term investment alternative, particularly at the NBG
and BNB subsidiaries. At December 31, 2002, the U.S. Treasury and agency
securities portfolio totaled $120.6 million, all of which was classified as
available for sale. The portfolio consisted of $1.0 million in U. S. Treasury
securities and $119.6 million in U. S. federal agency securities. The $91.3
million increase in the Company's investment in U.S. agency securities during
2003 relates to the utilization of agency discount notes as a cash management
tool, as well as the overall attractiveness of U.S. agency securities from a
yield, risk or liquidity perspective.
State and Municipal Obligations. At December 31, 2003, the portfolio of state
and municipal obligations totaled $242.5 million, of which $195.4 million was
classified as available for sale. At that date, $47.1 million was classified as
held to maturity, with a fair value of $48.1 million. At December 31, 2002, the
portfolio of state and municipal obligations totaled $222.0 million, of which
$174.9 million was classified as available for sale. At that date, $47.1 million
was classified as held to maturity, with a fair value of $48.1 million. Over the
past few years, more favorable yields on new purchases of these securities, when
compared to taxable investment alternatives, has led to growth in this
portfolio. In addition, the Company has expanded its overall municipal banking
relationship business that includes both deposit activities and investing in
obligations issued by those municipalities.
Mortgage-Backed Securities. Mortgage-backed securities, all of which were
classified as available for sale, totaled $192.7 million and $283.5 million at
December 31, 2003 and 2002, respectively. The portfolio was comprised of $138.5
million of mortgage-backed pass-through securities, $45.1 million of
collateralized mortgage obligations (CMOs) and $9.1 million of other
asset-backed securities at December 31, 2003. The mortgage backed pass-through
securities were predominantly issued by government sponsored enterpises (FNMA,
FHLMC, or GNMA). Approximately 80% of the mortgage-
40
backed pass-through securities were in fixed rate securities that were most
frequently formed with mortgages having an original balloon payment of five or
seven years. The adjustable rate agency mortgage-backed securities portfolio is
principally indexed to the one-year Treasury bill. The CMO portfolio consists of
government issues and privately issued AAA rated securities. The other
asset-backed securities are primarily Student Loan Marketing Association (SLMA)
floaters, which are securities backed by student loans. At December 31, 2002 the
portfolio consisted of $193.4 million of mortgage-backed pass-through
securities, $78.6 million of CMOs and $11.5 million of SLMAs. The decrease in
mortgage-backed securities is a result of significant prepayments of this
security class during the year due to the historically low interest rate
environment and redeployment of the funds in alternative investment vehicles,
namely U.S. agency securities.
Corporate Bonds. The corporate bond portfolio, all of which was classified as
available for sale, totaled $4.1 million and $13.9 million at December 31, 2003
and 2002, respectively. The decline in this class of securities relates to the
liquidation of certain bonds to satisfy managements desire to decrease overall
credit risk. The Company's investment policy limits investments in corporate
bonds to no more than 10% of total investments and to bonds rated as Baa or
better by Moody's Investors Service, Inc. or BBB or better by Standard & Poor's
Ratings Services at the time of purchase.
Equity Securities. At December 31, 2003 and 2002, available for sale equity
securities totaled $0.9 million and $3.9 million, respectively.
Security Yields and Maturities Schedule
The following table sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of the Company's debt
securities portfolio as of December 31, 2003. No tax equivalent adjustments were
made to the weighted average yields.
December 31, 2003
--------------------------------------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years After Ten Years Total
--------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average Amortized Average Amortized Average
(Dollars in thousands) Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield
--------------------------------------------------------------------------------------------------------
Available for Sale:
US Treasury and
agency $ 39,424 1.57% $ 26,946 4.41% $ 45,534 4.94% $ 98,666 4.47% $210,570 4.02%
Mortgage-backed
securities 176 2.28 20,520 4.67 82,698 4.43 86,518 4.30 189,912 4.39
State and municipal
obligations 13,712 4.40 105,978 3.74 61,636 3.87 5,003 4.74 186,329 3.86
Corporate bonds 3,015 5.84 506 6.38 -- -- 499 9.50 4,020 6.37
-------------------------------------------------------------------------------------------------------
Total debt securities
available for sale $ 56,327 2.49% $153,950 3.99% $189,868 4.37% $190,686 4.41% $590,831 4.11%
=======================================================================================================
Held to Maturity:
State and municipal
obligations $ 33,458 2.14% $ 10,654 4.39% $ 2,220 4.81% $ 799 5.11% $ 47,131 2.82%
=======================================================================================================
Total debt securities
held to maturity $ 33,458 2.14% $ 10,654 4.39% $ 2,220 4.81% $ 799 5.11% $ 47,131 2.82%
=======================================================================================================
41
Borrowing Activities
Outstanding borrowings at December 31, 2003 and 2002 are summarized as follows:
(Dollars in thousands) 2003 2002
------- -------
Short-term borrowings:
Federal funds purchased and securities
sold under repurchase agreements $22,525 $60,679
FHLB advances 26,500 26,000
Other 1,000 510
------- -------
Total short-term borrowings $50,025 $87,189
======= =======
Long-term borrowings:
FHLB advances $62,469 $86,822
Other 25,051 5,268
------- -------
Total long-term borrowings $87,520 $92,090
======= =======
Information related to Federal funds purchased and securities sold under
repurchase agreements as of and for the years ended December 31, 2003, 2002 and
2001 is summarized as follows:
(Dollars in thousands) 2003 2002 2001
------- ------- -------
Weighted average interest rate at year-end 0.89% 1.50% 1.88%
Maximum outstanding at any month-end $36,414 $61,951 $65,474
Average amount outstanding during the year $30,284 $47,924 $33,157
The average amounts outstanding are computed using daily average balances.
Related interest expense for 2003, 2002 and 2001 was $376,000, $ 951,000 and
$1,108,000, respectively.
At December 31, 2003, the Company had outstanding various short and long-term
FHLB advances with maturity dates extending through 2014. The FHLB advances bear
interest at fixed rates ranging from 2.41% to 7.80% and the weighted average
interest rate amounted to 4.47% as of December 31, 2003.
The Company's FHLB advances include $20.0 million in fixed-rate callable
borrowings, which can be called by the FHLB on a quarterly basis. FHLB advances
are collateralized by $6.0 million of FHLB stock, mortgage loans with a carrying
value of $84.2 million at December 31, 2003 and investment securities with a
fair market value of $37.8 million at December 31, 2003. At December 31, 2003,
the Company had remaining credit available of $27.8 million under lines of
credit with the FHLB. The Company also had $74.3 million of remaining credit
available under unsecured lines of credit with various banks at December 31,
2003. The Company also has available lines of credit with Farmer Mac permitting
borrowings to a maximum of $25.0 million. Advances outstanding against the
Farmer Mac lines at December 31, 2003 amounted to $1.0 million.
During 2003, FII expanded the terms of an existing credit agreement with M&T
Bank to aid in achieving the capital plans established for its NBG and BNB
subsidiaries. The credit agreement includes a $25.0 million term loan facility
and a $5.0 million revolving loan facility. The term loan requires monthly
payments of interest only, at a variable interest rate of London Interbank
Offered Rate ("LIBOR") plus 1.75%, which was 2.98% as of December 31, 2003. The
$25.0 million term loan is included in long-term borrowings on the consolidated
statements of financial condition as principal installments are due as follows:
$5 million in December 2006, $10 million in December 2007 and $10 million in
December 2008. The $5 million revolving loan accrues interest at a rate of LIBOR
plus 1.50%. There were no advances outstanding on the revolving loan as of
December 31, 2003. The credit agreement includes affirmative financial
covenants, all of which were met as of December 31, 2003. FII pledged the stock
of its subsidiary banks as collateral for the credit facility.
42
Trust Preferred Securities and Junior Subordinated Debentures
On February 22, 2001, the Company established FISI Statutory Trust I (the
"Trust"), which is a statutory business trust formed under Connecticut law. The
Trust exists for the exclusive purposes of (i) issuing and selling 30 year
guaranteed preferred beneficial interests in the trust assets ("trust preferred"
or "capital" securities) in the aggregate amount of $16.2 million at a fixed
rate of 10.20%, (ii) using the proceeds from the sale of the capital securities
to acquire the junior subordinated debentures issued by the Company and (iii)
engaging in only those other activities necessary, advisable or incidental
thereto.
The Company's junior subordinated debentures are the primary assets of the Trust
and, accordingly, payments under the corporation obligated junior debentures are
the sole revenue of the Trust. The capital securities of the Trust are
non-voting. The Company owns all of the common securities of the Trust. The
Company used the net proceeds from the sale of the capital securities to
partially fund the BNB acquisition. The capital securities qualified as Tier 1
capital under regulatory definitions as of December 31, 2003 and 2002.
The Company's primary sources of funds to pay interest on the debentures held by
the Trust are current dividends from its subsidiary banks. Accordingly, the
Company's ability to service the debentures is dependent upon the continued
ability of the subsidiary banks to pay dividends to the Company. Since the
junior subordinated debentures and trust preferred securities at December 31,
2003 and 2002, respectively are classified as debt for financial statement
purposes, the tax-deductible expense associated with the capital securities is
recorded as interest expense in the consolidated statements of income.
The Company incurred $487,000 in costs to issue the securities and the costs are
being amortized over 20 years using the straight-line method
As of December 31, 2003, the Company deconsolidated the subsidiary Trust, which
had issued trust preferred securities, and replaced the presentation of such
instruments with the Company's junior subordinated debentures issued to the
subsidiary Trust. Such presentation reflects the adoption of FASB Interpretation
No. 46 ("FIN 46 R"), "Consolidation of Variable Interest Entities."
Deposits
The Banks offer a broad array of core deposit products including checking
accounts, interest-bearing transaction accounts, savings and money market
accounts and certificates of deposit under $100,000. These core deposits totaled
$1.552 billion or 85.3% of total deposits of $1.819 billion at December 31,
2003. The core deposit base consists almost exclusively of in-market accounts.
Core deposits are supplemented with certificates of deposit over $100,000, which
amounted to $267.1 million as of December 31, 2003, primarily from in-market
municipal, business and individual customers. As of December 31, 2003, brokered
certificates of deposit included in certificates of deposit over $100,000
totaled $125.4 million.
Total deposits at December 31, 2003 amounted to $1.819 billion, an increase of
$110.4 million or 6.5% from $1.709 billion at December 31, 2002. Core deposit
products were $1.507 billion or 88.2% of total deposits at December 31, 2002.
Certificates of deposit over $100,000 totaled $201.8 million at December 31,
2002, which included $71.6 million in brokered certificates of deposit.
43
The daily average balances, percentage composition and weighted average rates
paid on deposits for each of the years ended December 31, 2003, 2002 and 2001
are presented below:
For the year ended December 31
------------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------------------------------------------------------------------------
Percent Percent Percent
of Total Weighted of Total Weighted of Total Weighted
Average Average Average Average Average Average Average Average Average
(Dollars in thousands) Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
------------------------------------------------------------------------------------------------
Interest-bearing checking $ 389,267 21.8% 0.91% $ 354,687 22.2% 1.43% $ 172,022 13.2% 1.23%
Savings and money market 411,587 23.0 0.96 366,708 23.0 1.57 253,128 19.4 2.07
Certificates of deposit
under $100,000 509,056 28.4 2.93 438,587 27.5 3.80 376,256 28.9 5.36
Certificates of deposit
over $100,000 234,966 13.1 2.90 217,150 13.6 3.53 319,974 24.6 4.97
Non-interest bearing accounts 245,234 13.7 -- 219,028 13.7 -- 181,831 13.9 --
------------------------------------------------------------------------------------------------
Total average deposits $1,790,110 100.0% 1.63% $1,596,160 100.0% 2.20% $1,303,211 100.0% 3.33%
================================================================================================
The following table indicates the amount of the Company's certificates of
deposit by time remaining until maturity as of December 31, 2003:
At December 31, 2003
----------------------------------------------------------
3 Months Over 3 To Over 6 To Over 12
(Dollars in thousands) Or Less 6 Months 12 Months Months Total
---------- ---------- ---------- ---------- ----------
Certificates of deposit
less than $100,000 $ 147,641 $ 105,578 $ 105,686 $ 143,661 $ 502,566
Certificates of deposit
of $100,000 or more 92,378 35,401 39,033 100,304 267,116
---------- ---------- ---------- ---------- ----------
Total certificates of deposit $ 240,019 $ 140,979 $ 144,719 $ 243,965 $ 769,682
========== ========== ========== ========== ==========
RECENT ACCOUNTING DEVELOPMENTS
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of a commitment to an exit or disposal
plan. The provisions of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002, with early application
encouraged. SFAS No. 142 does not apply to costs associated with an exit
activity that involves an entity newly acquired in a business combination. The
provisions of SFAS No. 146 did not affect the Company's consolidated financial
statements.
FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others," was
issued in November 2002. FASB Interpretation No. 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and initial measurement
provisions of FASB Interpretation No. 45 are applicable on a prospective basis
to guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements of interim or annual periods
ending after December 15, 2002. The Company has provided the required
disclosures. The Company adopted the recognition and measurement provisions of
FASB Interpretation No. 45 effective January 1, 2003. The adoption did not have
a material impact on the Company's consolidated financial statements.
44
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150
requires that certain financial instruments, which under previous guidance could
be accounted for as equity, be accounted for as liabilities. Financial
instruments affected include mandatorily redeemable securities, certain
financial instruments that require or may require the issuer to buy back some of
its shares in exchange for cash or other assets and certain obligations that can
be settled with shares of stock. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003 for all other financial instruments. The Company adopted the provisions of
SFAS No. 150 on July 1, 2003. The adoption did not have a material impact on the
Company's consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities". The objective of this
interpretation is to provide guidance on how to identify a variable interest
entities ("VIE") and determine when the assets, liabilities, non-controlling
interests, and results of operations of a VIE need to be included in a company's
consolidated financial statements. FIN 46 was effective for all VIEs created
after January 31, 2003. However, the FASB postponed that effective date to
December 31, 2003. In December 2003, the FASB issued a revised FIN 46 ("FIN
46R') which further delayed the effective date until March 31, 2004 for VIE's
created prior to February 1, 2003. The requirements of FIN 46R resulted in the
deconsolidation of the Company's wholly-owned subsidiary trust, formed to issue
mandatorily redeemable preferred securities ("trust preferred securities"). The
deconsolidation, as of December 31, 2003, results in the derecognition of the
$16.2 million of trust preferred securities and the recognition of junior
subordinated debentures of $16.7 million and investment in the subsidiary trust
of $502,000 in the Company's 2003 consolidated statement of financial position.
In December 2003, the FASB issued a revision of SFAS No. 132, "Employers
Disclosure about Pensions and Other Post Retirement Benefits" to expand
disclosure requirements to include descriptions of plan assets, investment
strategy, measurement dates, plan obligations, cash flows and components of net
periodic benefit cost recognized during interim periods. The Company adopted the
provisions of SFAS No. 132, as revised, on December 31, 2003. Required
disclosures have been made in the notes to the consolidated financial
statements.
LIQUIDITY
The objective of maintaining adequate liquidity is to assure the ability of the
Company and its subsidiaries to meet their financial obligations. These
obligations include the withdrawal of deposits on demand or at their contractual
maturity, the repayment of borrowings as they mature, the ability to fund new
and existing loan commitments and the ability to take advantage of new business
opportunities. The Company and its subsidiaries achieve liquidity by maintaining
a strong base of core customer funds, maturing short-term assets, the ability to
sell securities, lines of credit, and access to capital markets.
Liquidity at the subsidiary bank level is managed through the monitoring of
anticipated changes in loans, the investment portfolio, core deposits and
wholesale funds. The strength of the subsidiary bank's liquidity position is a
result of its base of core customer deposits. These core deposits are
supplemented by wholesale funding sources that include credit lines with the
other banking institutions, the FHLB, Farmer Mac and the Federal Reserve Bank.
The primary source of liquidity for the parent company is dividends from
subsidiaries, lines of credit, and access to capital markets. Dividends from
subsidiaries are limited by various regulatory requirements related to capital
adequacy and earnings trends. The Company's subsidiaries rely on cash flows from
operations, core deposits, borrowings, short-term liquid assets, and, in the
case of non-banking subsidiaries, funds from the parent company.
The Company's cash and cash equivalents were $85.6 million at December 31, 2003,
an increase of $37.2 million from the balance of $48.4 million at December 31,
2002. The principal sources of cash from financing activities were $110 million
from the net increase in deposits, offset by $42 million of net decrease in
borrowings and $9 million in dividend payments. The principal source of net cash
from
45
operating activities is the Company's net income of $14 million and loan sale
proceeds. The Company utilized its cash in the following investing activities:
$14 million in the net acquisition of securities, $37 million in the net
origination of loans and $10 million in the purchase of premises and equipment.
An additional source of liquidity to the Company is provided from its ability to
limit its investing activities and/or dispose of its securities and loans.
Additional liquidity can be provided to the Company through limiting the growth
in loans by offering terms and pricing that would not be competitive. Securities
available for sale and newly originated loans could be sold to provide
additional liquidity. The fair value of assets being sold is dependent upon
market conditions at the time of sale and potentially could adversely affect the
Company's earnings.
CONTRACTUAL OBLIGATIONS
The following table presents the Company's contractual obligations as of
December 31, 2003:
Less Than More Than
Total 1 Year 1-3 Years 3-5 Years 5 Years
---------- ---------- ---------- ---------- ----------
Operating Leases $ 5,540 $ 651 $ 1,105 $ 942 $ 2,842
Long-term Borrowings 87,520 -- 22,421 44,330 20,769
Junior subordinated debentures 16,702 -- -- -- 16,702
---------- ---------- ---------- ---------- ----------
Total Obligations $ 109,762 $ 651 $ 23,526 $ 45,272 $ 40,313
========== ========== ========== ========== ==========
OFF-BALANCE SHEET ARRANGEMENTS
The Company has an off-balance sheet arrangement, which includes the guarantee
of distributions, and payments for redemption or liquidation of trust preferred
securities issued by a wholly owned, deconsolidated subsidiary trust to the
extent of funds held by the trust. Although the guarantee is not separately
recorded, the obligation underlying the guarantee is fully reflected on the
Company's consolidated statement of financial condition as junior subordinated
debentures. The subsidiary's trust preferred securities currently qualify as
Tier 1 capital under the Federal Reserve capital adequacy guidelines. For
further information regarding the junior subordinated debentures issued to
unconsolidated subsidiary trust, see Note 9 of the notes to consolidated
financial statements.
In the normal course of business, the Company has outstanding commitments to
extend credit, which are not reflected in the Company's consolidated financial
statements. The commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. At December 31, 2003
letters of credit totaling $11.8 million and unused loan commitments of $271.9
million were contractually available. Comparable amounts for these commitments
at December 31, 2002 were $13.4 million and $316.6 million, respectively. The
total commitment amounts do not necessarily represent future cash requirements
as many of the commitments are expected to expire without funding. For further
information regarding the outstanding loan commitments, see Note 4 of the notes
to consolidated financial statements.
46
CAPITAL RESOURCES
The Federal Reserve Board has adopted a system using risk-based capital
guidelines to evaluate the capital adequacy of bank holding companies. The
guidelines require a minimum total risk-based capital ratio of 8.0%. Leverage
ratio is also utilized in assessing capital adequacy with a minimum requirement
that can range from 3.0% to 5.0%. The following table reflects the changes in
the components of those ratios:
(Dollars in thousands) 2003 2002 2001
---------- ---------- ----------
Total shareholders' equity $ 183,103 $ 178,294 $ 149,187
Less: Unrealized gains/(losses) on securities
available or sale 8,197 10,368 2,176
Disallowed goodwill and other intangible assets 43,556 44,667 39,256
Plus: Minority interests in consolidated subsidiaries 172 161 475
Qualifying trust preferred securities 16,200 16,200 12,408
---------- ---------- ----------
Total Tier 1 capital $ 147,722 $ 139,620 $ 120,638
========== ========== ==========
Adjusted average assets $2,102,061 $2,005,837 $1,718,034
Tier 1 leverage ratio 7.03% 6.96% 7.02%
Total Tier 1 capital $ 147,722 $ 139,620 $ 120,638
Plus: Qualifying allowance for loan losses 18,270 17,813 15,417
Nonqualifying trust preferred securities -- -- 3,792
---------- ---------- ----------
Total risk-based capital $ 165,992 $ 157,433 $ 139,847
========== ========== ==========
Net risk-weighted assets $1,450,839 $1,421,160 $1,229,811
Total risk-based capital ratio 11.44% 11.08% 11.37%
The Company's Tier 1 leverage ratio was 7.03% at December 31, 2003. The ratio
increased slightly from 6.96% at December 31, 2002. Total Tier 1 capital of
$147.7 million at December 31, 2003 increased $8.1 million from $139.6 million
at December 31, 2002. The increase in Tier 1 capital relates primarily to the
increase in retained earnings resulting from 2003 net income of $14.2 million
and reduced by $8.6 million in preferred and common dividends declared during
2003.
The Company's total risk-weighted capital ratio was 11.44% at December 31, 2003.
The ratio increased from 11.08% at December 31, 2002. Total risk-based capital
was $166.0 million at December 31, 2002 an increase of $8.6 million from $157.4
million at December 31, 2001. The increase is primarily attributed to the $8.3
million increase in Tier 1 capital previously discussed plus the slight increase
in qualifying allowance for loan losses.
In addition, the formal agreements entered into by NBG and BNB with their
primary regulator required both banks to develop capital plans enabling them to
achieve, by March 31, 2004, a Tier 1 leverage capital ratio equal to 8%, a Tier
1 risk-based capital ratio equal to 10%, and a total risk-based capital ratio of
12%. Each of the banks meets the required levels at December 31, 2003. For
further information regarding regulatory capital, see Note 15 of the notes to
consolidated financial statements.
47
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
MARKET RISK
The principal objective of the Company's interest rate risk management is to
evaluate the interest rate risk inherent in certain assets and liabilities,
determine the appropriate level of risk to the Company given its business
strategy, operating environment, capital and liquidity requirements and
performance objectives, and manage the risk consistent with the guidelines
approved by the Company's Board of Directors. The Company's senior management is
responsible for reviewing with the Board its activities and strategies, the
effect of those strategies on the net interest margin, the fair value of the
portfolio and the effect that changes in interest rates will have on the
portfolio and exposure limits. Senior Management develops an Asset-Liability
Policy that meets strategic objectives and regularly reviews the activities of
the subsidiary banks. Each subsidiary bank board adopts an Asset-Liability
Policy within the parameters of the overall FII Asset-Liability Policy and
utilizes an asset/liability committee comprised of senior management of the bank
under the direction of the bank's board.
The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are "interest rate sensitive" and by
monitoring the Company's interest rate sensitivity "gap." An asset or liability
is said to be interest rate sensitive within a specific time period if it will
mature or re-price within that time period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets maturing
or re-pricing within a specific time period and the amount of interest-bearing
liabilities maturing or re-pricing within that same time period. A gap is
considered positive when the amount of interest rate sensitive assets exceeds
the amount of interest rate sensitive liabilities. A gap is considered negative
when the amount of interest rate sensitive liabilities exceeds the amount of
interest rate sensitive assets. At December 31, 2003, the one-year gap position,
representing the difference between the amount of interest-earning assets
maturing or re-pricing within one year and interest-bearing liabilities maturing
or re-pricing within one year, was a positive $540.4 million, or 24.9% of total
assets. Accordingly, over the one-year period following December 31, 2003, the
Company will have an estimated $540.4 million more in assets re-pricing than
liabilities. Generally if rate-sensitive assets re-price sooner than
rate-sensitive liabilities, earnings will be positively impacted in a rising
rate environment. Conversely, in a declining rate environment, earnings will
generally be negatively impacted. If rate-sensitive liabilities re-price sooner
than rate-sensitive assets then generally earnings will be negatively impacted
in a rising rate environment. Conversely, in a declining rate environment
earnings will generally be positively impacted. Management believes that the
positive gap position at December 31, 2003 will not have a material adverse
effect on the Company's operating results.
Gap Analysis
The following table (the "Gap Table") sets forth the amounts of interest-earning
assets and interest-bearing liabilities outstanding at December 31, 2003 which
management anticipates, based upon certain assumptions, to re-price or mature in
each of the future time periods shown. Except as stated below, the amount of
assets and liabilities shown which re-price or mature during a particular period
were determined in accordance with the earlier of the re-pricing date or the
contractual maturity of the asset or liability. The table sets forth an
approximation of the projected re-pricing of assets and liabilities at December
31, 2003, on the basis of contractual maturities, anticipated prepayments and
scheduled rate adjustments within the selected time intervals. All non-maturity
deposits (demand deposits and savings deposits) were assumed to become rate
sensitive over time, with 1%, 3%, 4%, 15%, 14% and 63% of such deposits assumed
to re-price in the periods of less than 30 days, 31 to 180 days, 181 to 365
days, 1 to 3 years, 3 to 5 years and more than 5 years, respectively. Prepayment
and re-pricing rates can have a significant impact on the estimated gap. While
management believes the assumptions used in modeling the Gap Table are
reasonable, there can be no assurance that assumed prepayment and re-pricing
rates will approximate actual future activity.
48
Gap Table
December 31, 2003
----------------------------------------------------------------------------------------------
Volumes Subject to Repricing Within
----------------------------------------------------------------------------------------------
0-30 31-180 181-365 1-3 3-5 >5 Non-
(Dollars in thousands) days days days years years years Sensitive Total
-------- --------- --------- -------- -------- --------- --------- ----------
Interest-earning assets:
Federal funds sold and
and interest-bearing
deposits $ 40,006 $ 75 $ -- $ -- $ -- $ -- $ -- $ 40,081
Investment
securities (1) 113,974 74,375 72,844 143,315 93,006 154,581 -- 652,095
Loans (2) 632,422 119,431 98,974 262,859 148,398 81,281 1,952 1,345,317
-------- --------- --------- -------- -------- --------- --------- ----------
Total interest-earning
assets 786,402 193,881 171,818 406,174 241,404 235,862 1,952 2,037,493
-------- --------- --------- -------- -------- --------- --------- ----------
Interest-bearing liabilities:
Interest-bearing checking,
savings and money
market deposits 4,901 24,507 29,408 117,633 117,633 490,137 -- 784,219
Certificates of deposit 110,234 267,254 144,963 197,490 48,035 1,706 -- 769,682
Borrowed funds (3) 7,247 18,719 4,467 27,864 50,016 45,934 -- 154,247
-------- --------- --------- -------- -------- --------- --------- ----------
Total interest-bearing
liabilities 122,382 310,480 178,838 342,987 215,684 537,777 -- 1,708,148
-------- --------- --------- -------- -------- --------- --------- ----------
Period gap $664,020 $(116,599) $ (7,020) $ 63,187 $ 25,720 $(301,915) $ 1,952 $ 329,345
======== ========= ========= ======== ======== ========= ========= ==========
Cumulative gap $664,020 $ 547,421 $ 540,401 $603,588 $629,308 $ 327,393 $ 329,345
======== ========= ========= ======== ======== ========= =========
Period gap to total assets 30.55% (5.36)% (0.32)% 2.91% 1.18% (13.89)% 0.09% 15.15%
======== ========= ========= ======== ======== ========= ========= ==========
Cumulative gap to
total assets 30.55% 25.18% 24.86% 27.77% 28.95% 15.06% 15.15%
======== ========= ========= ======== ======== ========= =========
Cumulative interest-earning assets
to cumulative interest-
bearing liabilities 642.58% 226.47% 188.34% 163.22% 153.77% 119.17% 119.28%
======== ========= ========= ======== ======== ========= =========
(1) Amounts shown include the amortized cost of held to maturity securities
and the fair value of available for sale securities.
(2) Amounts shown include principal balance net of deferred loan fees and
costs, unamortized premiums and discounts.
(3) Amounts shown include junior subordinated debentures.
Certain shortcomings are inherent in the method of analysis presented in the Gap
Table. For example, although certain assets and liabilities may have similar
maturities or periods to repricing, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate loans, have
features which restrict changes in interest rates, both on a short-term basis
and over the life of the asset. Further, in the event of changes in interest
rates, prepayment and early withdrawal levels would likely deviate significantly
from those assumed in calculating the table.
As a result of these shortcomings, the Company directs more attention on
simulation modeling, such as "net interest income at risk" discussed below,
rather than gap analysis. Even though the gap analysis reflects a ratio of
cumulative gap to total assets within acceptable limits, the net interest income
at risk simulation modeling is considered by management to be more informative
in forecasting future income at risk.
49
Net Interest Income at Risk Analysis
In addition to the Gap Analysis, management uses a "rate shock" simulation to
measure the rate sensitivity of the balance sheet. Rate shock simulation is a
modeling technique used to estimate the impact of changes in rates on net
interest income and economic value of equity. The following table sets forth the
results of the modeling analysis at December 31, 2003:
Change in Interest Net Interest Income Economic Value of Equity
Rates in Basis Points -------------------------------- --------------------------------
(Rate Shock) Amount $ Change % Change Amount $ Change % Change
------------ --------- --------- --------- --------- --------- ---------
(Dollars in thousands)
200 $ 82,800 $ 5,113 6.58% $ 414,868 $ (32,092) (7.18%)
100 80,406 2,719 3.50% 425,572 (21,388) (4.79%)
Static 77,687 -- -- 446,960 -- --
(100) 72,072 (5,615) (7.23%) 435,342 (11,618) (2.60%)
The Company measures net interest income at risk by estimating the changes in
net interest income resulting from instantaneous and sustained parallel shifts
in interest rates of different magnitudes over a period of 12 months. As of
December 31, 2003, a 200 basis point increase in rates would increase net
interest income by $5.1 million, or 6.58%, over the next twelve-month period. A
100 basis point decrease in rates would decrease net interest income by $5.6
million, or 7.23%, over a twelve-month period. This simulation is based on
management's assumption as to the effect of interest rate changes on assets and
liabilities and assumes a parallel shift of the yield curve. It also includes
certain assumptions about the future pricing of loans and deposits in response
to changes in interest rates. Further, it assumes that delinquency rates would
not change as a result of changes in interest rates, although there can be no
assurance that this will be the case. While this simulation is a useful measure
as to net interest income at risk due to a change in interest rates, it is not a
forecast of the future results and is based on many assumptions that, if
changed, could cause a different outcome.
50
Item 8. Financial Statements and Supplementary Data
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2003 AND 2002
(Dollars in thousands, except per share amounts) 2003 2002
----------- -----------
Assets
Cash, due from banks and interest-bearing deposits $ 45,635 $ 48,429
Federal funds sold 40,006 --
Securities available for sale, at fair value 604,964 596,862
Securities held to maturity (fair value of $48,121 and
$48,089 at December 31, 2003 and 2002, respectively) 47,131 47,125
Loans, net 1,316,253 1,300,232
Premises and equipment, net 34,239 27,254
Goodwill 40,621 40,593
Other assets 44,883 44,539
----------- -----------
Total assets $ 2,173,732 $ 2,105,034
=========== ===========
Liabilities And Shareholders' Equity
Liabilities:
Deposits:
Demand $ 264,990 $ 240,755
Savings, money market and interest-bearing checking 784,219 779,772
Certificates of deposit 769,682 687,996
----------- -----------
Total deposits 1,818,891 1,708,523
Short-term borrowings 50,025 87,189
Long-term borrowings 87,520 92,090
Junior subordinated debentures issued to unconsolidated
subsidiary trust ("Junior subordinated debentures") 16,702 --
Guaranteed preferred beneficial interests in corporation's
junior subordinated debentures ("Trust preferred securities") -- 16,200
Accrued expenses and other liabilities 17,491 22,738
----------- -----------
Total liabilities 1,990,629 1,926,740
Shareholders' equity:
3% cumulative preferred stock, $100 par value,
authorized 10,000 shares, issued and outstanding
1,666 shares in 2003 and 2002 167 167
8.48% cumulative preferred stock, $100 par value,
authorized 200,000 shares, issued and outstanding
175,683 shares in 2003 and 175,755 shares in 2002 17,568 17,575
Common stock, $ 0.01 par value, authorized 50,000,000
shares, issued 11,303,533 shares in 2003 and 2002 113 113
Additional paid-in capital 21,055 19,728
Retained earnings 136,938 131,320
Accumulated other comprehensive income 8,197 10,368
Treasury stock, at cost - 135,223 shares in 2003 and
199,719 shares in 2002 (935) (977)
----------- -----------
Total shareholders' equity 183,103 178,294
----------- -----------
Total liabilities and shareholders' equity $ 2,173,732 $ 2,105,034
=========== ===========
See accompanying notes to consolidated financial statements.
51
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(Dollars in thousands, except per share amounts) 2003 2002 2001
-------- -------- --------
Interest income:
Loans $ 86,556 $ 90,315 $ 91,482
Securities 24,389 27,630 22,628
Other 505 494 358
-------- -------- --------
Total interest income 111,450 118,439 114,468
-------- -------- --------
Interest expense:
Deposits 29,263 35,167 43,414
Borrowings 5,009 5,741 4,840
Guaranteed preferred beneficial interests in corporation's
junior subordinated debentures ("Trust preferred securities") 1,677 1,677 1,440
-------- -------- --------
Total interest expense 35,949 42,585 49,694
-------- -------- --------
Net interest income 75,501 75,854 64,774
Provision for loan losses 22,526 6,119 4,958
-------- -------- --------
Net interest income after provision for loan losses 52,975 69,735 59,816
-------- -------- --------
Noninterest income:
Service charges on deposits 11,461 10,603 7,653
Financial services group fees and commissions 5,692 5,629 2,690
Mortgage banking activities 4,036 2,279 2,190
Gain on sale and call of securities 1,041 285 531
Other 3,842 3,393 2,718
-------- -------- --------
Total noninterest income 26,072 22,189 15,782
-------- -------- --------
Noninterest expense:
Salaries and employee benefits 33,825 30,093 22,958
Occupancy and equipment 8,270 7,285 6,050
Supplies and postage 2,468 2,371 1,953
Amortization of goodwill -- -- 1,653
Amortization of other intangible assets 1,226 898 728
Computer and data processing 1,829 1,759 1,501
Professional fees 1,881 1,612 1,326
Other 11,324 9,031 7,183
-------- -------- --------
Total noninterest expense 60,823 53,049 43,352
-------- -------- --------
Income before income taxes 18,224 38,875 32,246
Income taxes 3,977 12,419 11,033
-------- -------- --------
Net income $ 14,247 $ 26,456 $ 21,213
======== ======== ========
Earnings per common share:
Basic $ 1.14 $ 2.26 $ 1.79
Diluted $ 1.13 $ 2.23 $ 1.77
See accompanying notes to consolidated financial statements.
52
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Accumulated
Other Total
3% 8.48% Additional Comprehensive Share-
(Dollars in thousands, Preferred Preferred Common Paid in Retained Income Treasury holders'
except per share amounts) Stock Stock Stock Capital Earnings (Loss) Stock Equity
--------- --------- ------ -------- -------- ------- -------- --------
Balance - December 31, 2000 $ 171 $ 17,587 $ 113 $ 16,472 $ 98,348 $ (144) $ (929) $131,618
Purchase of 45 shares of 3%
preferred stock (4) -- -- 2 -- -- -- (2)
Purchase of 11 shares of 8.48%
preferred stock -- (2) -- -- -- -- -- (2)
Purchase of 1,000 shares of common stock -- -- -- -- -- -- (12) (12)
Issue 1,141 shares of common stock -
directors plan -- -- -- 23 -- -- 4 27
Issue 34,452 shares of common stock -
Burke Group, Inc. acquisition -- -- -- 698 -- -- 102 800
Comprehensive income:
Net income -- -- -- -- 21,213 -- -- 21,213
Unrealized gain on securities available
for sale (net of tax of $1,803) -- -- -- -- -- 2,636 -- 2,636
Reclassification adjustment for gains
included in net income (net of
tax of $215) -- -- -- -- -- (316) -- (316)
--------
Net unrealized gain on securities
available for sale (net of tax
of $1,588) 2,320
--------
Total comprehensive income 23,533
--------
Cash dividends declared:
3% Preferred - $3.00 per share -- -- -- -- (5) -- -- (5)
8.48% Preferred - $8.48 per share -- -- -- -- (1,491) -- -- (1,491)
Common - $0.482 per share -- -- -- -- (5,279) -- -- (5,279)
--------- --------- ------ -------- -------- ------- ------- --------
Balance - December 31, 2001 $ 167 $ 17,585 $ 113 $ 17,195 $112,786 $ 2,176 $ (835) $149,187
Purchase of 100 shares of 8.48%
preferred stock -- (10) -- -- -- -- -- (10)
Purchase of 22,240 shares of common stock -- -- -- -- -- -- (571) (571)
Issue 1,049 shares of common stock -
directors plan -- -- -- 33 -- -- 4 37
Issue 19,955 shares of common stock -
exercised stock options -- -- -- 342 -- -- 84 426
Issue 36,700 shares of common stock -
Burke Group, Inc. acquisition and earnout -- -- -- 840 -- -- 160 1,000
Issue 47,036 shares of common stock -
Bank of Avoca acquisition -- -- -- 1,318 -- -- 181 1,499
Comprehensive income:
Net income -- -- -- -- 26,456 -- -- 26,456
Unrealized gain on securities available
for sale (net of tax of $5,603) -- -- -- -- -- 8,362 -- 8,362
Reclassification adjustment for gains
included in net income (net of
tax of$115) -- -- -- -- -- (170) -- (170)
--------
Net unrealized gain on securities
available for sale (net of tax
of $5,488) 8,192
--------
Total comprehensive income 34,648
--------
Cash dividends declared:
3% Preferred - $3.00 per share -- -- -- -- (5) -- -- (5)
8.48% Preferred - $8.48 per share -- -- -- -- (1,491) -- -- (1,491)
Common - $0.58 per share -- -- -- -- (6,426) -- -- (6,426)
--------- --------- ------ -------- -------- ------- ------- --------
Balance - December 31, 2002 $ 167 $ 17,575 $ 113 $ 19,728 $131,320 $10,368 $ (977) $178,294
Purchase of 72 shares of 8.48%
preferred stock -- (7) -- (1) -- -- -- (8)
Purchase of 22,000 shares of
common stock -- -- -- -- -- -- (417) (417)
Issue 2,440 shares of common stock -
directors plan -- -- -- 34 -- -- 16 50
Issue 21,669 shares of common stock -
exercised stock options -- -- -- 259 -- -- 138 397
Issue 62,387 shares of common stock -
Burke Group, Inc. acquisition
and earnout -- -- -- 1,035 -- -- 305 1,340
Comprehensive income:
Net income -- -- -- -- 14,247 -- -- 14,247
Unrealized loss on securities
available for sale (net of
tax of ($1,120)) -- -- -- -- -- (1,545) -- (1,545)
Reclassification adjustment for
gains included in net income
(net of tax of $415) -- -- -- -- -- (626) -- (626)
--------
Net unrealized loss on securities
available for sale (net of
tax of ($1,535)) (2,171)
--------
Total comprehensive income 12,076
--------
Cash dividends declared:
3% Preferred - $3.00 per share -- -- -- -- (5) -- -- (5)
8.48% Preferred - $8.48 per share -- -- -- -- (1,490) -- -- (1,490)
Common - $0.64 per share -- -- -- -- (7,134) -- -- (7,134)
--------- --------- ------ -------- -------- ------- ------- --------
Balance - December 31, 2003 $ 167 $ 17,568 $ 113 $ 21,055 $136,938 $ 8,197 $ (935) $183,103
========= ========= ====== ======== ======== ======= ======= ========
See accompanying notes to consolidated financial statements.
53
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(Dollars in thousands) 2003 2002 2001
--------- --------- ---------
Cash flows from operating activities:
Net income $ 14,247 $ 26,456 $ 21,213
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 7,548 5,697 5,984
Provision for loan losses 22,526 6,119 4,958
Deferred income tax benefit (1,971) (1,060) (112)
Proceeds from sale of loans held for sale 192,295 139,426 117,446
Origination of loans held for sale (190,205) (140,569) (119,994)
Gain on sale and call of securities (1,041) (285) (531)
Gain on sale of loans held for sale (3,153) (1,542) (1,513)
(Gain) loss on sale of other assets (25) 54 131
Minority interest in net income of subsidiaries 31 175 104
Decrease (increase) in other assets 2,372 (2,609) (1,518)
(Decrease) increase in accrued expenses
and other liabilities (3,946) 698 (625)
--------- --------- ---------
Net cash provided by operating activities 38,678 32,560 25,543
Cash flows from investing activities:
Purchase of securities:
Available for sale (425,849) (425,269) (377,111)
Held to maturity (32,890) (35,152) (21,933)
Proceeds from maturity and call of securities:
Available for sale 329,359 232,379 200,315
Held to maturity 32,812 43,419 37,381
Proceeds from sale and call of securities 82,906 45,059 91,412
Loan originations less principal payments (37,483) (143,622) (87,814)
Proceeds from sales of premises and equipment 81 73 174
Purchase of premises and equipment (10,439) (5,251) (4,359)
Net cash paid in equity method investment -- (2,400) --
Net cash acquired (paid) in purchase acquisitions -- 42,156 (49,072)
--------- --------- ---------
Net cash used in investing activities (61,503) (248,608) (211,007)
Cash flows from financing activities:
Net increase in deposits 110,368 213,913 124,080
Net (decrease) increase in short-term borrowings (37,164) (16,581) 46,497
Proceeds from long-term borrowings 29,000 23,056 28,912
Repayment of long-term borrowings (33,570) (1,386) (179)
Proceeds from trust preferred securities, net of costs -- -- 15,713
Purchase of preferred and common shares (425) (581) (16)
Issuance of preferred and common shares 447 463 27
Dividends paid (8,619) (7,578) (6,551)
--------- --------- ---------
Net cash provided by financing activities 60,037 211,306 208,483
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 37,212 (4,742) 23,019
Cash and cash equivalents at the beginning of the year 48,429 53,171 30,152
--------- --------- ---------
Cash and cash equivalents at the end of the year $ 85,641 $ 48,429 $ 53,171
========= ========= =========
Supplemental disclosure of cash flow information: Cash paid during year for:
Interest $ 37,466 $ 44,309 $ 46,912
Income taxes 7,935 14,295 10,793
Noncash investing and financing activities:
Fair value of noncash assets acquired in purchase acquisitions $ -- $ 19,020 $ 282,534
Fair value of liabilities assumed in purchase acquisitions -- 61,603 271,644
Issuance of common stock in purchase acquisitions/earnouts 1,340 2,499 800
See accompanying notes to consolidated financial statements.
54
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Basis of Presentation
Financial Institutions, Inc. ("FII"), a bank holding company organized under the
laws of New York State, and subsidiaries (the "Company") provide deposit,
lending and other financial services to individuals and businesses in Central
and Western New York State. FII and subsidiaries are each subject to regulation
by certain federal and state agencies.
The consolidated financial statements include the accounts of FII, its four
banking subsidiaries, Wyoming County Bank (99.65% owned) ("WCB"), National Bank
of Geneva (100% owned) ("NBG"), First Tier Bank & Trust (100% owned) ("FTB") and
Bath National Bank (100% owned) ("BNB"), collectively referred to as the
"Banks". During 2002, the Company completed a geographic realignment of the
subsidiary banks, which involved the merger of the subsidiary formerly known as
The Pavilion State Bank ("PSB") into NBG and transfer of other branch offices
between subsidiary banks. The merger and transfers were accounted for at
historical cost as a combination of entities under common control.
During 2003, the Company disclosed that the Boards of Directors of its two
national bank subsidiaries, NBG and BNB entered into agreements with their
primary regulator, the Office of the Comptroller of the Currency ("OCC"). Under
the terms of the agreements, NBG and BNB, without admitting any violations, have
taken actions designed to assure that their operations are in accordance with
applicable laws and regulations.
The Company formerly qualified as a financial holding company under the
Gramm-Leach-Bliley Act, which allowed FII to expand business operations to
include financial services businesses. The Company currently has two financial
services subsidiaries: The FI Group, Inc. ("FIGI") and the Burke Group, Inc.
("BGI"), collectively referred to as the "Financial Services Group" ("FSG").
FIGI is a brokerage subsidiary that commenced operations as a start-up company
in March 2000. BGI is an employee benefits and compensation consulting firm
acquired by the Company in October 2001. During 2003, the Company terminated its
financial holding company status to operate instead as a bank holding company.
The change in status did not affect the non-financial subsidiaries or activities
being conducted by the Company, although future acquisitions or expansions of
non-financial activities may require prior Federal Reserve Board approval and
will be limited to those that are permissible for bank holding companies.
In February 2001, the Company formed FISI Statutory Trust I ("FISI" or "Trust")
(100% owned) and capitalized the trust with a $502,000 investment in FISI's
common securities. The Trust was formed to accommodate the private placement of
$16.2 million in capital securities ("trust preferred securities"), the proceeds
of which were utilized to partially fund the acquisition of BNB. Effective
December 31, 2003, the provisions of FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities," resulted in the deconsolidation of the Company's
wholly-owned Trust. The deconsolidation resulted in the derecognition of the
$16.2 million in trust preferred securities and the recognition of $16.7 million
in junior subordinated debentures and a $502,000 investment in the subsidiary
trust recorded in other assets in the Company's 2003 consolidated statement of
financial position.
The consolidated financial information included herein combines the results of
operations, the assets, liabilities and shareholders' equity of the Company and
its subsidiaries. All significant inter-company transactions and balances have
been eliminated in consolidation.
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
prevailing practices in the banking industry. In preparing the financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities, and the reported revenues and expenses for the period.
Actual results could differ from those estimates.
55
Amounts in the prior years' consolidated financial statements are reclassified
when necessary to conform to the current year's presentation.
Cash Equivalents
For purposes of the consolidated statements of cash flows, interest-bearing
deposits and federal funds sold are considered cash equivalents.
Securities
The Company classifies its debt securities as either available for sale or held
to maturity. Debt securities, which the Company has the ability and positive
intent to hold to maturity, are carried at amortized cost and classified as held
to maturity. Investments in other debt and equity securities are classified as
available for sale and are carried at estimated fair value. Unrealized gains or
losses related to securities available for sale are included in accumulated
other comprehensive income, a component of shareholders' equity, net of the
related deferred income tax effect.
A decline in the fair value of any security below cost that is deemed other than
temporary is charged to income resulting in the establishment of a new cost
basis for the security. Interest income includes interest earned on the
securities adjusted for amortization of premiums and accretion of discounts on
the related securities using the interest method. Realized gains or losses from
the sale of available for sale securities are recognized on the trade date using
the specific identification method.
Loans and Mortgage Banking Activities
Loans are stated at the principal amount outstanding, net of discounts and
deferred loan origination fees and costs, which are recorded in interest income
based on the interest method. Interest income on loans is recognized based on
loan principal amounts outstanding at applicable interest rates. Accrual of
interest on loans is suspended and all unpaid accrued interest is reversed when
management believes, after considering collection efforts and the period of time
past due, that reasonable doubt exists with respect to the collectibility of
interest.
Loans, including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of principal or interest for a period of
more than 90 days (120 days for consumer loans), unless such loans are
well-collateralized and in the process of collection. If a loan or a portion of
a loan is internally classified as doubtful or is partially charged-off, the
loan is classified as nonaccrual. Loans that are on a current payment status or
past due less than 90 days may also be classified as nonaccrual if repayment in
full of principal and/or interest is in doubt.
Loans may be returned to accrual status when all principal and interest amounts
contractually due (including arrearages) are reasonably assured of repayment and
there is a sustained period of repayment performance (generally a minimum of six
months) in accordance with the contractual terms of the loan.
While a loan is classified as nonaccrual and the future collectibility of the
recorded loan balance is uncertain, any payments received are generally used to
reduce the principal balance. When the future collectibility of the recorded
loan balance is expected, interest income may be recognized on a cash basis. In
the case where a nonaccrual loan had been partially charged-off, recognition of
interest on a cash basis is limited to that which would have been recognized on
the recorded loan balance at the contractual interest rate. Interest collections
in excess of that amount are recorded as recoveries to the allowance for loan
losses until prior charge-offs have been fully recovered.
The Company originates and sells certain residential real estate loans in the
secondary market. The Company typically retains the right to service the loan
upon sale. The Company makes the determination of whether or not to identify a
loan as held for sale at the time the application is received from the borrower.
Loans held for sale are evaluated on an aggregate basis to determine if fair
value is less than carrying value. If necessary, a valuation allowance is
recorded by a charge to income for unrealized losses attributable to changes in
market interest rates. There was no valuation allowance necessary at December
31, 2003 or 2002. Gains and losses on the disposition of loans held for sale are
determined on the specific identification method. Loan servicing fees are
recognized when payments are received.
56
Capitalized mortgage servicing rights are recorded at their fair value at the
time a loan is sold and servicing rights are retained. Capitalized mortgage
servicing rights are reported in other assets and are amortized to noninterest
income in proportion to and over the period of estimated net servicing income.
The Company uses a valuation model that calculates the present value of future
cash flows to determine the fair value of servicing rights. In using this
valuation method, the Company incorporates assumptions that market participants
would use in estimating future net servicing income, which include estimates of
the cost to service the loan, the discount rate, an inflation rate and
prepayment speeds. The carrying value of originated mortgage servicing rights is
periodically evaluated for impairment. Impairment is determined by stratifying
rights by predominant risk characteristics, such as interest rates and terms,
using discounted cash flows and market-based assumptions. Impairment is
recognized through a valuation allowance, to the extent that fair value is less
than the capitalized asset.
The Company also has rate lock commitments extended to borrowers that relate to
the origination of residential mortgage loans ("rate locks"). To mitigate the
interest rate risk inherent in rate locks, as well as closed mortgage loans held
for sale ("loans held for sale"), the Company enters into forward commitments to
sell individual mortgage loans ("forward commitments"). Rate locks and forward
commitments are considered derivatives under SFAS No. 133. The impact of the
estimated fair value of the rate locks and forward commitments was not
significant to the consolidated financial statements.
Mortgage banking activities (a component of noninterest income) consist of fees
earned for servicing mortgage loans sold to third parties, gains (or losses)
recognized on sales of mortgages, and amortization and impairment losses
recognized on capitalized mortgage servicing assets.
Allowance for Loan Losses
The Company periodically evaluates the allowance for loan losses in order to
maintain the allowance at a level that represents management's estimate of
probable losses in the loan portfolio at the balance sheet date. Management's
evaluation of the allowance is based on the Company's past loan loss experience,
adverse circumstances that may affect the ability of borrowers to repay, the
estimated value of collateral, and an analysis of the levels and trends of
delinquencies, charge-offs, and the risk ratings of the various loan categories.
Other factors such as the level and trend of interest rates and the condition of
the national and local economies are also considered.
The allowance for loan losses is established through charges to earnings in the
form of a provision for loan losses. When a loan or portion of a loan is
determined to be uncollectible, the portion deemed uncollectible is charged
against the allowance and subsequent recoveries, if any, are credited to the
allowance.
A loan is considered impaired when, based on current information and events, it
is probable that a creditor will be unable to collect all amounts of principal
and interest under the original terms of the agreement. Accordingly, the Company
evaluates impaired commercial and agricultural loans individually based on the
present value of future cash flows discounted at the loan's effective interest
rate, or at the loan's observable market price or the fair value of the
collateral if the loan is collateral dependent. The Company collectively
evaluates large groups of small balance, homogeneous loans for impairment
including commercial and agricultural loans less than $250,000, all residential
mortgages, home equity and consumer loans.
57
Federal Home Loan Bank (FHLB) Stock
As a member of the FHLB system, the Company is required to maintain a specified
investment in FHLB stock. This non-marketable investment, which is carried at
cost, must be at an amount at least equal to the greater of 5% of the
outstanding advance balance or 1% of the aggregate outstanding residential
mortgage loans held by the Company. Included in other assets is FHLB stock
totaling $6.0 million and $6.3 million, at December 31, 2003 and 2002,
respectively.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation is computed using straight-line and accelerated
methods over estimated useful lives of the assets. Leasehold improvements are
amortized over the shorter of lease terms or the useful lives of the assets.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the fair value of net
assets acquired in accordance with the purchase method of accounting for
business combinations. Goodwill is not being amortized, but is required to be
tested for impairment at least annually. Other intangible assets are being
amortized on the straight-line method, over the expected periods to be
benefited. Intangible assets are periodically reviewed for impairment or when
events or changed circumstances may affect the underlying basis of the assets.
Equity Method Investment
During 2002, the Company made a $2.4 million cash investment to acquire a 50%
interest in Mercantile Adjustment Bureau, LLC, a full-service accounts
receivable management firm located in Rochester, New York. The Company has
accounted for this investment using the equity method and the investment is
included in other assets on the consolidated statements of financial condition.
Stock Compensation
The Company uses a fixed award stock option plan to compensate certain key
members of management of the Company and its subsidiaries. The Company accounts
for issuance of stock options under the intrinsic value-based method of
accounting prescribed by Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees." Under APB No. 25, compensation
expense is recorded on the date the options are granted only if the current
market price of the underlying stock exceeded the exercise price. SFAS No. 123,
"Accounting for Stock-Based Compensation," established accounting and disclosure
requirements using a fair value-based method of accounting for stock-based
employee compensation plans. As allowed under SFAS No. 123, the Company has
elected to continue to apply the intrinsic value-based method of accounting
described above and has adopted only the disclosure requirements of SFAS No.
123, as amended by SFAS No. 148, "Accounting for Stock Based Compensation -
Transition and Disclosure."
58
Pro forma disclosure for the years ended December 31, 2003, 2002 and 2001,
utilizing the estimated fair value of the options granted under SFAS No. 123, is
as follows:
Years ended December 31
(Dollars in thousands, except per share amounts) 2003 2002 2001
-------- -------- --------
Reported net income $ 14,247 $ 26,456 $ 21,213
Deduct: Total stock-based compensation expense
determined under fair value based method for
all awards, net of related tax effects (336) (274) (288)
-------- -------- --------
Pro forma net income $ 13,911 $ 26,182 $ 20,925
======== ======== ========
Basic earnings per share:
Reported $ 1.14 $ 2.26 $ 1.79
Pro forma $ 1.11 $ 2.23 $ 1.77
Diluted earnings per share:
Reported $ 1.13 $ 2.23 $ 1.77
Pro forma $ 1.10 $ 2.20 $ 1.75
The weighted-average fair value of options granted during the years ended
December 31, 2003, 2002, and 2001 amounted to $10.61, $11.90 and $5.53,
respectively. The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model and the following
weighted-average assumptions:
For the years ended December 31
---------------------------------
2003 2002 2001
-------- ---------- ----------
Dividend yield 2.89% 1.94% 2.43%
Expected life (in years) 10.00 10.00 10.00
Expected volatility 50.96% 38.14% 20.00%
Risk-free interest rate 3.96% 4.98% 4.99%
The Company's stock options have characteristics significantly different from
those of traded options for which the Black-Scholes model was developed. Since
changes in the subjective input assumptions can materially affect the fair value
estimates, the existing model, in management's opinion, does not necessarily
provide a single reliable measure of the fair value of its stock options. In
addition, the pro forma effect on reported net income and earnings per share for
the years ended December 31, 2003, 2002 and 2001, may not be representative of
the pro forma effects on reported net income and earnings per share for future
years.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and the respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Financial Instruments With Off-Balance Sheet Risk
The Company's financial instruments with off-balance sheet risk are commercial
letters of credit and mortgage, commercial and credit card loan commitments.
These financial instruments are reflected in the statement of financial
condition upon funding.
59
Financial Services Group Fees and Commissions and Trust Department Assets
Financial services group fees and commissions consist of commissions from sales
of investment products and services to customers, fees and commissions from
trust services provided to customers, and fees and commissions earned from
design, consulting, administrative and actuarial services provided to employee
benefits plans and their sponsors. Fees and commissions are recorded on the
accrual basis of accounting. Assets held in fiduciary or agency capacities for
customers are not included in the accompanying consolidated statements of
condition, since such items are not assets of the Company.
New Accounting Pronouncements
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150
requires that certain financial instruments, which under previous guidance could
be accounted for as equity, be accounted for as liabilities. Financial
instruments affected include mandatorily redeemable securities, certain
financial instruments that require or may require the issuer to buy back some of
its shares in exchange for cash or other assets and certain obligations that can
be settled with shares of stock. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003 for all other financial instruments. The Company adopted the provisions of
SFAS No. 150 on July 1, 2003. The adoption did not have a material impact on the
Company's consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities". The objective of this
interpretation is to provide guidance on how to identify a variable interest
entities ("VIE") and determine when the assets, liabilities, non-controlling
interests, and results of operations of a VIE need to be included in a company's
consolidated financial statements. FIN 46 was effective for all VIEs created
after January 31, 2003. However, the FASB postponed that effective date to
December 31, 2003. In December 2003, the FASB issued a revised FIN 46 ("FIN
46R') which further delayed the effective date until March 31, 2004 for VIE's
created prior to February 1, 2003. The requirements of FIN 46R resulted in the
deconsolidation of the Company's wholly-owned subsidiary trust, formed to issue
mandatorily redeemable preferred securities ("trust preferred securities"). The
deconsolidation, as of December 31, 2003, results in the derecognition of the
$16.2 million of trust preferred securities and the recognition of junior
subordinated debentures of $16.7 million and investment in the subsidiary trust
of $502,000 in the Company's 2003 consolidated statement of financial position.
In December 2003, the FASB issued SFAS No. 132, "Employers Disclosure about
Pensions and Other Postretirement Benefits" to expand disclosure requirements to
include descriptions of plan assets, investment strategy, measurement dates,
plan obligations, cash flows and components of net periodic benefit cost
recognized during interim periods. The Company adopted the provisions of SFAS
No. 132, as revised, on December 31, 2003. The required disclosures are included
in Note 12.
(2) Mergers and Acquisitions
On December 13, 2002, BNB acquired the two Chemung County branch offices of BSB
Bank & Trust Company of Binghamton, New York. The two offices purchased, located
in Elmira and Elmira Heights, had deposit liabilities totaling $44.2 million at
the time of acquisition. The acquisition was accounted for as a business
combination using the purchase method of accounting, and accordingly, the excess
of the purchase price over the fair value of identifiable tangible and
intangible assets acquired, less liabilities assumed, of approximately $1.5
million has been recorded as goodwill. In accordance with SFAS No. 142, the
Company is not required to amortize goodwill. The Company also recorded a $2.0
million intangible asset attributable to core deposits, which is being amortized
using the straight-line method over seven years.
On May 1, 2002, FII acquired all of the common stock of the Bank of Avoca
("BOA") in exchange for 47,036 shares of FII common stock. BOA was a community
bank with its main office located in Avoca, New York, as well as a branch office
in Cohocton, New York. Subsequent to the acquisition, BOA was merged with BNB.
The acquisition was accounted for as a business combination using the purchase
method of accounting, and accordingly, the excess of the purchase price ($1.5
million) over the fair value
60
of identifiable tangible and intangible assets acquired ($18.4 million), less
liabilities assumed ($17.3 million), of approximately $0.4 million has been
recorded as goodwill. In accordance with SFAS No. 142, the Company is not
required to amortize goodwill recognized in this acquisition. The Company
recorded a $146,000 core deposit intangible asset, which is being amortized
using the straight-line method over seven years. The results of operations for
BOA are included in the income statements from the date of acquisition (May 1,
2002).
On October 22, 2001, the Company acquired the Burke Group, Inc. ("BGI"); an
employee benefits administration and compensation consulting firm, with offices
in Honeoye Falls and Syracuse, New York. BGI's expertise includes design and
consulting for retirement and employee welfare plans, administrative services
for defined contribution and benefit plans, actuarial services and post
employment benefits. The agreement provided for merger consideration of
$1,500,000 to BGI shareholders. Merger consideration payments of $200,000 in
cash and 34,452 shares of FII common stock (valued at $800,000 in accordance
with merger agreement) were made on October 22, 2001. The balance of the merger
consideration of $500,000 was paid on October 22, 2002 in the form of 18,852
shares of FII common stock as provided for in the agreement. In addition the
agreement provided for the payment of earned amount consideration based on
achievement of financial performance targets. For the period ending December 31,
2001 those targets were achieved and $500,000 in earned amount consideration was
paid on April 1, 2002 in the form of 17,848 shares of FII common stock. For the
period ending December 31, 2002 financial performance targets were also achieved
and $750,000 in the form of 34,918 shares of FII common stock was paid on April
1, 2003. The agreement further provides for payment of contingent consideration
in the form of FII common stock based on other financial performance targets for
the periods ending December 31, 2002, 2003, and 2004 with the maximum amount of
payment for 2004 being $2,500,000. For the year ended December 31, 2002
financial performance for contingent consideration was achieved and $590,000 was
paid on April 1, 2003 in the form of 27,469 shares of FII common. For the year
ended December 31, 2003 financial performance for contingent consideration was
not achieved. The acquisition was accounted for as a business combination using
the purchase method of accounting, and accordingly, the excess of the purchase
price ($3.3 million including earned amounts and contingent amounts to date)
over the fair value of identifiable tangible and intangible assets acquired
($1.7 million), less liabilities assumed ($1.7 million), of approximately $3.3
million has been recorded as goodwill. In accordance with SFAS No. 142, the
Company is not required to amortize goodwill recognized in this acquisition. The
Company also recorded a $500,000 intangible asset for a customer list that is
being amortized using the straight-line method over five years. The results of
operations for BGI are included in the income statements from the date of
acquisition (October 22, 2001).
On May 1, 2001, the Company acquired all of the common stock of Bath National
Corporation ("BNC"), and its wholly owned subsidiary bank, Bath National Bank.
BNB is a full service community bank headquartered in Bath, New York, which has
9 branch locations in Steuben, Yates, Ontario and Schuyler Counties. The Company
paid $48.00 per share in cash for each of the outstanding shares of BNC common
stock with an aggregate purchase price of approximately $62.6 million. The
acquisition was accounted for under the purchase method of accounting, and
accordingly, the excess of the purchase price ($62.6 million) over the fair
value of identifiable tangible and intangible assets acquired ($295.4 million),
less liabilities assumed ($269.9 million), of approximately $37.1 million has
been recorded as goodwill. Goodwill was amortized in 2001 using the
straight-line method over 15 years, since the transaction was consummated prior
to June 30, 2001, the effective date of SFAS No. 142. However, in accordance
with SFAS No. 142, the Company ceased goodwill amortization on January 1, 2002.
The results of operations for BNB are included in the income statements from the
date of acquisition (May 1, 2001).
61
(3) Securities
The aggregate amortized cost and fair value of securities available for sale and
securities held to maturity follow:
December 31, 2003
------------------------------------------------------
Gross Unrealized
Amortized ------------------------ Fair
(Dollars in thousands) Cost Gains Losses Value
--------- --------- --------- ---------
Securities Available for Sale:
U.S. Treasury and agency $ 210,570 $ 1,882 $ 583 $ 211,869
Mortgage-backed securities 189,913 3,199 454 192,658
State and municipal obligations 186,328 9,166 83 195,411
Corporate bonds 4,020 70 -- 4,090
Equity securities 81 855 -- 936
--------- --------- --------- ---------
Total securities available for sale $ 590,912 $ 15,172 $ 1,120 $ 604,964
========= ========= ========= =========
Securities Held to Maturity:
State and municipal obligations $ 47,131 $ 1,006 $ 16 $ 48,121
--------- --------- --------- ---------
Total securities held to maturity $ 47,131 $ 1,006 $ 16 $ 48,121
========= ========= ========= =========
December 31, 2002
------------------------------------------------------
Gross Unrealized
Amortized ------------------------ Fair
(Dollars in thousands) Cost Gains Losses Value
--------- --------- --------- ---------
Securities Available for Sale:
U.S. Treasury and agency $ 117,581 $ 3,058 $ 13 $ 120,626
Mortgage-backed securities 277,747 5,809 79 283,477
State and municipal obligations 166,981 7,959 17 174,923
Corporate bonds 13,775 203 55 13,923
Equity securities 3,010 903 -- 3,913
--------- --------- --------- ---------
Total securities available for sale $ 579,094 $ 17,932 $ 164 $ 596,862
========= ========= ========= =========
Securities Held to Maturity:
State and municipal obligations $ 47,125 $ 969 $ 5 $ 48,089
--------- --------- --------- ---------
Total securities held to maturity $ 47,125 $ 969 $ 5 $ 48,089
========= ========= ========= =========
Information on temporarily impaired securities at December 31, 2003, segregated
according to the period of time such securities were in a continuous unrealized
loss position, is summarized as follows:
Less than 12 months
12 months or longer Total
----------------------------------------------------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
(Dollars in thousands) Value Losses Value Losses Value Losses
---------- ---------- ---------- ---------- ---------- ----------
Securities available for sale:
U.S. Treasury and agency $ 96,483 $ 583 $ -- $ -- $ 96,483 $ 583
Mortgage-backed securities 44,200 437 8,763 17 52,963 454
State and municipal obligations 7,582 83 -- -- 7,582 83
---------- ---------- ---------- ---------- ---------- ----------
Total securities available for sale $ 148,265 $ 1,103 $ 8,763 $ 17 $ 157,028 $ 1,120
========== ========== ========== ========== ========== ==========
The table above represents 114 investment securities where the current fair
value is less than the related amortized cost. These unrealized losses do not
reflect any deterioration in the credit worthiness of the issuing securities and
result primarily from fluctuations in market interest rates.
62
The amortized cost and fair value of debt securities by contractual maturity are
as follows:
December 31, 2003
------------------------------------------------------
Available for Sale Held to Maturity
------------------------ ------------------------
Amortized Fair Amortized Fair
(Dollars in thousands) Cost Value Cost Value
--------- --------- --------- ---------
Due in one year or less $ 56,325 $ 56,690 $ 33,458 $ 33,574
Due in one to five years 153,950 160,617 10,654 11,241
Due in five to ten years 189,868 194,962 2,220 2,423
Due after ten years 190,688 191,759 799 883
--------- --------- --------- ---------
$ 590,831 $ 604,028 $ 47,131 $ 48,121
========= ========= ========= =========
Maturities of mortgage-backed securities are classified in accordance with the
contractual repayment schedules. Expected maturities will differ from
contractual maturities since issuers generally have the right to prepay
obligations.
Proceeds from the sale and call of securities during 2003 were $82,906,000;
realized gross gains were $1,042,000 and gross losses were $1,000. Proceeds from
the sale and call of securities during 2002 were $45,059,000; realized gross
gains were $615,000 and gross losses were $330,000. Proceeds from the sale and
call of securities during 2001 were $91,412,000; realized gross gains were
$617,000 and gross losses were $86,000. Gains and losses were computed using the
specific identification method. There were no transfers between held to maturity
and available for sale securities in 2003, 2002 or 2001.
Securities held to maturity and available for sale with carrying values of
$465,083,000 and $475,567,000 were pledged as collateral for municipal deposits
and repurchase agreements at December 31, 2003 and 2002, respectively.
(4) Loans
Loans outstanding at December 31, 2003 and 2002 are summarized as follows:
(Dollars in thousands) 2003 2002
----------- -----------
Commercial $ 248,313 $ 262,630
Commercial real estate 369,712 332,134
Agricultural 235,199 233,769
Residential real estate 251,502 251,898
Consumer and home equity 240,591 241,461
----------- -----------
Loans, gross 1,345,317 1,321,892
Allowance for loan losses (29,064) (21,660)
----------- -----------
Loans, net $ 1,316,253 $ 1,300,232
=========== ===========
63
The following table sets forth the changes in the allowance for loan losses for
the years indicated.
Years ended December 31
(Dollars in thousands) 2003 2002 2001
------- ------- -------
Balance at beginning of year $21,660 $19,074 $13,883
Addition resulting from acquisitions -- 174 2,686
Charge-offs:
Commercial 8,891 1,771 1,003
Commercial real estate 2,953 944 394
Agricultural 1,876 106 58
Residential real estate 215 98 178
Consumer and home equity 2,107 1,499 1,319
------- ------- -------
Total charge-offs 16,042 4,418 2,952
Recoveries:
Commercial 525 210 58
Commercial real estate 35 69 23
Agricultural 3 36 --
Residential real estate 11 67 19
Consumer and home equity 346 329 399
------- ------- -------
Total recoveries 920 711 499
------- ------- -------
Net charge-offs 15,122 3,707 2,453
Provision for loan losses 22,526 6,119 4,958
------- ------- -------
Balance at end of year $29,064 $21,660 $19,074
======= ======= =======
The following table sets forth information regarding nonaccrual loans and other
nonperforming assets at December 31:
(Dollars in thousands) 2003 2002
------- -------
Nonaccrual loans:
Commercial $12,983 $12,760
Commercial real estate 11,745 8,407
Agricultural 18,870 8,739
Residential real estate 2,496 1,065
Consumer and home equity 578 915
------- -------
Total nonaccrual loans 46,672 31,886
Restructured loans 3,069 4,129
Accruing loans 90 days or more delinquent 1,709 1,091
------- -------
Total nonperforming loans 51,450 37,106
Other real estate owned 653 1,251
------- -------
Total nonperforming assets $52,103 $38,357
======= =======
The recorded investment in impaired loans that have been evaluated individually
for impairment totaled $21,990,000 and $24,626,000 at December 31, 2003 and
2002, respectively. The allowance for loan losses related to impaired loans
amounted to $4,324,000 and $4,462,000 at December 31, 2003 and 2002,
respectively. The average recorded investment in impaired loans during 2003,
2002 and 2001 was $28,650,000, $25,332,000 and $10,842,000, respectively.
Interest income recognized on impaired loans, while such loans were impaired,
during 2003, 2002 and 2001 was approximately $218,000, $455,000 and $392,000,
respectively.
64
In the normal course of business there are various outstanding commitments to
extend credit that are not reflected in the accompanying consolidated financial
statements. Loan commitments have off-balance-sheet credit risk until
commitments are fulfilled or expire. The credit risk amounts are equal to the
contractual amounts, assuming that the amounts are ultimately advanced in full
and that the collateral or other security is of no value. The Company's policy
generally requires customers to provide collateral, usually in the form of
customers' operating assets or property, prior to the disbursement of approved
loans. At December 31, 2003, letters of credit totaling $11,789,000 and unused
loan commitments and lines of credit of $271,874,000 were contractually
available. Comparable amounts for these letters of credit and commitments at
December 31, 2002 were $13,359,000 and $316,595,000, respectively. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without funding, the total commitment amounts do not necessarily represent
future cash requirements.
Loans outstanding by subsidiary banks to certain officers, directors, or
companies in which they have 10% or more beneficial ownership, including
officers and directors of the Company, as well as its subsidiaries ("Insiders"),
approximated $25,651,000 and $36,406,000 at December 31, 2003 and 2002,
respectively.
An analysis of activity with respect to insider loans during the year ended
December 31, 2003 is as follows:
(Dollars in thousands)
Balance as of December 31, 2002 $ 36,406
New loans to insiders 3,913
Repayments received from insiders (1,063)
Other changes * (13,605)
--------
Balance as of December 31, 2003 $ 25,651
========
* Other changes relate primarily to changes in director status during 2003.
These loans were made on substantially the same terms, including interest rate
and collateral, as comparable transactions with other customers.
As of December 31, 2003, the Company had no significant concentration of credit
risk in the loan portfolio other than normal geographic concentration pertaining
to the communities that the Company serves and the dairy industry in Western,
New York. At December 31, 2003, the Company had $119.3 million, or 8.9% of the
portfolio, in loans to borrowers operating in the dairy industry, of which $16.5
million, or 13.8% were in nonperforming status. There is no significant exposure
to highly leveraged transactions and there are no foreign credits in the loan
portfolio.
Loans serviced for others amounting to $439,450,000 and $356,419,000 at December
31, 2003 and 2002, respectively, are not included in the consolidated statements
of financial condition. The Company had capitalized mortgage servicing rights of
$2,073,000 and $1,243,000 as of December 31, 2003 and 2002, respectively.
Proceeds from the sale of loans were $192,295,000, $139,426,000 and $117,446,000
in 2003, 2002 and 2001, respectively. Net gain on the sale of loans included in
mortgage banking activities on the income statement, was $3,153,000, $1,542,000
and $1,513,000 in 2003, 2002 and 2001, respectively. Included in net loans are
loans held for sale totaling $4,881,000 and $6,971,000 at December 31, 2003 and
2002, respectively. The Company enters into forward contracts for future
delivery of residential mortgage loans at a specified yield to reduce the
interest rate risk associated with fixed rate residential mortgage loans held
for sale and commitments to fund residential mortgages. Credit risk arises from
the possible inability of the other parties to comply with the contract terms.
Substantially all of the Company's contracts are with government-sponsored
enterprises or government agencies (FHLMC and FHA).
65
(5) Premises and Equipment
A summary of premises and equipment at December 31, 2003 and 2002 follows:
(Dollars in thousands) 2003 2002
-------- --------
Land and land improvements $ 4,101 $ 3,320
Buildings and leasehold improvements 29,946 24,275
Furniture, fixtures, equipment and vehicles 22,833 19,129
-------- --------
Premises and equipment, gross 56,880 46,724
Accumulated depreciation and amortization (22,641) (19,470)
-------- --------
Premises and equipment, net $ 34,239 $ 27,254
======== ========
Depreciation and amortization expense amounted to $3,434,000, $2,879,000 and
$2,403,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
(6) Goodwill and Other Intangible Assets
As discussed in Note 1, the Company adopted the provisions of SFAS No. 142,
"Goodwill and Other Intangible Assets," on January 1, 2002. Under SFAS No. 142,
goodwill is no longer amortized, but is reviewed for impairment at least
annually. Identifiable intangible assets acquired in a business combination are
amortized over their useful lives.
The following table presents the pro forma effects of applying the
non-amortization provisions of SFAS No. 142 to the results of operations for
2001. There was no impact to the results of operations for 2003 and 2002.
Years ended December 31
(Dollars in thousands, except per share amounts) 2003 2002 2001
--------- --------- ---------
Reported net income $ 14,247 $ 26,456 $ 21,213
Goodwill amortization add-back -- -- 1,653
--------- --------- ---------
Adjusted net income $ 14,247 $ 26,456 $ 22,866
========= ========= =========
Basic earnings per share:
Reported $ 1.14 $ 2.26 $ 1.79
Goodwill amortization add-back -- -- 0.15
--------- --------- ---------
Adjusted $ 1.14 $ 2.26 $ 1.94
========= ========= =========
Diluted earnings per share:
Reported $ 1.13 $ 2.23 $ 1.77
Goodwill amortization add-back -- -- 0.15
--------- --------- ---------
Adjusted $ 1.13 $ 2.23 $ 1.92
========= ========= =========
Goodwill resulting from the previously disclosed mergers and acquisitions (see
Note 2) amounted to $40.6 million at December 31, 2003 and 2002. Goodwill
amortization expense included in the results of operations for 2001 amounted to
$1.7 million, which was non-deductible for income tax purposes. In accordance
with SFAS No. 142, there is no goodwill amortization included in 2003 or 2002.
66
The following table presents the change in the carrying amount of goodwill
allocated by business segment for the years ended December 31, 2003 and 2002:
Financial Services
BNB Group
(Dollars in thousands) Segment Segment Total
-------- ------ --------
Balance as of December 31, 2001 $ 35,535 $1,294 $ 36,829
Goodwill acquired during the period 1,925 -- 1,925
Contingent earnout -- 1,840 1,840
Goodwill adjustments (119) 118 (1)
-------- ------ --------
Balance as of December 31, 2002 $ 37,341 $3,252 $ 40,593
Goodwill adjustments 28 -- 28
-------- ------ --------
Balance as of December 31, 2003 $ 37,369 $3,252 $ 40,621
======== ====== ========
During 2003, in accordance with SFAS No. 142, the Company evaluated goodwill for
impairment using a discounted cash flow analysis and determined no impairment
existed.
A summary of the major classes of amortizable intangible assets (included in
other assets on the consolidated statements of financial condition) at December
31, 2003 and 2002 follows:
(Dollars in thousands) 2003 2002
-------- --------
Core deposits $ 11,452 $ 11,452
Customer list 500 500
-------- --------
Other intangible assets, gross 11,952 11,952
Accumulated amortization (9,224) (7,998)
-------- --------
Other intangible assets, net $ 2,728 $ 3,954
======== ========
Intangible amortization expense for these other intangible assets amounted to
$1,226,000, $898,000 and $728,000 for the years ended December 31, 2003, 2002
and 2001, respectively. Amortization of other intangible assets was computed
using the straight-line method over the estimated lives of the respective assets
(primarily 5 and 7 years). Based on the current level of intangible assets,
estimated amortization expense for other intangible assets is as follows:
Year ending December 31,
(Dollars in thousands)
2004 $ 809
2005 530
2006 498
2007 303
2008 307
Thereafter 281
-------
$ 2,728
=======
67
(7) Deposits
Scheduled maturities for certificates of deposit at December 31, 2003 are as
follows:
Mature in year ending December 31,
(Dollars in thousands)
2004 $525,547
2005 165,348
2006 31,243
2007 26,152
2008 21,034
Thereafter 358
--------
$769,682
========
Certificates of deposit greater than $100,000 totaled $267,116,000 and
$201,751,000 at December 31, 2003 and 2002, respectively. Interest expense on
certificates of deposit greater than $100,000 amounted to $6,846,000, $7,682,000
and $15,922,000 for the years ended December 31, 2003, 2002 and 2001,
respectively.
As of December 31, 2003 and 2002, overdrawn deposits included in loans on the
consolidated statements of financial condition amounted to $1,054,000 and
$3,459,000, respectively.
(8) Borrowings
Outstanding borrowings at December 31, 2003 and 2002 are summarized as follows:
(Dollars in thousands) 2003 2002
------- -------
Short-term borrowings:
Federal funds purchased and securities
sold under repurchase agreements $22,525 $60,679
FHLB advances 26,500 26,000
Other 1,000 510
------- -------
Total short-term borrowings $50,025 $87,189
======= =======
Long-term borrowings:
FHLB advances $62,469 $86,822
Other 25,051 5,268
------- -------
Total long-term borrowings $87,520 $92,090
======= =======
Information related to Federal funds purchased and securities sold under
repurchase agreements as of and for the years ended December 31, 2003, 2002 and
2001 is summarized as follows:
(Dollars in thousands) 2003 2002 2001
------- ------- -------
Weighted average interest rate at year-end 0.89% 1.50% 1.88%
Maximum outstanding at any month-end $36,414 $61,951 $65,474
Average amount outstanding during the year $30,284 $47,924 $33,157
The average amounts outstanding are computed using daily average balances.
Related interest expense for 2003, 2002 and 2001 was $376,000, $951,000 and
$1,108,000, respectively.
At December 31, 2003, the Company had outstanding various short and long-term
FHLB advances with maturity dates extending through 2014. The FHLB advances bear
interest at fixed rates ranging from 2.41% to 7.80% and the weighted average
interest rate amounted to 4.47% as of December 31, 2003.
68
The Company's FHLB advances include $20.0 million in fixed-rate callable
borrowings, which can be called by the FHLB on a quarterly basis. FHLB advances
are collateralized by $6.0 million of FHLB stock, mortgage loans with a carrying
value of $84.2 million at December 31, 2003 and investment securities with a
fair market value of $37.8 million at December 31, 2003. At December 31, 2003,
the Company had remaining credit available of $27.8 million under lines of
credit with the FHLB. The Company also had $74.3 million of remaining credit
available under unsecured lines of credit with various banks at December 31,
2003. The Company also has available lines of credit with Farmer Mac permitting
borrowings to a maximum of $25.0 million. Advances outstanding against the
Farmer Mac lines at December 31, 2003 amounted to $1.0 million.
During 2003, FII expanded the terms of an existing credit agreement with M&T
Bank and infused approximately $15 million of the financing proceeds as capital
to the NBG and BNB subsidiaries allowing those banks to meet higher capital
ratios required in agreements imposed by their regulator. The credit agreement
includes a $25.0 million term loan facility and a $5.0 million revolving loan
facility. The term loan requires monthly payments of interest only, at a
variable interest rate of London Interbank Offered Rate ("LIBOR") plus 1.75%,
which was 2.98% as of December 31, 2003. The $25.0 million term loan is included
in long-term borrowings on the consolidated statements of financial condition as
principal installments are due as follows: $5.0 million in December 2006, $10.0
million in December 2007 and $10.0 million in December 2008. The $5.0 million
revolving loan accrues interest at a rate of LIBOR plus 1.50%. There were no
advances outstanding on the revolving loan as of December 31, 2003. The credit
agreement includes affirmative financial covenants, all of which were met as of
December 31, 2003. FII pledged the stock of its subsidiary banks as collateral
for the credit facility.
The aggregate maturities of long-term borrowings at December 31, 2003 are as
follows:
Mature in year ending December 31,
(Dollars in thousands)
2005 $ 7,282
2006 15,139
2007 14,098
2008 30,232
2009 20,529
Thereafter 240
--------
$ 87,520
========
(9) Trust Preferred Securities and Junior Subordinated Debentures
On February 22, 2001, the Company established FISI Statutory Trust I (the
"Trust"), which is a statutory business trust formed under Connecticut law. The
Trust exists for the exclusive purposes of (i) issuing and selling 30 year
guaranteed preferred beneficial interests in the trust assets ("trust preferred"
or "capital" securities) in the aggregate amount of $16.2 million at a fixed
rate of 10.20%, (ii) using the proceeds from the sale of the capital securities
to acquire the junior subordinated debentures issued by the Company and (iii)
engaging in only those other activities necessary, advisable or incidental
thereto.
The Company's junior subordinated debentures are the primary assets of the Trust
and, accordingly, payments under the corporation obligated junior debentures are
the sole revenue of the Trust. The capital securities of the Trust are
non-voting. The Company owns all of the common securities of the Trust. The
Company used the net proceeds from the sale of the capital securities to
partially fund the BNB acquisition. The capital securities qualified as Tier 1
capital under regulatory definitions as of December 31, 2003 and 2002.
The Company's primary sources of funds to pay interest on the debentures held by
the Trust are current dividends from its subsidiary banks. Accordingly, the
Company's ability to service the debentures is dependent upon the continued
ability of the subsidiary banks to pay dividends to the Company. Since the
junior subordinated obligations and trust preferred securities at December 31,
2003 and 2002,
69
respectively are classified as debt for financial statement purposes, the
associated tax-deductible expense has been recorded as interest expense in the
consolidated statements of income.
The Company incurred $487,000 in costs to issue the securities and the costs are
being amortized over 20 years using the straight-line method
As of December 31, 2003, the Company deconsolidated the subsidiary Trust, which
had issued trust preferred securities, and replaced the presentation of such
instruments with the Company's junior subordinated debentures issued to the
subsidiary Trust. Such presentation reflects the adoption of FASB Interpretation
No. 46 ("FIN 46 R"), "Consolidation of Variable Interest Entities."
(10) Income Taxes
Total income taxes for the years ended December 31, 2003, 2002 and 2001 were
allocated as follows:
(Dollars in thousands) 2003 2002 2001
-------- -------- --------
Income from operations $ 3,977 $ 12,419 $ 11,033
Additional paid-in capital for stock options exercised (87) (148) --
Shareholders' equity for unrealized gain (loss)
on securities available for sale (1,535) 5,488 1,588
-------- -------- --------
$ 2,355 $ 17,759 $ 12,621
======== ======== ========
Income tax expense (benefit) attributable to operations for the years ended
December 31, 2003, 2002 and 2001 consists of:
(Dollars in thousands) 2003 2002 2001
-------- -------- --------
Current:
Federal $ 5,245 $ 10,828 $ 8,676
State 703 2,651 2,469
-------- -------- --------
Total current 5,948 13,479 11,145
Deferred:
Federal (1,909) (908) (68)
State (62) (152 (44)
-------- -------- --------
Total deferred (1,971) (1,060) (112)
-------- -------- --------
Total income taxes $ 3,977 $ 12,419 $ 11,033
======== ======== ========
The following is a reconciliation of the actual and statutory tax rates
applicable to income from operations for the years ended December 31, 2003, 2002
and 2001:
2003 2002 2001
-------- -------- --------
Statutory rate 35.0% 35.0% 35.0%
Increase (decrease) resulting from:
Tax exempt interest income (16.3) (7.8) (8.1)
State taxes, net of federal income tax benefit 2.3 4.2 4.9
Goodwill amortization -- -- 1.8
Other 0.8 0.5 0.6
-------- -------- --------
Total 21.8% 31.9% 34.2%
======== ======== ========
70
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities at December 31, 2003 and 2002 are presented
as follows:
(Dollars in thousands) 2003 2002
-------- --------
Deferred tax assets:
Allowance for loan losses $ 11,106 $ 8,216
Core deposit intangible 965 822
Interest on nonaccrual loans 1,178 869
Other 1,106 946
-------- --------
Total gross deferred tax assets 14,355 10,853
Deferred tax liabilities:
Prepaid pension costs 1,046 1,017
Unrealized gain on securities available for sale 5,441 6,976
Depreciation of premises and equipment 1,591 917
Loan servicing assets 826 479
Other 1,178 697
-------- --------
Total gross deferred tax liabilities 10,082 10,086
-------- --------
Net deferred tax asset, at year-end * $ 4,273 $ 767
Net deferred tax asset, at beginning of year 767 4,922
-------- --------
Decrease (increase) in net deferred tax asset (3,506) 4,155
Net deferred tax asset acquired -- 368
Initial purchase accounting adjustments, net -- (95)
Change in unrealized gain/loss on securities available for sale 1,535 (5,488)
-------- --------
Deferred tax benefit $ (1,971) $ (1,060)
======== ========
* Included in other assets on the consolidated statements of financial
condition
Realization of deferred tax assets is dependent upon the generation of future
taxable income or the existence of sufficient taxable income within the
carry-back period. A valuation allowance is provided when it is more likely than
not that some portion of the deferred tax assets will not be realized. In
assessing the need for a valuation allowance, management considers the scheduled
reversal of the deferred tax liabilities, the level of historical taxable income
and projected future taxable income over the periods in which the temporary
differences comprising the deferred tax assets will be deductible. Based on its
assessment, management determined that no valuation allowance is necessary at
December 31, 2003 and 2002.
The Company has Federal and state net operating loss carryforwards of $434,000
that expire in 2021. The utilization of the tax net operating carryforwards is
subject to limitations imposed by the Internal Revenue Code. The Company
believes these limitations will not prevent the carryforward benefits from being
utilized.
71
(11) Lease Commitments
At December 31, 2003, the Company was obligated under a number of noncancellable
operating leases for land, buildings and equipment. Certain of these leases
provide for escalation clauses and contain renewal options calling for increased
rentals if the lease is renewed. Future minimum lease payments on operating
leases at December 31, 2003 were as follows:
Operating lease payments in year ending December 31,
(Dollars in thousands)
2004 $ 651
2005 591
2006 514
2007 484
2008 458
Thereafter 2,842
-------
$ 5,540
=======
(12) Retirement Plans and Postretirement benefits
Defined Benefit Plan
The Company participates in The New York State Bankers Retirement System, which
is a defined benefit pension plan covering substantially all employees. The
benefits are based on years of service and the employee's highest average
compensation during five consecutive years of employment. The Company's funding
policy is to contribute annually an actuarially determined amount to cover
current service cost plus amortization of prior service costs.
The following table sets forth the defined benefit pension plan's change in
benefit obligation and change in plan assets using the most recent actuarial
data measured at September 30:
(Dollars in thousands) 2003 2002 2001
-------- -------- --------
Change in benefit obligation:
Benefit obligation at beginning of year $(16,282) $(13,608) $(12,114)
Service cost (1,282) (1,071) (1,249)
Interest cost (1,079) (968) (890)
Actuarial (loss) gain (2,136) (1,303) 72
Benefits paid 590 559 470
Plan expenses 109 109 103
-------- -------- --------
Benefit obligation at end of year (20,080) (16,282) (13,608)
Change in plan assets:
Fair value of plan assets at beginning of year 14,294 15,240 17,180
Actual (loss) return on plan assets 2,544 (830) (1,367)
Employer contributions 1,421 552 --
Benefits paid (590) (559) (470)
Plan expenses (109) (109) (103)
-------- -------- --------
Fair value of plan assets at end of year 17,560 14,294 15,240
-------- -------- --------
Funded status (2,520) (1,988) 1,632
Unamortized net asset at transition (103) (141) (179)
Unrecognized net loss subsequent to transition 5,362 4,722 1,292
Unamortized prior service cost 231 322 345
-------- -------- --------
Prepaid benefit cost, included in other assets $ 2,970 $ 2,915 $ 3,090
======== ======== ========
72
Net periodic pension cost consists of the following components for the years
ended December 31:
(Dollars in thousands) 2003 2002 2001
-------- -------- --------
Service cost $ 1,351 $ 1,071 $ 850
Interest cost on projected benefit obligation 1,079 968 890
Expected return on plan assets (1,251) (1,297) (1,429)
Amortization of net transition asset (38) (38) (38)
Amortization of unrecognized loss 201 -- --
Amortization of unrecognized prior service cost 22 22 (3)
-------- -------- --------
Net periodic pension cost $ 1,364 $ 726 $ 270
======== ======== ========
Weighted-average assumptions used to determine the net periodic pension cost for
the years ended December 31:
2003 2002 2001
-------- -------- --------
Weighted average discount rate 6.00% 6.75% 7.25%
Expected long-term rate of return 8.00% 8.50% 8.50%
Rate of compensation increase 3.00% 4.00% 5.00%
The expected long-term rate-of-return on plan assets reflects long-term earnings
expectations on existing plan assets and those contributions expected to be
received during the current plan year. In estimating that rate, appropriate
consideration was given to historical returns earned by plan assets in the fund
and the rates of return expected to be available for reinvestment. Average rates
of return over the past 1,3,5 and 10 year periods were determined and
subsequently adjusted to reflect current capital market assumptions and changes
in investment allocations.
The pension plan weighted-average asset allocations at September 30, 2003 and
2002, by asset category are as follows:
(Dollars in thousands) 2003 2002
---- ----
Asset category:
Equity securities 59.7% 55.3%
Debt securities 34.5 36.3
Other 5.8 8.4
---- ----
Total 100.0% 100.0%
==== ====
The New York State Bankers Retirement System (the "System") was established in
1938 to provide for the payment of benefits to employees of participating banks.
A Board of Trustees meets quarterly to set the investment policy guidelines and
oversee the System.
The System utilizes two investment management firms, (which will be referred to
as Firm I and Firm II) each investing approximately 50% of the total portfolio.
The System's investment objective is to exceed the investment benchmarks in each
asset category. Each firm operates under a separate written investment policy
approved by the Trustees and designed to achieve an allocation approximating 60%
invested in equity securities and 40% invested in debt securities.
Each Firm reports at least quarterly to the Investment Committee and
semi-annually to the Board.
Equities: The target allocation percentage for equity securities is 60% but may
vary from 50%-70% at the investment manager's discretion.
Fixed Income: For both investment portfolios, the target allocation percentage
for debt securities is 40% but may vary from 30%-50% at the investment manager's
discretion.
73
The Company expects to contribute approximately $1,406,000 to the pension plan
prior to June 15, 2004.
Defined Contribution Plan
The Company also sponsors a defined contribution profit sharing (401(k)) plan
covering substantially all employees. The Company matches certain percentages of
each eligible employee's contribution to the plan. Expense for the plan amounted
to $299,000, $1,057,000 and $708,000 in 2003, 2002 and 2001, respectively.
Postretirement Benefits
Prior to December 31, 2001, BNB provided health and dental care benefits to
retired employees who met specified age and service requirements through a
postretirement health and dental care plan in which both BNB and the retiree
shared the cost. The plan provided for substantially the same medical insurance
coverage as for active employees until their death and was integrated with
Medicare for those retirees aged 65 or older. In 2001, the plan's eligibility
requirements were amended to curtail eligible benefit payments to only retired
employees and active participants who were fully vested under the Plan. In 2003,
retirees under age 65 began contributing to health coverage at the same
cost-sharing level as that of active employees. The retirees aged 65 or older
were offered new Medicare supplemental plans as alternatives to the plan
historically offered. The cost sharing of medical coverage was standardized
throughout the group of retirees aged 65 or older. In addition, to be consistent
with the administration of the Company's dental plan for active employees, all
retirees who continued dental coverage began paying the full monthly premium.
The accrued liability related to this plan amounted to $828,000 and $844,000 as
of December 31, 2003 and 2002, respectively. Expense for the plan amounted to
$108,000 and $172,000 for the years ended December 31, 2003 and 2002,
respectively.
(13) Stock Compensation Plans
The Company has a Management Stock Incentive Plan and a Directors' Stock
Incentive Plan. Under the plans, the Company may grant stock options to its
directors, directors of its subsidiaries, and key employees to purchase shares
of common stock, shares of restricted stock and stock appreciation rights.
Grants under the plans may be made to up to 10% of the number of shares of
common stock issued, including treasury shares. The exercise price of each
option equals the market price of the Company's stock on the date of the grant.
The maximum term of each option is ten years and the options' generally vest
between three and five years.
74
The following is a summary of the status of the Company's stock option plans as
of December 31, 2003, 2002 and 2001, as well as changes in the plans during the
years then ended:
Weighted
Stock Average
Options Exercise
Outstanding Price
----------- ---------
Balance December 31, 2000 $ 384,518 $ 13.90
Granted 115,637 18.94
Cancelled (3,474) (13.65)
--------- ---------
Balance December 31, 2001 $ 496,681 $ 15.08
Granted 52,353 27.41
Exercised (19,955) (13.95)
Cancelled (74,792) (13.99)
--------- ---------
Balance December 31, 2002 454,287 16.73
Granted 65,831 22.16
Exercised (21,669) (14.30)
Cancelled (66,173) (15.31)
--------- ---------
Balance December 31, 2003 $ 432,276 $ 17.89
========= =========
Exercisable at:
December 31, 2003 $ 260,225 $ 15.83
December 31, 2002 224,284 14.75
December 31, 2001 153,826 13.92
The following table summarizes information about stock options outstanding and
exercisable at December 31, 2003:
Outstanding Exercisable
------------------------------------ -----------------------
Weighted Weighted Weighted
Number Average Average Number Average
Range of of Stock Exercise Life of Stock Exercise
Exercise Price Options Price (in years) Options Price
----------------------- ---------- ----------- ---------- --------- -----------
$11.75 to $14.13 253,146 $ 13.91 5.72 208,159 $ 13.89
$20.50 to $22.50 80,400 21.57 7.89 31,923 21.61
$22.51 to $25.00 50,772 22.75 8.96 4,002 22.99
$25.33 to $26.45 38,041 25.48 8.16 12,838 25.47
$33.15 to $36.00 9,917 35.74 8.36 3,303 35.74
------- -------- ---- ------- -------
432,276 $ 17.89 6.78 260,225 $ 15.83
======= ======== ==== ======= =======
75
(14) Earnings Per Common Share
Basic earnings per share, after giving effect to preferred stock dividends, has
been computed using weighted average common shares outstanding. Diluted earnings
per share reflect the effects, if any, of incremental common shares issuable
upon exercise of dilutive stock options.
Earnings per common share have been computed based on the following:
Years Ended December 31
------------------------------------
(Dollars and shares in thousands) 2003 2002 2001
-------- -------- --------
Net income $ 14,247 $ 26,456 $ 21,213
Less: Preferred stock dividends 1,495 1,496 1,496
-------- -------- --------
Net income available to common shareholders $ 12,752 $ 24,960 $ 19,717
======== ======== ========
Weighted average number of common shares outstanding
used to calculate basic earnings per common share 11,148 11,068 10,994
Add: Effect of dilutive options 98 150 132
-------- -------- --------
Weighted average number of common shares used to
calculate diluted earnings per common share 11,246 11,218 11,126
======== ======== ========
(15) Regulatory Capital
The Company is subject to various regulatory capital requirements administered
by the Federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory, and possibly additional discretionary, actions
by regulators that, if undertaken, could have a direct material impact on the
Company's financial statements.
For evaluating regulatory capital adequacy, companies are required to determine
capital and assets under regulatory accounting practices. Quantitative measures
established by regulation to ensure capital adequacy require the Company to
maintain minimum amounts and ratios. The leverage ratio requirement is based on
period-end capital to average total assets during the previous three months.
Compliance with risk-based capital requirements is determined by dividing
regulatory capital by the sum of a company's weighted asset values. Risk
weightings are established by the regulators for each asset category according
to the perceived degree of risk. As of December 31, 2003 and 2002, the Company
and each subsidiary bank met all capital adequacy requirements to which they are
subject.
As of December 31, 2003, the most recent notification from the Federal Deposit
Insurance Corporation ("FDIC") categorized the Company and its subsidiary banks
as well capitalized under the regulatory framework for prompt corrective action.
For purposes of determining the annual deposit insurance assessment rate for
insured depository institutions, each insured institution is assigned an
assessment risk classification. Each institution's assigned risk classification
is composed of a group and subgroup assignment based on capital group and
supervisory subgroup. Although the NBG and BNB subsidiaries remain assigned to
the well capitalized capital group, these two subsidiaries received notification
of a downgrade in supervisory subgroup based on the formal agreements in place
with the OCC.
Payments of dividends by the subsidiary banks to FII are limited or restricted
in certain circumstances under banking regulations. At December 31, 2003, an
aggregate of $13,233,000 was available for payment of dividends by the
subsidiary banks to FII without the approval from the appropriate regulatory
authorities.
76
The following is a summary of the actual capital amounts and ratios for the
Company and its subsidiary banks as of December 31:
2003
-------------------------------------------------------------------------------
Actual Regulatory
Capital Minimum Requirements Well-Capitalized
------------------------- ------------------------- -------------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Leverage capital (Tier 1) as percent of three-month average assets:
Company $ 147,722 7.03% $ 84,082 4.00% $ 105,103 5.00%
BNB 34,202 8.02 17,065 4.00 21,332 5.00
FTB 13,550 6.09 8,901 4.00 11,126 5.00
NBG 58,593 8.04 29,162 4.00 36,452 5.00
WCB 48,215 6.71 28,738 4.00 35,923 5.00
As percent of risk-weighted, period-end assets: Core capital (Tier 1):
Company 147,722 10.18 58,033 4.00 87,050 6.00
BNB 34,202 13.69 9,995 4.00 14,993 6.00
FTB 13,550 10.90 4,971 4.00 7,456 6.00
NBG 58,593 11.15 21,027 4.00 31,540 6.00
WCB 48,215 8.91 21,655 4.00 32,483 6.00
Total capital (Tiers 1 and 2):
Company 165,992 11.44 116,067 8.00 145,084 10.00
BNB 37,343 14.94 19,991 8.00 24,989 10.00
FTB 15,108 12.16 9,942 8.00 12,427 10.00
NBG 65,233 12.41 42,053 8.00 52,566 10.00
WCB 55,027 10.16 43,310 8.00 54,138 10.00
2002
-------------------------------------------------------------------------------
Actual Regulatory
Capital Minimum Requirements Well-Capitalized
------------------------- ------------------------- -------------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Leverage capital (Tier 1) as percent of three-month average assets:
Company $ 139,620 6.96% $ 80,233 4.00% $ 100,292 5.00%
BNB 24,505 5.93 16,527 4.00 20,658 5.00
FTB 11,356 5.67 8,017 4.00 10,022 5.00
NBG 48,420 6.71 28,870 4.00 36,087 5.00
WCB 44,175 6.64 26,592 4.00 33,240 5.00
As percent of risk-weighted, period-end assets: Core capital (Tier 1):
Company 139,620 9.82 56,846 4.00 85,270 6.00
BNB 24,505 9.70 10,110 4.00 15,165 6.00
FTB 11,356 9.45 4,807 4.00 7,210 6.00
NBG 48,420 8.90 21,758 4.00 32,637 6.00
WCB 44,175 8.94 19,761 4.00 29,642 6.00
Total capital (Tiers 1 and 2):
Company 157,433 11.08 113,693 8.00 142,116 10.00
BNB 27,669 10.95 20,220 8.00 25,275 10.00
FTB 12,861 10.70 9,613 8.00 12,017 10.00
NBG 55,243 10.16 43,515 8.00 54,394 10.00
WCB 50,369 10.20 39,522 8.00 49,403 10.00
The formal agreements entered into by NBG and BNB with their primary regulator
required both banks to develop capital plans enabling them to achieve, by March
31, 2004, a Tier 1 leverage capital ratio equal to 8%, a Tier 1 risk-based
capital ratio equal to 10%, and a total risk-based capital ratio of 12%. As
indicated in the table above, each of the banks meets the required levels at
December 31, 2003.
77
(16) Fair Value of Financial Instruments
The "fair value" of a financial instrument is defined as the price a willing
buyer and a willing seller would exchange in other than a distressed sale
situation. The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments at December 31, 2003 and 2002:
2003 2002
-------------------------- --------------------------
Carrying Fair Carrying Fair
(Dollars in thousands) Amount Value Amount Value
---------- ---------- ---------- ----------
Financial Assets
Cash and cash equivalents $ 45,635 $ 45,635 $ 48,429 $ 48,429
Securities 652,095 653,085 643,987 644,951
FHLB and FRB stock 8,351 8,351 8,558 8,558
Loans, net 1,316,253 1,355,654 1,300,232 1,345,314
Financial Liabilities
Deposits:
Interest Bearing:
Savings and interest
bearing demand 784,219 784,219 779,772 779,772
Time deposits 769,682 769,682 687,996 691,020
Non-interest bearing demand 264,990 264,990 240,755 240,755
---------- ---------- ---------- ----------
Total deposits 1,818,891 1,818,891 1,708,523 1,711,547
Borrowings:
Short-term 50,025 50,223 87,189 88,027
Long-term 87,520 86,635 92,090 101,772
Junior subordinated debentures 16,702 19,959 -- --
Trust preferred securities -- -- 16,200 19,082
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments.
Cash and cash equivalents: The carrying amounts reported in the consolidated
statements of financial condition for cash, due from banks, interest-bearing
deposits and Federal funds sold approximate the fair value of those assets.
Securities: Fair value is based on quoted market prices, where available. Where
quoted market prices are not available, fair value is based on quoted market
prices of comparable instruments.
FHLB and FRB stock: The carrying amounts reported in the consolidated statements
of financial condition for FHLB and FRB stock approximate the fair value of
those assets.
Loans: For variable rate loans that reprice frequently, fair value approximates
carrying amount. The fair value for fixed rate loans is estimated through
discounted cash flow analysis using interest rates currently being offered on
loans with similar terms and credit quality. The fair value of loans held for
sale is based on quoted market prices and investor commitments. For
nonperforming loans, fair value is estimated by discounting expected cash flows
at a rate commensurate with the risk associated with the estimated cash flows.
Deposits: The fair value for savings, interest bearing and non-interest bearing
demand accounts is equal to the carrying amount because of the customer's
ability to withdraw funds immediately. The fair value of time deposits is
estimated using a discounted cash flow approach that applies prevailing market
interest rates for similar maturity instruments.
78
Borrowings: Carrying value approximates fair value for short-term borrowings.
The fair value for long-term borrowings is estimated using a discounted cash
flow approach that applies prevailing market interest rates for similar maturity
instruments.
Junior subordinated debentures and trust preferred securities: The fair value
for the junior subordinated debentures is estimated using a discounted cash flow
approach that applies prevailing market interest rates for similar maturity
instruments.
(17) Segment Information
Reportable segments are comprised of WCB, NBG, BNB and FTB as the Company
evaluates performance on an individual bank basis. As stated in Note 1, during
2002 the Company completed a geographic realignment of the subsidiary banks,
which involved the merger of the subsidiary formerly known as PSB into NBG and
subsequent transfer of branches between NBG and WCB. Accordingly, the Company
restated segment results to reflect the merger and transfers for each of the
years presented. All of the revenue, expenses, assets and liabilities of PSB
have been reallocated to the WCB and NBG segments. The reportable segment
information as of and for the years ended December 31, 2003, 2002 and 2001
follows:
(Dollars in thousands) 2003 2002 2001
----------- ----------- -----------
Net interest income
WCB $ 28,384 $ 28,577 $ 27,039
NBG 25,642 26,853 24,732
BNB 15,019 14,048 8,184
FTB 8,207 8,175 6,041
Financial Services Group -- -- --
----------- ----------- -----------
Total segment net interest income 77,252 77,653 65,996
Parent and eliminations, net (1,751) (1,799) (1,222)
----------- ----------- -----------
Total net interest income $ 75,501 $ 75,854 $ 64,774
=========== =========== ===========
Net income
WCB $ 9,042 $ 10,565 $ 9,643
NBG 151 9,765 9,777
BNB 4,108 5,001 1,142
FTB 2,117 2,775 1,827
Financial Services Group (115) 246 143
----------- ----------- -----------
Total segment net income 15,303 28,352 22,532
Parent and eliminations, net (1,056) (1,896) (1,319)
----------- ----------- -----------
Total net income $ 14,247 $ 26,456 $ 21,213
=========== =========== ===========
Assets
WCB $ 754,639 $ 674,755 $ 632,058
NBG 721,374 721,090 642,827
BNB 462,113 495,055 362,645
FTB 225,080 203,382 161,763
Financial Services Group 5,135 5,052 2,788
----------- ----------- -----------
Total segment assets 2,168,341 2,099,334 1,802,081
Parent and eliminations, net 5,391 5,700 (7,785)
----------- ----------- -----------
Total assets $ 2,173,732 $ 2,105,034 $ 1,794,296
=========== =========== ===========
79
(18) Condensed Parent Company Only Financial Statements
The following are the condensed statements of condition of FII as of December
31, 2003 and 2002, and the condensed statements of income and cash flows for the
years ended December 31, 2003, 2002 and 2001:
Condensed Statements of Condition
(Dollars in thousands) 2003 2002
-------- --------
Assets:
Cash and due from subsidiaries $ 13,698 $ 14,267
Securities available for sale, at fair value 1,436 1,268
Investment in subsidiaries 209,788 186,703
Other assets 5,098 5,099
-------- --------
Total assets $230,020 $207,337
======== ========
Liabilities and shareholders' equity
Junior subordinated debentures $ 16,702 $ 16,702
Short-term borrowings -- 500
Long-term borrowings 25,000 5,000
Other liabilities 5,215 6,841
Shareholders' equity 183,103 178,294
-------- --------
Total liabilities and shareholders' equity $230,020 $207,337
======== ========
Condensed Statements of Income
(Dollars in thousands) 2003 2002 2001
-------- -------- --------
Dividends from subsidiaries $ 6,058 $ 22,015 $ 16,643
Other income 10,542 8,542 7,577
-------- -------- --------
Total income 16,600 30,557 24,220
Expenses 12,341 11,477 9,602
-------- -------- --------
Income before income taxes and equity in
undistributed earnings of subsidiaries 4,259 19,080 14,618
Income tax benefit 723 1,160 788
-------- -------- --------
Income before effect of subsidiaries'
earnings and dividends 4,982 20,240 15,406
Equity in undistributed earnings of subsidiaries 9,265 6,216 5,807
-------- -------- --------
Net income $ 14,247 $ 26,456 $ 21,213
======== ======== ========
80
Condensed Statements of Cash Flows
(Dollars in thousands) 2003 2002 2001
-------- -------- --------
Cash flows from operating activities:
Net income $ 14,247 $ 26,456 $ 21,213
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 851 878 711
Equity in undistributed earnings of
subsidiaries (9,265) (6,216) (5,807)
Deferred income tax expense (benefit) 70 (176) (102)
Gain on sale of securities -- (161) --
Decrease in accrued dividends
receivable from subsidiaries -- -- 22,962
Increase in other assets (588) (4,953) (1,139)
(Decrease) increase in other liabilities (442) 1,393 1,562
-------- -------- --------
Net cash provided by
operating activities 4,873 17,221 39,400
-------- -------- --------
Cash flows from investing activities:
Purchase of available for sale securities -- (26) --
Proceeds from sale of available for sale securities -- 256 --
Investment in Mercantile Adjustment Bureau, LLC -- (2,400) --
Equity investment in subsidiaries, net (15,700) -- (63,381)
Purchase of premises and equipment, net (645) (274) (1,109)
-------- -------- --------
Net cash used in
investing activities (16,345) (2,444) (64,490)
-------- -------- --------
Cash flows from financing activities:
Proceeds from short-term borrowings -- -- 500
Proceeds from long-term borrowings 25,000 -- 5,000
Repayment on long-term borrowings (5,000) -- --
Repayment of short-term borrowings (500) -- --
Proceeds from issuance of trust
preferred securities -- -- 16,200
Purchase of preferred and common shares (425) (581) (16)
Issuance of preferred and common shares 447 463 27
Dividends paid (8,619) (7,578) (6,551)
-------- -------- --------
Net cash provided by (used in)
financing activities 10,903 (7,696) 15,160
-------- -------- --------
Net (decrease) increase in cash and
cash equivalents (569) 7,081 (9,930)
Cash and cash equivalents at the
beginning of the year 14,267 7,186 17,116
-------- -------- --------
Cash and cash equivalents at the
end of the year $ 13,698 $ 14,267 $ 7,186
======== ======== ========
81
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Financial Institutions, Inc.:
We have audited the accompanying consolidated statements of financial condition
of Financial Institutions, Inc. and subsidiaries as of December 31, 2003 and
2002, and the related consolidated statements of income, changes in
shareholders' equity and comprehensive income, and cash flows for each of the
years in the three-year period ended December 31, 2003. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
the significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Financial
Institutions, Inc. and subsidiaries as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
As discussed in Notes 1 and 6 to the consolidated financial statements, the
Company changed its method of accounting for goodwill in 2002 upon adoption of
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets."
/s/ KPMG LLP
Buffalo, New York
February 6, 2004
82
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 9A. Controls and Procedures
As of December 31, 2003 the Company, under the supervision of its Chief
Executive Officer and Chief Financial Officer conducted an evaluation of the
effectiveness of disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended).
As part of a similar review, in early 2003, the Company identified two control
issues at a subsidiary bank that if not corrected could impact the effectiveness
of the Company's internal disclosure controls and procedures. The two areas of
concern at the subsidiary bank were disclosure controls over the timing of
problem loan identification and disclosure controls over lending to insiders
under Regulation O. Since the identification of these issues, new procedures
have been put in place to evaluate and assess the process of loan grading and
problem loan identification at each subsidiary bank. The Company has also added
credit administration and loan workout personnel at the holding company level to
improve insider loan reporting and to facilitate earlier intervention with
respect to problem loans. Based on their evaluation of the effectiveness of
disclosure controls and procedures, and following the implementation of the
above described actions, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective in
ensuring that all material information required to be filed in the Company's
periodic SEC reports is made known to them in a timely fashion. Except as
described herein, there has been no change in the Company's internal control
over financial reporting that occurred during the fourth quarter of the year
ended December 31, 2003 that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant
Certain information required by this item is incorporated by reference from the
Company's Proxy Statement for its 2004 Annual Meeting of Shareholders to be
filed with the U.S. Securities and Exchange Commission.
The Company has adopted a Code of Ethics that applies to its principal executive
officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions. The Code of Ethics is
located on the Company's internet website at www.fiiwarsaw.com. In addition, the
Company will provide a copy of the Code of Ethics to anyone, without charge,
upon request addressed to Director of Human Resources at Financial Institutions,
Inc., 220 Liberty Street, Warsaw, NY 14569. The Company intends to disclose any
amendment to, or waiver from, a provision of its Code of Ethics that applies to
the Company's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing similar
functions, and that relates to any element of the Code of Ethics definition
enumerated in Item 406 of Regulation S-K, by posting such information on the
Company's website.
The following table sets forth current information about the executive officers
of FII.
83
======================================================================================================================
Name Age Starting In Positions/Offices with FII and Subsidiaries
======================================================================================================================
Peter G. Humphrey 49 1983 Chairman of the Board, President and Chief Executive Officer of FII
(since 1994). Chairman of the Boards of Wyoming County Bank, The
National Bank of Geneva, Bath National Bank and First Tier Bank & Trust.
Director of Burke Group, Inc. and The F. I. Group, Inc.
----------------------------------------------------------------------------------------------------------------------
Jon J. Cooper 51 1997 Senior Vice President of FII. President and Chief Executive Officer of
Wyoming County Bank. Director of Wyoming County Bank.
----------------------------------------------------------------------------------------------------------------------
Douglas L. McCabe 56 2001 Senior Vice President of FII. President and Chief Executive Officer of
Bath National Bank since 1998. Director of Bath National Bank.
----------------------------------------------------------------------------------------------------------------------
Randolph C. Brown 50 1991 Senior Vice President of FII. President and Chief Executive Officer of
The National Bank of Geneva since 2003. From 1991 - 2003 was President
and CEO of First Tier Bank & Trust. Director of The National Bank of
Geneva.
----------------------------------------------------------------------------------------------------------------------
Patrick C. Burke 43 2001 Senior Vice President of FII. President and Chief Executive Officer of
The Burke Group, Inc. since 2001. Previous owner/partner of Burke
Group. Director of The Burke Group, Inc. and The FI Group, Inc.
----------------------------------------------------------------------------------------------------------------------
Gary M. Rougeau 54 1993 Senior Vice President of FII. President and Chief Executive Officer of
First Tier Bank & Trust since 2003. From 1993 to 2003 was the Sr. Loan
Administrator for First Tier Bank. Director of First Tier Bank & Trust.
----------------------------------------------------------------------------------------------------------------------
Ronald A. Miller 55 1996 Senior Vice President and Chief Financial Officer of FII. Corporate
Secretary of FII.
----------------------------------------------------------------------------------------------------------------------
Thomas D. Grover 56 2002 Senior Vice President and Chief Risk Officer of FII. From 2001 - 2002
was the Executive Director for Canisius College Center for
Entrepreneurship. From 1999 - 2001 was Executive Vice President of Fleet
Bank Small Business Services.
----------------------------------------------------------------------------------------------------------------------
Matthew T. Murtha 49 2000 Senior Vice President and Director of Marketing of FII. From 1995 - 2000
was Small Business Segment Manager at HSBC.
----------------------------------------------------------------------------------------------------------------------
Item 11. Executive Compensation
Information regarding executive compensation on pages 10 through 14 of the
Registrant's Proxy Statement for its 2004 Annual Meeting of Shareholders to be
filed with the U.S. Securities and Exchange Commission is incorporated herein by
reference thereto.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Information regarding security ownership of certain beneficial owners of the
Company's management on pages 6, 7 and 17 of the Registrant's Proxy Statement
for its 2004 Annual Meeting of Shareholders to be filed with the U.S. Securities
and Exchange Commission is incorporated herein by reference thereto.
84
The following table provides information as of December 31, 2003, regarding the
Company's equity compensation plans.
Number of Securities to be Weighted Average Number of Securities
Issued Upon Exercise of Exercise Price of Remaining Available for
Oustanding Options, Oustanding Options, Future Issuance Under
Plan Category Warrants and Rights Warrants and Rights Equity Compensation Plans
--------------------------- ----------------------------- ---------------------- -----------------------------
432,276 17.89 1,198,077
Equity Compensation Plans
Approved by Shareholders
Equity Compensation Plans
not Approved by
Shareholders -- -- --
Item 13. Certain Relationships and Related Transactions
Information regarding certain relationships and related transactions on page 16
of the Registrant's Proxy Statement for its 2004 Annual Meeting of Shareholders
to be filed with the U.S. Securities and Exchange Commission is incorporated
herein by reference thereto.
85
Item 14. Principal Accountant Fees and Services
Information regarding principal accountant fees and services and pre-approval
policies and procedures on pages 9 and 10 of the Registrant's Proxy Statement
for its 2004 Annual Meeting of Shareholders to be filed with the U.S. Securities
and Exchange Commission is incorporated herein by reference thereto.
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) List of Documents Filed as Part of this Report
(1) Financial Statements.
The financial statements listed below and the Independent
Auditors' Report are included in this Annual Report on Form
10-K:
Independent Auditors' Report
Consolidated Statements of Financial Condition as of
December 31, 2003 and 2002
Consolidated Statements of Income for the years ended
December 31, 2003, 2002 and 2001
Consolidated Statements of Changes in Shareholders'
Equity and Comprehensive Income for the years ended
December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows the years ended
December 31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements
(2) Schedules.
All schedules are omitted since the required information is
either not applicable, not required, or is contained in the
respective financial statements or in the notes thereto.
86
(3) Exhibits.
The following is a list of all exhibits filed or incorporated
by reference as part of this Registration Statement.
Exhibit No. Description Location
------------- -------------------------------------------- -----------------------------------
1.1 Term and Revolving Credit Loan Agreements Filed Herewith
between the Company and M&T Bank, dated
December 15, 2003
3.1 Amended and Restated Certificate of Contained in Exhibit 3.1 of the
Incorporation Registrant's Registration Statement
on Form S-1 dated June 25, 1999
(File No. 333-76865)
(The "S-1 Registration Statement")
3.2 Amended and Restated Bylaws dated Contained in Exhibit 3.2 of the Form 10-K
May 23 ,2001 for the year ended December 31, 2001
dated March 11, 2002
3.3 Amended and Restated Bylaws dated Filed Herewith
February 18, 2004
10.1 1999 Management Stock Incentive Plan Contained in Exhibit 10.1
of the S-1 Registration Statement
10.2 1999 Directors Stock Incentive Plan Contained in Exhibit 10.2
of the S-1 Registration Statement
11 Statement of Computation of Per Share Earnings Contained in Note 14 of the
Registrant's Consolidated
Financial Statements Under
Item 8 Filed Herewith
21 Subsidiaries of Financial Institutions, Inc. Filed Herewith
23 Independent Accountants' Consent Filed Herewith
24 Power of Attorney Filed Herewith
31.1 Certification of Annual Report on Form 10-K Filed Herewith
pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 -CEO
31.2 Certification of Annual Report on Form 10-K Filed Herewith
pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 -CFO
32.1 Certification of Annual Report on Form 10-K Filed Herewith
pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 -CEO
32.2 Certification of Annual Report on Form 10-K Filed Herewith
pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 -CFO
(b) Reports on Form 8-K
The Company furnished a Current Report on Form 8-K dated October 16, 2003
relating to a press release to announce the Company's third quarter 2003
financial results.
87
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
FINANCIAL INSTITUTIONS, INC.
Date: March 12, 2004 By: /s/ Peter G. Humphrey
------------------------------------
Peter G. Humphrey
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, the
following persons on behalf of the Registrant and in the capacities and on the
date indicated have signed this report below.
Signatures Title Date
---------- ----- ----
/s/ Peter G. Humphrey President, Chief Executive Officer March 12, 2004
------------------------------- (Principal Executive Officer),
Peter G. Humphrey Chairman of the Board and Director
/s/ Ronald A. Miller Senior Vice President and March 12, 2004
------------------------------- Chief Financial Officer
Ronald A. Miller (Principal Accounting Officer)
* Director March 12, 2004
-------------------------------
John E. Benjamin
* Director and Senior Vice President March 12, 2004
-------------------------------
Jon J. Cooper
* Director March 12, 2004
-------------------------------
Barton P. Dambra
* Director March 12, 2004
-------------------------------
Samuel M. Gullo
* Director March 12, 2004
-------------------------------
Pamela Davis Heilman
Director March 12, 2004
-------------------------------
Joseph F. Hurley
* Director March 12, 2004
-------------------------------
Susan R. Holliday
* Director March 12, 2004
-------------------------------
W.J. Humphrey, Jr.
* Director March 12, 2004
-------------------------------
James E. Stitt
* Director March 12, 2004
-------------------------------
John R. Tyler, Jr.
* Director March 12, 2004
-------------------------------
James H. Wyckoff
* The undersigned, acting pursuant to a power of attorney, has signed this
Annual Report on Form 10-K for and on behalf of the persons indicated
above as such persons' true and lawful attorney-in-fact and their names,
places and stead, in the capacities and on the date indicated above.
/s/ Ronald A. Miller
-------------------------------
Ronald A. Miller
Attorney-in-fact
88