UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

(Mark One)Form 10-K

 

 

(Mark One)

x[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year endedDecember 31, 20132015

OR

¨[  ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                            to                            

Commission file number000-26481

 

 

FINANCIAL INSTITUTIONS, INC.

(Exact name of registrant as specified in its charter)

 

 

NEW YORK  16-0816610

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

220 LIBERTY STREET, WARSAW, NEW YORK  14569
(Address of principal executive offices)  (ZIP Code)

Registrant’s telephone number, including area code:    (585) 786-1100

Securities registered under Section 12(b) of the Exchange Act:

 

Securities registered under Section 12(b) of the Exchange Act:

Title of each class  Name of exchange on which registered
Common stock, par value $.01 per share  NASDAQ Global Select Market

Securities registered under Section 12(g) of the Exchange Act:                NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.         Yes ¨    No xþ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes ¨    No xþ

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 past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                                                                                  Yesxþ    No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).        Yes xþ    No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements

incorporated by reference in Part III of this form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer¨ ¨  Accelerated filerxþ
Non-accelerated filer¨ ¨  Smaller reporting company¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).        Yes ¨    No xþ

The aggregate market value of the registrant’s common stock, par value $0.01 per share, held by non-affiliates of the registrant, as computed by reference to the June 30, 20132015 closing price reported by NASDAQ, was approximately $236,055,000.$340,191,000.

As of February 28, 2014,29, 2016, there were outstanding, exclusive of treasury shares, 13,848,25814,485,883 shares of the registrant’s common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s proxy statement for the 20142016 Annual Meeting of Shareholders are incorporated by reference in Part III of this Annual Report on Form 10-K.


TABLE OF CONTENTS

TABLE OF CONTENTS                  
PART I  PAGE
Item 1.    

Business

      4
Item 1A.    

Risk Factors

    1718
Item 1B.    

Unresolved Staff Comments

    2526
Item 2.    

Properties

    2526
Item 3.    

Legal Proceedings

    2526
Item 4.    

Mine Safety Disclosures

    2526
PART II  
Item 5.    

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

    2627
Item 6.    

Selected Financial Data

    28
Item 7.    

Management’s Discussion and Analysis of Financial Condition and Results of Operations

    3233
Item 7A.    

Quantitative and Qualitative Disclosures About Market Risk

    57
Item 8.    

Financial Statements and Supplementary Data

    60
Item 9.    

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

  115118
Item 9A.    

Controls and Procedures

  115118
Item 9B.    

Other Information

  115118
PART III  
Item 10.    

Directors, Executive Officers and Corporate Governance

  116119
Item 11.    

Executive Compensation

  116119
Item 12.    

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

  116119
Item 13.    

Certain Relationships and Related Transactions, and Director Independence

  117119
Item 14.    

Principal Accounting Fees and Services

  117119
PART IV  
Item 15.    

Exhibits and Financial Statement Schedules

  118120
    

Signatures

  121123


PART I

FORWARD LOOKING INFORMATION

Statements in this Annual Report on Form 10-K that are based on other than historical data are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations or forecasts of future events and include, among others:

 

statements with respect to the beliefs, plans, objectives, goals, guidelines, expectations, anticipations, and future financial condition, results of operations and performance of Financial Institutions, Inc. (the “parent”“Parent” or “FII”) and its subsidiaries (collectively the “Company,” “we,” “our,” “us”); and

 

statements preceded by, followed by or that include the words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “projects,” or similar expressions.

These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. Forward-looking statements involve significant risks and uncertainties and actual results may differ materially from those presented, either expressed or implied, in this Annual Report on Form 10-K, including, but not limited to, those presented in the Management’s Discussion and Analysis of Financial Condition and Results of Operations. Factors that might cause such material differences include, but are not limited to:

 

If we experience greater credit losses than anticipated, earnings may be adversely impacted;

Our tax strategies and the value of our deferred tax assets could adversely affect our operating results and regulatory capital ratios;

Geographic concentration may unfavorably impact our operations;

We depend on the accuracy and completeness of information about or from customers and counterparties;

Our insurance brokerage subsidiary, SDN, is subject to risk related to the insurance industry;

We are subject to environmental liability risk associated with our lending activities;

Commercial real estate and business loans increase our exposure to credit risks;

Our indirect lending involves risk elements in addition to normal credit risk;

We accept deposits that do not have a fixed term and which may be withdrawn by the customer at any time for any reason;

Any future FDIC insurance premium increases may adversely affect our earnings;

We are highly regulated and may be adversely affected by changes in banking laws, regulations and regulatory practices;

The new Basel III Capital Standards may have an adverse effect on us;

New regulations could adversely impact our earnings due to, among other things, increased compliance costs or costs due to noncompliance;

New or changing tax accounting, and regulatoryaccounting rules and interpretations could significantly impact our strategic initiatives, results of operations, cash flows, and financial condition;

Legal and regulatory proceedings and related matters could adversely affect us and banking industry in general;

A breach in security of our or third party information systems, including the occurrence of a cyber incident or a deficiency in cyber security, may subject us to liability, result in a loss of customer business or damage to our brand image;

We face competition in staying current withtechnological changes to compete and meet customer demands;

We rely on other companies to provide key components of our business infrastructure;

We use financial models for business planning purposes that may not adequately predict future result;results;

We may not be able to attract and retain skilled people and our ongoing leadership transition may be unsuccessful;people;

Acquisitions may disrupt our business and dilute shareholder value;

We are subject to interest rate risk;

Our business may be adversely affected by conditions in the financial markets and economic conditions generally;

Our earnings are significantly affected by theThe fiscal and monetary policies of the federal government and its agencies;agencies have a significant impact on our earnings;

The soundness of other financial institutions could adversely affect us;

WeThe value of our goodwill and other intangible assets may be requireddecline in the future;

A potential proxy contest for the election of directors at our annual meeting or proposals arising out of shareholder initiatives could cause us to recognize an impairment of goodwill:incur substantial costs and negatively affect our business;

We operate in a highly competitive industry and market area;

Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business;

Liquidity is essential to our businesses;

We may need to raise additional capital in the future and such capital may not be available on acceptable terms or at all;

We rely on dividends from our subsidiaries for most of our revenue;

We may not pay or may reduce the dividends on our common stock;

We may issue debt and equity securities or securities convertible into equity securities, any of which may be senior to our common stock as to distributions and in liquidation, which couldcoulddilute our current shareholders or negatively affect the value of our common stock;

Our certificate of incorporation, our bylaws, and certain banking laws may have an anti-takeover effect; and

The market price of our common stock may fluctuate significantly in response to atoa number of factors; andfactors.

 

Our certificate of incorporation, our bylaws, and certain banking laws contain anti-takeover provisions.

- 3 -


We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advise readers that various factors, including those described above, could affect our financial performance and could cause our actual results or circumstances for future periods to differ materially from those anticipated or projected. See also Item 1A, Risk Factors, inof this Annual Report on Form 10-K for further information. Except as required by law, we do not undertake, and specifically disclaim 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 -ITEM 1.    BUSINESS


ITEM 1.BUSINESS

GENERAL

Financial Institutions, Inc., (the “Company”) is a financial holding company organized in 1931 under the laws of New York State (“New York” or “NYS”), and through its wholly-owned. The principal office of the Company is located at 220 Liberty Street, Warsaw, New York chartered14569 and its telephone number is (585) 786-1100. The Company was incorporated on September 15, 1931, but the continuity of its banking subsidiary, Five Starbusiness is traced to the organization of the National Bank Financial Institutions, Inc. offers a broad array of deposit, lendingGeneva on March 28, 1817. Except as the context otherwise requires, the Company and other financial servicesits direct and indirect subsidiaries are collectively referred to individuals, municipalities and businesses in Western and Central New York. We have also expanded our indirect lending network to include relationships with franchised automobile dealers in the Capital District of New York and Northern Pennsylvania. All references in this Annual Report on Form 10-K toreport as the parent are to Financial Institutions, Inc. (“FII”). Unless otherwise indicated, or unless the context requires otherwise, all references in this Annual Report on Form 10-K to “the Company,“Company. “we,” “our” or “us” means Financial Institutions, Inc. and its subsidiaries on a consolidated basis. Five Star Bank is referred to as Five Star Bank, “FSB” or “the Bank”. FIIBank,” and Scott Danahy Naylon, LLC is referred to as “SDN.” The consolidated financial statements include the accounts of the Company, the Bank and SDN. The Company’s common stock is traded on the NASDAQ Global Select Market under the ticker symbol “FISI.”

At December 31, 2015, the Company had consolidated total assets of $3.38 billion, deposits of $2.73 billion and shareholders’ equity of $293.8 million.

The Company’s primary business is the operation of its subsidiaries. It does not engage in any other substantial business activities. At December 31, 2015, the Company had two direct wholly-owned subsidiaries: (1) the Bank, which provides a full range of banking services to consumer, commercial and municipal customers in Western and Central New York; and (2) SDN, which sells various premium-based insurance policies on a commission basis to commercial and consumer customers. At December 31, 2015, the Bank represented 99.3% and SDN represented 0.6% of the consolidated assets of the Company. Further discussion of our segments is included in Note 20 to the Company’s Consolidated Financial Statements included under Item 8 of this Annual Report on Form 10-K.

Five Star Bank

The Bank is a legal entity, separate and distinct fromNew York chartered bank that has its subsidiaries, assisting those subsidiaries by providing financial resources and oversight. Our executive offices are locatedheadquarters at 220 Liberty55 North Main Street, Warsaw, NY, and a total of 50 full-service banking offices in the New York.York State counties of Allegany, Cattaraugus, Cayuga, Chautauqua, Chemung, Erie, Genesee, Livingston, Monroe, Ontario, Orleans, Seneca, Steuben, Wyoming and Yates counties.

During late 2013, ourAt December 31, 2015, the Bank had total assets of $3.36 billion, investment securities of $1.03 billion, net loans of $2.06 billion, deposits of $2.74 billion and shareholders’ equity of $302.6 million, compared to total assets of $3.07 billion, investment securities of $916.9 million, net loans of $1.88 billion, deposits of $2.46 billion and shareholders’ equity of $256.3 million at December 31, 2014. The Bank offers deposit products, which include checking and NOW accounts, savings accounts, and certificates of deposit, as its principal source of funding. The Bank’s deposits are insured up to the maximum permitted by the Bank Insurance Fund (the “Insurance Fund”) of the Federal Deposit Insurance Corporation (“FDIC”). The Bank offers a variety of loan products to its customers, including commercial and consumer loans and commercial and residential mortgage loans.

Scott Danahy Naylon, LLC

Acquired in August 2014, SDN is a full-service insurance agency founded in 1923 and headquartered in Amherst, NY. SDN offers personal, commercial and financial services products and serves over 6,000 clients in 44 states. For the year ended December 31, 2015, SDN had total revenue of $5.0 million.

SDN’s primary market area is Erie and Niagara counties in New York State. Most lines of personal insurance are provided, including automobile, homeowners, boat, recreational vehicle, landlord, and umbrella coverage. Commercial insurance products are also provided, consisting of property, liability, automobile, inland marine, workers compensation, bonds, crop and umbrella insurance. SDN also provides the following financial services products: life and disability insurance, Medicare supplements, long-term care, annuities, mutual funds, retirement programs and New York State disability.

Courier Capital

Acquired in January 2016, Courier Capital, LLC is an SEC-registered investment advisory and wealth management firm based in Western New York, with offices in Buffalo and Jamestown. With $1.2 billion in assets under management, Courier Capital offers customized investment management, investment consulting and retirement plan services to over 1,100 individuals, businesses and institutions.

- 4 -


Other Subsidiaries

In addition to the Bank and SDN, the Company had the following indirect wholly-owned subsidiary as of December 31, 2015:

Five Star Investment Services,REIT, Inc. (“FSIS”) ceased operations as an active broker-dealer and the securities licenses of advisors associated with FSIS who elected to transfer, as well as their respective client accounts which had previously cleared through a third-party platform, were transferred to the LPL Financial (“LPL”) clearing platform. Following the completion of these transfer activities, FSB began offering investment and securities-related services, including brokerage and investment advice through a strategic partnership with LPL. FSB has employees who are LPL registered representatives, located throughout its branch network, offering customers insurance and investment products including stocks, bonds, mutual funds, annuities, and managed accounts through a program called Five Star Investment Services. FSIS withdrew its registration withREIT, Inc., a wholly-owned subsidiary of the Financial Industry Regulatory Authority (“FINRA”) effective December 31, 2013,Bank, operates as a real estate investment trust that holds residential mortgages and is expected to be dissolved in 2014.commercial real estate loans. Five Star REIT provides additional flexibility and planning opportunities for the business of the Bank.

Our Business Strategy

Our business strategy has been to maintain a community bank philosophy, which consists of focusing on and understanding the individualized banking and other financial services needs of individuals, municipalities and businesses of the local communities surrounding our banking centers.primary service area. We believe this focus allows us to be more responsive to our customers’ needs and provide a high level of personal service that differentiates us from larger competitors, resulting in long-standing and broad basedbroad-based banking relationships. Our core customers are primarily comprised of small- to medium-sized businesses, individuals and community organizations who prefer to build a banking, relationshipinsurance and wealth management relationships with a community bank that offers and combines high quality, competitively-priced banking products and services with personalized service. Because of our identity and origin as a locally operated bank, we believe that our level of personal service provides a competitive advantage over larger banks, which tend to consolidate decision-making authority outside local communities.

A key aspect of our current business strategy is to foster a community-oriented culture where our customers and employees establish long-standing and mutually beneficial relationships. We believe that we are well-positioned to be a strong competitor within our market area because of our focus on community banking needs and customer service, our comprehensive suite of deposit, loan, insurance and loanwealth management products typically found at larger banks, our highly experienced management team and our strategically located banking centers. AWe believe that the foregoing factors all help to grow our core deposits, which supports a central partelement of our business strategy is generating core deposits to support- the growth of a diversified and high-quality loan portfolio.

Acquisition Strategy

We will continue to explore market expansion opportunities in or near our current market areas as opportunities arise. Our primary focus will be on increasing market share within existing markets, while taking advantage of potential growth opportunities within our insurance and wealth management lines of business by acquiring new businesses that can be added to existing operations. We believe our capital position remains strong enough to support an active merger and acquisition strategy, and expansion of our core financial service businesses of banking, insurance and wealth management. Consequently, we continue to explore acquisition opportunities in these activities. In evaluating acquisition opportunities, we will balance the potential for earnings accretion with maintaining adequate capital levels, which could result in our common stock being the predominate form of consideration and/or the need for us to raise capital.

Conversations with potential strategic partners are occurring on a regular basis. The evaluation of any potential opportunity will favor a transaction that complements our core competencies and strategic intent, with a lesser emphasis being placed on geographic location or size. Additionally, we remain committed to maintaining a diversified revenue stream. Our senior management team has had extensive experience in acquisitions and post-acquisition integration of operations, and is prepared to act quickly should a potential opportunity arise, but will remain disciplined with its approach. We believe this experience positions us to successfully acquire and integrate additional financial services and banking businesses.

MARKET AREAS AND COMPETITION

We provide a wide range of banking and financial services to individuals, municipalities and businesses through a network of over 50 offices and an extensive ATM network in fifteen contiguous counties ofthroughout Western and Central New York:York. The region includes the counties of Allegany, Cattaraugus, Cayuga, Chautauqua, Chemung, Erie, Genesee, Livingston, Monroe, Ontario, Orleans, Schuyler, Seneca, Steuben, Wyoming and Yates counties. Our banking activities, though concentrated in the communities where we maintain branches, also extend into neighboring counties. In addition, we have expanded our consumer indirect lending presence to the Capital District of New York and Northern and Central Pennsylvania.

Our market area is economically diversified in that we serve both rural markets and the larger more affluent markets of suburbanin and around Rochester and suburban Buffalo. Rochester and Buffalo are the two largest metropolitan areas in New York outside of New York City, with a combined metropolitan areapopulation of over two million people. We anticipate continuing to increase our presence in and around these metropolitan statistical areas in the coming years.

- 5 -


We face significant competition in both making loans and attracting deposits, as both Western and Central New York have a high density of financial institutions. Our 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. Our most direct competition for deposits has historically come from commercial banks, savings banks and credit unions. We face additional competition for deposits from non-depository competitors such as the mutual fund industry, securities and brokerage firms and insurance companies. We generally compete with other financial service providers on factors such as:as level of customer service, responsiveness to customer needs, availability and pricing of products, and geographic location. Our industry frequently experiences merger activity, which affects competition by eliminating some institutions while potentially strengthening the franchises of others.

- 4 -


The following table presents the Bank’s market share percentage for total deposits as of June 30, 2013,2015, in each county where we have operations. The table also indicates the ranking by deposit size in each market. All information in the table was obtained from SNL Financial of Charlottesville, Virginia, which compiles deposit data published by the FDIC as of June 30, 20132015 and updates the information for any bank mergers and acquisitions completed subsequent to the reporting date.

 

County

  Market
Share
  Market
Rank
   Number of
Branches (1)
 

Allegany

   8.2  3     1  

Cattaraugus

   24.6  2     5  

Cayuga

   3.1  11     1  

Chautauqua

   1.2  9     1  

Chemung

   15.0  3     3  

Erie

   0.4  11     3  

Genesee

   21.6  3     4  

Livingston

   32.3  1     5  

Monroe

   1.3  10     5  

Ontario

   13.6  2     5  

Orleans

   24.5  1     2  

Seneca

   20.7  3     2  

Steuben

   27.5  1     7  

Wyoming

   48.7  1     4  

Yates

   38.3  1     2  

(1)Number of branches current as of December 31, 2013.

County

     Market    
Share
     Market    
Rank
   Number of  
Branches(1)
  

Allegany

   7.4%   3    1  

Cattaraugus

   28.1%   2    5  

Cayuga

   3.3%   10    1  

Chautauqua

   1.2%   8    1  

Chemung

   14.4%   3    3  

Erie

   0.4%   10    3  

Genesee

   21.7%   3    3  

Livingston

   37.0%   1    5  

Monroe

   1.4%   10    6  

Ontario

   13.9%   2    5  

Orleans

   23.5%   2    2  

Seneca

   24.6%   2    2  

Steuben

   27.9%   1    7  

Wyoming

   53.8%   1    4  

Yates

   43.6%   1    2  

 

(1)    Number of branches current as of December 31, 2015.

INVESTMENT ACTIVITIES

Our investment policy is contained within our 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, we consider the ability of an investment to provide earnings consistent with factors ofrelated to quality, maturity, marketability, pledgeable nature and risk diversification. Our Treasurer, guided by our Asset-Liability Committee (“ALCO”), is responsible for investment portfolio decisions within the established policies.

Our investment securities strategy centersis focused on providing liquidity to meet loan demand and redeeming liabilities, meeting pledging requirements, managing credit risks, managing overall interest rate risks and maximizing portfolio yield. Our current policy generally limits security purchases to the following:

 

U.S. treasury securities;

 

U.S. government agency securities, which are securities issued by official Federal government bodies (e.g., the Government National Mortgage Association (“GNMA”) and the Small Business Administration (“SBA”)), and U.S. government-sponsored enterprise (“GSE”) securities, which are securities issued by independent organizations that are in part sponsored by the federal government (e.g., the Federal Home Loan Bank (“FHLB”) system, the Federal National Mortgage Association (“FNMA”), the Federal Home Loan Mortgage Corporation (“FHLMC”), the Small Business Administration (“SBA”) and the Federal Farm Credit Bureau);

 

Mortgage-backed securities (“MBS”) include mortgage-backed pass-through securities, (“pass-throughs”), collateralized mortgage obligations (“CMO”) and DUS (delegated underwriting & servicing)multi-family MBS issued by GNMA, FNMA and FHLMC;

 

Investment grade municipal securities, including revenue, tax and bond anticipation notes, statutory installment notes and general obligation bonds;

 

Certain creditworthy un-rated securities issued by municipalities;

 

Certificates of deposit;

 

Equity securities at the holding company level; and

 

Limited partnership investments.

 

- 56 -


LENDING ACTIVITIES

General

We offer a broad range of loans including commercial business and revolving lines of credit, commercial mortgages, equipment loans, residential mortgage loans and home equity loans and lines of credit, home improvement loans, automobile loans and personal loans. Newly originated and refinanced fixed rate residential mortgage loans are either retained in our portfolio or sold to the secondary market with servicing rights retained.

We continually evaluate and update our lending policy. The key elements of our lending philosophy include the following:

 

To ensure consistent underwriting, employees must share a common view of the risks inherent in lending activities as well as the standards to be applied in underwriting and managing credit risk;

 

Pricing of credit products should be risk-based;

 

The loan portfolio must be diversified to limit the potential impact of negative events; and

 

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.

Commercial Business and Commercial Mortgage Lending

We originate commercial business loans in our primary market areas and underwrite them based on the borrower’s ability to service the loan from operating income. We offer 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. CommercialWe offer commercial business loans are offered to customers in the agricultural industry for short-term crop production, farm equipment and livestock financing. As a general practice, where possible, a first position collateral lien is placed on any available real estate, equipment or other assets owned by the borrower and a personal guarantee of the owner is obtained. As of December 31, 2013, $86.72015, $102.9 million, or 33%, of our aggregate commercial business loan portfolio were at fixed rates, while $179.1$210.8 million, or 67%, were at variable rates.

We also offer commercial mortgage loans to finance the purchase of real property, which generally consists of real estate with completed structures and, to a smaller extent, agricultural real estate financing. Commercial mortgage loans are secured by first liens on the real estate and are typically amortized over a 10 to 20 year period. The underwriting analysis includes credit verification, appraisals and a review of the borrower’s financial condition and repayment capacity. As of December 31, 2013, $187.52015, $238.0 million, or 40%42%, of the loans in our aggregate commercial mortgage portfolio were at fixed rates, while $281.8$328.1 million, or 60%58%, were at variable rates.

We utilize government loan guarantee programs where available and appropriate.

Government Guarantee Programs

We participate in government loan guarantee programs offered by the SBA, U.S. Department of Agriculture, Rural Economic and Community Development and Farm Service Agency, among others. As of December 31, 2013,2015, we had loans with an aggregate principal balance of $56.6$54.3 million that were covered by guarantees under these programs. The guarantees typically only cover a certain percentage of these loans. By participating in these programs, we are able to broaden our base of borrowers while minimizing credit risk.

Residential Mortgage Lending

We originate fixed and variable rate one-to-four family residential mortgages collateralized by owner-occupied properties located in our market areas. We offer a variety of real estate loan products, which are generally amortized over periods of up to 30 years. 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. We sell certain one-to-four family residential mortgages to the secondary mortgage market and typically retain the right to service the mortgages. To assure maximum salability of the residential loan products for possible resale, we typically follow the underwriting and appraisal guidelines of the secondary market, including the FHLMC and the FHA,Federal Housing Administration, and service the loans in a manner that satisfies the secondary market agreements. As of December 31, 2013,2015, our residential mortgage servicing portfolio totaled $237.9$196.0 million, the majority of which has been sold to the FHLMC. As of December 31, 2013,2015, our residential mortgage loan portfolio totaled $113.0$98.3 million, or 6%5% of our total loan portfolio. We do not engage in sub-prime or other high-risk residential mortgage lending as a line-of-business.

 

- 67 -


Consumer Lending

We offer a variety of loan products to our consumer customers, including home equity loans and lines of credit, automobile loans, secured installment loans and various other types of secured and unsecured personal loans. At December 31, 2013,2015, outstanding consumer loan balances were concentrated in indirect automobile loans and home equity products.products, which represented 61% and 37% of our outstanding consumer loan balances, respectively.

We originate indirect consumer loans for a mix of new and used vehicles through franchised new car dealers. The consumer indirect loan portfolio is primarily comprised of loans with terms that typically range from 36 to 84 months. We have expanded ourdeveloped relationships with franchised new car dealers in Western, Central and the Capital District of New York, and Northern and Central Pennsylvania. As of December 31, 2013,2015, our consumer indirect portfolio totaled $636.4$676.9 million, or 35%33% of our total loan portfolio. The consumer indirect loan portfolio is primarily consists of fixed rate loans with relatively short durations.

We also originate, independently of the indirect loans described above, consumer automobile loans, recreational vehicle loans, boat loans, home improvement loans, closed-end home equity loans, home equity lines of credit, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 180240 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. As of December 31, 2013, $201.32015, $286.5 million, or 62%70%, of our home equity portfolio was at fixed rates, while $124.8 million, or 38%, was at variable rates. Approximately 76% of the loans in our home equity portfolio arewere at fixed rates, while $123.6 million, or 30%, were at variable rates. Approximately 82% of the loans in our home equity portfolio were in first lien positions at December 31, 2013.2015. The other loans in our consumer portfolio totaled $23.1$18.5 million as of December 31, 2013,2015, all but $1.1 million$895 thousand of which were fixed rate loans.

Credit Administration

Our loan policy establishes standardized underwriting guidelines, as well as the loan approval process and the committee structures necessary to facilitate and ensure the highest possible loan quality decision-making in a timely and businesslike manner. The policy establishes requirements for extending credit based on the size, risk rating and type of credit involved. The policy also sets limits on individual loan officer lending authority and various forms of joint lending authority, while designating which loans are required to be approved at the committee level.

Our credit objectives are as follows:to:

 

Compete effectively and service the legitimate credit needs of our target market;

 

Enhance our reputation for superior quality and timely delivery of products and services;

 

Provide pricing that reflects the entire relationship and is commensurate with the risk profiles of our borrowers;

 

Retain, develop and acquire profitable, multi-product, value added relationships with high quality borrowers;

 

Focus on government guaranteed lending and establish a specializationspecialize in this area to meet the needs of the small businesses in our communities; and

 

Comply with theall relevant laws and regulations.

Our policy includes loan reviews, under the supervision of theour Audit and Risk Oversight committees of the Board of Directors and directed by our Chief Risk Officer, in order to render an independent and objective evaluation of our asset quality and credit administration process.

RiskWe assign risk ratings are assigned to loans in the commercial business and commercial mortgage portfolios. TheWe use those risk ratings are specifically used as follows:to:

 

Profile the risk and exposure in the loan portfolio and identify developing trends and relative levels of risk;

 

Identify deteriorating credits;

 

Reflect the probability that a given customer may default on its obligations; and

 

Assist with risk-based pricing.

Through the loan approval process, loan administration and loan review program, management seeks to continuously monitor our credit risk profile and assesses the overall quality of the loan portfolio and adequacy of the allowance for loan losses.

We have several procedures in place to assist in maintaining the overall quality of our loan portfolio. Delinquent loan reports are monitored by credit administration to identify adverse levels and trends. Loans, including impaired loans, are generally classified as non-accruing if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-collateralized and in the process of collection. Loans that are on a current payment status or past due less than 90 days may also be classified as non-accruing if repayment in full of principal and/or interest is uncertain.

 

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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 factors such as:

 

Specific allocations for individually analyzed credits;

 

Risk assessment process;

 

Historical net charge-off experience;

 

Evaluation of loss emergence and look-back periods;

Evaluation of the loan portfolio with loan reviews;

 

Levels and trends in delinquent and non-accruing loans;

 

Trends in volume and terms of loans;

 

Effects of changes in lending policy;

 

Experience, ability and depth of management;

 

National and local economic trends and conditions;

 

Concentrations of credit;

 

Interest rate environment;

 

Customer leverage;

 

Information (availability of timely financial information); and

 

Collateral values.

Our methodology in the estimation offor estimating the allowance for loan losses includes the following:

 

1.

Impaired commercial business and commercial mortgage loans, generally in excess of $50 thousand are reviewed individually and assigned a specific loss allowance, if considered necessary, in accordance with U.S. generally accepted accounting principles (“GAAP”).

 

2.

The remaining portfolios of commercial business and commercial mortgage loans are segmented by risk rating into the following loan classification categories: uncriticized or pass, special mention, substandard and doubtful. Uncriticized loans, special mention loans, substandard loans and all doubtful loans not assigned a specific loss allowance are assigned allowance allocations based on historical net loan charge-off experience for each of the respective loan categories, supplemented with additional reserve amounts, if considered necessary, based upon loss emergence periods and qualitative factors. These qualitative factors include the levels and trends in delinquent and non-accruing loans, trends in volume and terms of loans, effects of changes in lending policy, experience, ability, and depth of management, national and local economic trends and conditions, concentrations of credit, interest rate environment, customer leverage, information (availability of timely financial information), and collateral values, among others.

 

3.

The retail loan portfolio is segmented into the following types of loans: residential real estate,mortgage, home equity (home equity loans and lines of credit), consumer indirect and other consumer. Allowance allocations for the real estate relatedretail loan portfolios (residential and home equity)portfolio are based on the average loss experience for the previous eight quarters, supplemented with loss emergence periods and qualitative factors similar to the elements described above. Allowance allocations for the consumer indirect and other consumer portfolios are based on vintage analyses performed with historical loss experience at 36 months and 24 months aging, respectively. The allocations on these portfolios are also supplemented with qualitative factors.

Management presents a quarterly review of the adequacy of the allowance for loan losses to the Audit Committee of our Board of Directors based on the methodology described above. See also the section titled “Allowance for Loan Losses” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K.

 

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SOURCES OF FUNDS

Our primary sources of funds are deposits, borrowed funds, scheduled amortization and prepayments of principal from loans and mortgage-backed securities, maturities and calls of investment securities and funds provided by operations.

Deposits

We maintain a full range of deposit products and accounts to meet the needs of the residents and businesses in our primary service area. Products include an array of checking and savings account programs for individuals and businesses, including money market accounts, certificates of deposit, sweep investment capabilities as well as Individual Retirement Accounts and other qualified plan accounts. We rely primarily on competitive pricing of our deposit products, customer service and long-standing relationships with customers to attract and retain these deposits and seek to make our services convenient to the community by offering 24-hour ATM access at somea choice of our facilities, access to other ATM networks available at other local financial institutionsseveral delivery systems and retail establishments,channels, including telephone, mail, online, automated teller machines (ATMs), debit cards, point-of-sale transactions, automated clearing house transactions (ACH), remote deposit, and mobile banking via telephone banking services including account inquiry and balance transfers.or wireless devices. We also take advantage of the use of technology by allowing ouroffering business customers banking access via the Internet and various advanced systems for cash management for our business customers.systems.

We had no traditional brokered deposits at December 31, 2013;2015; however, we do participate in the Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) programs, which enable depositors to receive FDIC insurance coverage for deposits otherwise exceeding the maximum insurable amount. Through these programs, deposits in excess of the maximum insurable amount are placed with multiple participating financial institutions. Reciprocal CDARS deposits and ICS deposits totaled $61.3$92.9 million and $56.4$146.6 million, respectively, at December 31, 2013.2015.

Borrowings

We have access to a variety of borrowing sources and use both short-term and long-term borrowings to support our asset base. Borrowings from time-to-time include federal funds purchased, securities sold under agreements to repurchase, FHLB advances and borrowings from the discount window of the FRB. We also offer customers a deposit account that sweeps balances in excess of an agreed upon target amount into overnight repurchase agreements.

OPERATING SEGMENTS

Our onlyAs of December 31, 2015 we had two reportable operating segments, banking and insurance, which are delineated by the subsidiaries of Financial Institutions, Inc. as of December 31, 2015. The banking segment isincludes all of the Company’s retail and commercial banking operations. The insurance segment includes the activities of SDN, a full service insurance agency that provides a broad range of insurance services to both personal and business clients. The Company operated as one business segment until the acquisition of SDN on August 1, 2014, at which time the new “Insurance” segment was created for financial reporting purposes.

For a discussion of the segments included in our subsidiary bank, FSB.principal activities and certain financial information for each segment, see Note 20, Business Segments, of the notes to consolidated financial statements included in this Annual Report on Form 10-K.

OTHER INFORMATION

We also make available, free of charge, through our website, all reports filed with the SEC, including our Annual Reports 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. These filings may be viewed by accessing theCompany Filingssubsection of theSEC Filings section under theInvestor Relations tab on our website (www.fiiwarsaw.com). Information available on our website is not a part of, and is not incorporated into, this Annual Report on Form 10-K.

All of the reports we file with the SEC, including this Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as well as any amendments thereto may be accessed atwww.sec.gov or at the public reference facility maintained by the SEC at its public reference room at 100 F. Street, N.E., Room 1580, 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.

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SUPERVISION AND REGULATION

The Company and our subsidiaries are subject to an extensive system of lawsregulation under federal and regulations that arestate laws. The regulatory framework is intended primarily for the protection of customersdepositors, federal deposit insurance funds and depositorsthe banking system as a whole and not for the protection of our security holders. Theseshareholders and creditors.

We are also subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the Securities and Exchange Commission (“SEC”). Our common stock is listed on the NASDAQ Global Select Market (“NASDAQ”) under the trading symbol “FISI” and is subject to NASDAQ rules for listed companies.

Significant elements of the laws and regulations govern such areas as capital, permissible activities, allowance for loan losses, loansapplicable to the Company and investments, and rates of interest that can be charged on loans. Described belowits subsidiaries are elements of selected laws and regulations.described below. The descriptions are not intended to be complete and aredescription is qualified in theirits entirety by reference to the full text of the statutes, regulations and policies that are described. Also, such statutes, regulations described.and policies are continually under review by Congress, state legislatures, and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to the Company and its subsidiaries could have a material effect on the business, financial condition and results of operations of the Company.

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Holding Company Regulation.   As a bank holding company and financial holding company, weWe are subject to comprehensive regulation by the Board of Governors of the Federal Reserve System, frequently referred to as the Federal Reserve Board (“FRB”), under the Bank Holding Company Act (the “BHC Act”), as amended by, among other laws, the Gramm-Leach-Bliley Act of 1999 (the “Gramm-Leach-Bliley Act”), and by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted in 2010. We are registered with the Federal Reserve as a bank holding company (“BHC”) and have elected to be treated as a financial holding company under the BHC Act. We must file reports with the FRB and such additional information as the FRB may require, and our holding company and non-banking affiliates are subject to examination by the FRB. Under FRB policy, a bank holding company must serve as a source of strength for its subsidiary banks. Under this policy, the FRB may require, and has required in the past, a holding company to contribute additional capital to an undercapitalized subsidiary bank. The BHC Act provides that a bank holding company must obtain FRB approval before:

 

Acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares);

 

Acquiring all or substantially all of the assets of another bank or bank holding company, or

 

Merging or consolidating with another bank holding company.

The BHC Act generally prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by FRB regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the FRB includes, among other things: lending; operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers’ checks and United States Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers. These activities may also be affected by federal legislation.

The Gramm-Leach-Bliley Act amended portions of the BHC Act to authorize bank holding companies, such as us, directly or through non-bank subsidiaries to engage in securities, insurance and other activities that are financial in nature or incidental to a financial activity. In order to undertake these activities, a bank holding company must become a “financial holding company” by submitting to the appropriate Federal Reserve Bank a declaration that the company elects to be a financial holding company and a certification that all of the depository institutions controlled by the company are well capitalized and well managed.

The Dodd-Frank Act.The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was signed into law in 2010, significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act amendsincludes provisions affecting large and small financial institutions alike, including several provisions that will profoundly affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the BHCfuture. Among other things, these provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, and impose new capital requirements on bank and thrift holding companies. The Dodd-Frank Act also includes several corporate governance provisions that apply to requireall public companies, not just financial institutions. These include provisions mandating certain disclosures regarding executive compensation and provisions addressing proxy access by shareholders.

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The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, including some that may affect our business in substantial and unpredictable ways. We have incurred higher operating costs in complying with the federalDodd -Frank Act, and we expect that these higher costs will continue for the foreseeable future. Our management continues to monitor the ongoing implementation of the Dodd-Frank Act and as new regulations are issued, will assess their effect on our business, financial regulatory agencies to adopt rules that prohibitcondition, and results of operations. See Item 1A, Risk Factors, for a more extensive discussion of this topic.

The Volcker Rule.The Dodd-Frank act prohibits banks and their affiliates from engaging in proprietary trading and from investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds), whichfunds. The statutory provision implementing these restrictions is commonly called the “Volcker Rule”.Rule.” To implement the Volcker Rule, federal regulators issued final rules in December 2013 that were to become effective April 2014. The Federal Reserve adopted final rules implementing the Volcker Rule on December 10, 2013. The final rules are effective April 1, 2014, but the Federal Reservesubsequently issued an order extending the period during whichthat institutions have to conform their activities and investments to the requirements of the Volcker Rule to July 21, 2015. The Final Rules require each regulated entity2015, and extended the compliance date for banks to establish an internal compliance programconform their investments in certain “legacy covered funds” until July 21, 2016. These final rules exempt the Bank, as a bank with less than $10 billion in total consolidated assets that is consistent with the extent to which it engagesdoes not engage in any covered activities covered by the Volcker Rule, which must include (for the largest entities) making regular reports about those activities to regulators. Community banks, such as FSB, have been afforded some relief under the Final Rules. If such banks are engaged only in exempted proprietary trading, such asother than trading in U.S.certain government, agency, state andor municipal obligations, they are exempt entirely from any significant compliance program requirements. Moreover, even if a community bank engages in proprietary trading or covered fund activitiesobligations under the rule, they need only incorporate references toVolcker Rule; therefore, the Volcker Rule into their existing policies and procedures. The Final Rules are effective April 1, 2014, but the conformance period has been extended from its statutory end date of July 21, 2014 until July 21, 2015. Although we are continuing to evaluate the impact of the Volcker Rule and the final rules adopted thereunder, we dorule will not currently anticipate that the Volcker Rule will have a material effect on the operationsour business, financial condition and results of FII or the Bank, as we do not engage in the businesses prohibited by the Volcker Rule. We may incur costs to adopt additional policies and systems to ensure compliance with the Volcker Rule, but any such costs are not expected to be material.

The Dodd-Frank Act. The Dodd-Frank Act, significantly restructures the financial regulatory regime in the United States. Although the Dodd-Frank Act’s provisions that have received the most public attention generally have been those applying to or more likely to affect larger institutions such as bank holding companies with total consolidated assets of $50 billion or more, it contains numerous other provisions that affect all bank holding companies and banks, including FII or the Bank, some of which are described in more detail below.

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Many of the Dodd-Frank Act’s provisions are subject to final rulemaking by the U.S. financial regulatory agencies, and the implications of the Dodd-Frank Act for our businesses will depend to a large extent on how such rules are adopted and implemented by the primary U.S. financial regulatory agencies. We continue to analyze the impact of rules adopted under Dodd-Frank, on our business. However, the full impact will not be known until the rules, and other regulatory initiatives that overlap with the rules, are finalized and their combined impacts can be understood.operations.

Depository Institution Regulation.The Bank is subject to regulation by the Federal Deposit Insurance Corporation (“FDIC”).FDIC. This regulatory structure includes:

 

Real estate lending standards, which provide guidelines concerning loan-to-value ratios for various types of real estate loans;

 

Risk-based capital rules, including accounting for interest rate risk, concentration of credit risk and the risks posed by non-traditional activities;

 

Rules requiring depository institutions to develop and implement internal procedures to evaluate and control credit and settlement exposure to their correspondent banks;

 

Rules restricting types and amounts of equity investments; and

 

Rules addressing various safety and soundness issues, including operations and managerial standards, standards for asset quality, earnings and compensation standards.

Capital Adequacy Requirements.The FRBCompany and FDIC have issuedthe Bank are each required to comply with applicable capital adequacy standards established by the Federal Reserve. The current risk-based capital standards applicable to the Company and the Bank, parts of which are currently in the process of being phased in, are based on the December 2010 final capital framework for strengthening international capital standards, known as Basel III, of the Basel Committee.

Prior to January 1, 2015, the risk-based capital standards applicable to the Company and the Bank (the “general risk-based capital rules”) were based on the 1988 Capital Accord, known as Basel I, of the Basel Committee. In July 2013, the federal bank regulators approved the final Basel III Rules implementing the Basel III framework as well as certain provisions of the Dodd-Frank Act. The Basel III Rules substantially similarrevised the risk-based and leverage capital guidelinesrequirements applicable to BHCs and their depository institution subsidiaries, including the Company and the Bank, as compared to the general risk-based capital rules. The Basel III Rules became effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions).

The Basel III Rules, among other things, (i) introduce a new capital measure called CET1, (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and (iv) expand the scope of the deductions/adjustments to capital as compared to existing regulations.

Under the Basel III Rules, the minimum capital ratios effective as of January 1, 2015 are:

4.5% CET1 to risk-weighted assets;

6.0% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets; and

8.0% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets.

The Basel III Rules also introduce a new capital conservation buffer designed to absorb losses during periods of economic stress. The capital conservation buffer is an amount in addition to these minimum risk-based capital ratio requirements. The Basel III Rules also provide for a countercyclical capital buffer applicable only to certain covered institutions. We do not expect the countercyclical capital buffer to be applicable to the Company or the Bank. Banking institutions that do not hold capital above the required minimum levels, including the capital conservation buffer, will face constraints on dividends and compensation based on the amount of the shortfall.

When fully phased in on January 1, 2019, the Basel III Rules will require the Company and the Bank to maintain an additional capital conservation buffer of 2.5% of risk-weighted assets, effectively resulting in minimum ratios of (i) CET1 to risk-weighted assets of at least 7%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5%, and (iii) Total capital to risk-weighted assets of at least 10.5%.

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The Basel III Rules also provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that MSRs, certain deferred tax assets and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1.

Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and will be phased in over a 4-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and will be phased in over a 4-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).

The Basel III Rules prescribe a new standardized approach for risk weightings that expands the risk-weighting categories from the four Basel I-derived categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset classes.

Leverage Requirements.BHCs and banks are also required to comply with minimum leverage ratio requirements. These requirements provide for a minimum ratio of Tier 1 capital to total consolidated quarterly average assets (as defined for regulatory purposes), net of the loan loss reserve, goodwill and certain other intangible assets (the “leverage ratio”), of 4.0%.

Liquidity Regulation.    During 2014, the U.S. banking agencies adopted final rules implementing one of the two new standards provided for in the Basel III liquidity framework - its liquidity coverage ratio (“LCR”), which is designed to ensure that a bank maintains an adequate level of unencumbered high quality liquid assets equal to the bank’s expected net cash outflows for a thirty-day time horizon under an acute liquidity stress scenario. The rules as adopted apply in their most comprehensive form only to advanced approaches bank holding companies and banks. In addition, these regulatory agencies may from time to time require that a bank holding company or bank maintain capital above the minimum levels, based on its financial condition or actual or anticipated growth.

The FRB’s risk-based guidelines establish a two-tier capital framework. Tier 1 capital generally consistsdepository institution subsidiaries of common shareholders’ equity, retained earnings, a limited amount of qualifying perpetual preferred stock, qualifying trust preferred securities and non-controlling interests in the equity accounts of consolidated subsidiaries, less goodwill and certain intangibles. Tier 2 capital generally consists of certain hybrid capital instruments and perpetual debt, mandatory convertible debt securities and a limited amount of subordinated debt, qualifying preferred stock, loan loss allowance, and unrealized holding gains on certain equity securities. The sum of Tier 1 and Tier 2 capital represents qualifying total capital, at least 50% of which must consist of Tier 1 capital.

Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets. Assets and off-balance sheet exposures are assigned to one of four categories of risk-weights, based primarily on relative credit risk. Forsuch bank holding companies generallyand, in a modified form, to banking organizations having $50 billion or more in total consolidated assets. Accordingly they do not apply to either the Company or the Bank. As a result, we do not manage our balance sheet to be compliant with these rules.

The Basel III framework also included a second standard, referred to as the net stable funding ratio (“NSFR”), which is designed to promote more medium-and long-term funding of the assets and activities of banks over a one-year time horizon. Although the Basel Committee finalized its formulation of the NSFR in 2014, the U.S. banking agencies have not yet proposed an NSFR for application to U.S. banking organizations or addressed the scope of banking organizations to which it will apply. The Basel Committee’s final NSFR document states that the NSFR applies to internationally active banks, as did its final LCR document as to that ratio.

Prompt Corrective Action.The Federal Deposit Insurance Act, as amended (“FDIA”), requires among other things, the federal banking agencies to take “prompt corrective action” in respect of depository institutions that do not meet minimum capital requirements. The FDIA establishes five capital categories for FDIC-insured banks: well capitalized, adequately capitalized,under-capitalized, significantly under-capitalized and critically under-capitalized. Under rules in effect through December 31, 2014, a depository institution is deemed to be “well-capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio is 4%of 6.0% or greater, and a leverage ratio of 5.0% or greater, and the minimuminstitution is not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific level for any capital measure. As of January 1, 2015, the standards for “well-capitalized” status under prompt corrective action regulations changed by, among other things, introducing a CET 1 ratio requirement of 6.5% and increasing the Tier 1 risk-based capital ratio requirement from 6.0% to 8.0%. The total risk-based capital ratio is 8%. Ourand Tier 1 leverage ratio requirements remain at 10.0% and total risk-based capital ratios under these guidelines at December 31, 2013 were 10.82% and 12.08%5.0%, respectively.

The FRB’s leverageFDIA imposes progressively more restrictive constraints on operations, management and capital guidelines establishdistributions, depending on the capital category in which an institution is classified. The current capital rule established by the federal bank regulators, discussed above under “Capital Requirements,” amend the prompt corrective action requirements in certain respects, including adding a CET1 risk-based capital ratio as one of the metrics (with a minimum leverage6.5% ratio determined by dividingfor well-capitalized status) and increasing the Tier 1 risk-based capital by adjusted average total assets. The minimum leverage ratio is 3%required for bank holding companies that meet certain specified criteria,each of the five capital categories, including havingan increase from 6.0% to 8.0% to be well-capitalized.

For further information regarding the highest regulatory rating. All other bank holding companies generally are required to maintain acapital ratios and leverage ratio of at least 4%. At December 31, 2013, we had a leverage ratio of 7.63%. See alsothe Company and the Bank see the section titled “Capital Resources” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”Operations,” included in this Annual Report on Form 10-K. The current requirements and the actual levels for the Company and the Bank are detailed in Note 11, Regulatory Matters, of the notes to consolidated financial statements, included in this Annual Report on Form 10-K.

Basel III Capital Rules. In July 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to FII and the Bank. The FDIC and the OCC have subsequently approved these rules. The final rules were adopted following the issuance of proposed rules by the Federal Reserve in June 2012, and implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. “Basel III” refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011, which include significant changes to bank capital, leverage and liquidity requirements.

The rules include new risk-based capital and leverage ratios, which would be phased in from 2015 to 2019, and would refine the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to FII and the Bank under the final rules would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The final rules also establish a “capital conservation buffer” above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The capital conservation buffer will be phased-in over four years beginning on January 1, 2016, as follows: the maximum buffer will be 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. This will result in the following minimum ratios beginning in 2019: (i) a common equity Tier 1 capital ratio of 7.0%; (ii) a Tier 1 capital ratio of 8.5%; and (iii) a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

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Basel III provided discretion for regulators to impose an additional buffer, the “countercyclical buffer,” of up to 2.5% of common equity Tier 1 capital to take into account the macro-financial environment and periods of excessive credit growth. However, the final rules permit the countercyclical buffer to be applied only to “advanced approach” banks ( i.e., banks with $250 billion or more in total assets or $10 billion or more in total foreign exposures), which currently excludes the Company and the Bank. The final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that will no longer qualify as Tier 1 capital, some of which will be phased out over time. However, the final rules provide that small depository institution holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes the Company) will be able to permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 in additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.

The final rules set forth certain changes for the calculation of risk-weighted assets, which we will be required to utilize beginning January 1, 2015. The “standardized approach” final rule utilizes an increased number of credit risk exposure categories and risk weights, and also addresses: (i) an alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; (iv) revised capital treatment for derivatives and repo-style transactions; and (v) disclosure requirements for top-tier banking organizations with $50 billion or more in total assets that are not subject to the “advance approach rules” that apply to banks with greater than $250 billion in consolidated assets. Based on our current capital composition and levels, we believe that we would be in compliance with the requirements as set forth in the final rules if they were presently in effect.

Prompt Corrective Action.The Federal Deposit Insurance Corporation Improvement Act of 1991, among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective federal bank regulatory agencies to implement systems for “prompt corrective action” for insured depository institutions that do not meet minimum capital requirements within these categories. This act imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An “undercapitalized” bank must develop a capital restoration plan and its parent holding company must guarantee that bank’s compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of five percent of the bank’s assets at the time it became “undercapitalized” or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent’s general unsecured creditors. In addition, the Federal Deposit Insurance Corporation Improvement Act requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation and permits regulatory action against a financial institution that does not meet these standards.

The various federal bank regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by the Federal Deposit Insurance Corporation Improvement Act, using the total risk-based capital, Tier 1 risk-based capital and leverage capital ratios as the relevant capital measures. These regulations establish various degrees of corrective action to be taken when an institution is considered undercapitalized. Under the regulations, a “well capitalized” institution must have a Tier 1 risk-based capital ratio of at least 6%, a total risk-based capital ratio of at least 10% and a leverage ratio of at least 5% and not be subject to a capital directive or order. An institution is “adequately capitalized” if it has a Tier 1 risk-based capital ratio of at least 4%, a total risk-based capital ratio of at least 8% and a leverage ratio of at least 4% (3% in certain circumstances). An institution is “undercapitalized” if it has a Tier 1 risk-based capital ratio of less than 4%, a total risk-based capital ratio of less than 8% or a leverage ratio of less than 4% (3% in certain circumstances). An institution is “significantly undercapitalized” if it has a Tier 1 risk-based capital ratio of less than 3%, a total risk-based capital ratio of less than 6% or a leverage ratio of less than 3%. An institution is “critically undercapitalized” if its tangible equity is equal to or less than 2% of total assets. Generally, an institution may be reclassified in a lower capitalization category if it is determined that the institution is in an unsafe or unsound condition or engaged in an unsafe or unsound practice.

As of December 31, 2013, the Bank met the requirements to be classified as “well-capitalized”.

The Basel III Capital Rules also contain revisions to the prompt corrective action framework, which are designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness. These revisions take effect January 1, 2015. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions will be required to meet the following increased capital level requirements in order to qualify as “well capitalized:” (i) a new common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8% (increased from 6%); (iii) a total capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (increased from 4%).

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Dividends.The FRB policy is that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition, and that it is inappropriate for a bank holding company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, a bank that is classified under the prompt corrective action regulations as “undercapitalized” will be prohibited from paying any dividends.

Our

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The primary source of cash for cash dividends we pay is the dividends we receive from the Bank. The Bank is subject to various regulatory policies and requirements relating to the payment of dividends, including requirements to maintain capital above regulatory minimums. Approval of the New York State Department of Financial Services is required prior to paying a dividend if the dividend declared by the Bank exceeds the sum of the Bank’s net profits for that year and its retained net profits for the preceding two calendar years. At January 1, 2016, the Bank could declare dividends of $25.6 million from retained net profits of the preceding two years. The bank declared dividends of $16.0 million in 2015 and $20.0 million in 2014.

Federal Deposit Insurance Assessments.The Bank is a member of the FDIC and pays an insurance premium to the FDIC based upon its assessable assets on a quarterly basis. Deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government.

Under the Dodd-Frank Act, a permanent increase in deposit insurance was authorized to $250,000. The coverage limit is per depositor, per insured depository institution for each account ownership category.

The Dodd-Frank Act also set a new minimum Deposit Insurance Fund (“DIF”) reserve ratio at 1.35% of estimated insured deposits. The FDIC is required to attain this ratio by September 30, 2020. The Dodd-Frank Act also required the FDIC to define the deposit insurance assessment base for an insured depository institution as an amount equal to the institution’s average consolidated total assets during the assessment period minus average tangible equity. Premiums for the Bank are now calculated based upon the average balance of total assets minus average tangible equity as of the close of business for each day during the calendar quarter.

The FDIC has the flexibility to adopt actual rates that are higher or lower than the total base assessment rates adopted without notice and comment, if certain conditions are met.

DIF-insured institutions pay a Financing Corporation (“FICO”) assessment in order to fund the interest on bonds issued in the 1980s in connection with the failures in the thrift industry. For the fourth quarter of 2013,2015, the FICO assessment was equal to 0.620.58 basis points computed on assets as required by the Dodd-Frank Act. These assessments will continue until the bonds mature in 2019.

The FDIC is authorized to conduct examinations of and require reporting by FDIC-insured institutions. It is also authorized to terminate a depository bank’s deposit insurance upon a finding by the FDIC that the bank’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the bank’s regulatory agency. The termination of deposit insurance for the Bank would have a material adverse effect on our earnings, operations and financial condition.

TransactionsConsumer Laws and Regulations.In addition to the laws and regulations discussed herein, the Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with Affiliates. FIIbanks. While the list set forth herein is not exhaustive, these laws and FSB are affiliates withinregulations include, among others, the meaningFair Credit Reporting Act, 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, the Fair Debt Collection Practices Act, the Service Members Civil Relief Act and these laws’ respective state-law counterparts, as well as state usury laws and laws regarding unfair and deceptive acts and practices. These and other federal laws, among other things, require disclosures of the cost of credit and terms of deposit accounts, provide substantive consumer rights, prohibit discrimination in credit transactions, regulate the use of credit report information, provide financial privacy protections, prohibit unfair, deceptive and abusive practices, restrict the Company’s ability to raise interest rates and subject the Company to substantial regulatory oversight. Violations of applicable consumer protection laws can result in significant potential liability from litigation brought by customers, including actual damages, restitution and attorneys’ fees. Federal Reserve Act. bank regulators, state attorneys general and state and local consumer protection agencies may also seek to enforce consumer protection requirements and obtain these and other remedies, including regulatory sanctions, customer rescission rights, action by the state and local attorneys general in each jurisdiction in which we operate and civil money penalties. Failure to comply with consumer protection requirements may also result in our failure to obtain any required bank regulatory approval for merger or acquisition transactions the Company may wish to pursue or our prohibition from engaging in such transactions even if approval is not required.

The Federal ReserveDodd-Frank Act imposes limitationscentralized responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (“CFPB”), and giving it responsibility for implementing, examining and enforcing compliance with federal consumer protection laws. The CFPB focuses on:

Risks to consumers and compliance with the federal consumer financial laws, when it evaluates the policies and practices of a financial institution.

The markets in which firms operate and risks to consumers posed by activities in those markets.

Depository institutions that offer a wide variety of consumer financial products and services; depository institutions with a more specialized focus.

Non-depository companies that offer one or more consumer financial products or services.

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The CFPB has broad rulemaking authority for a wide range of consumer financial laws that apply to all banks, including, among other things, the authority to prohibit “unfair, deceptive or abusive” acts and practices. Abusive acts or practices are defined as those that materially interfere with a consumer’s ability to understand a term or condition of a consumer financial product or service or take unreasonable advantage of a consumer’s (i) lack of financial savvy, (ii) inability to protect himself in the selection or use of consumer financial products or services, or (iii) reasonable reliance on a bankcovered entity to act in the consumer’s interests. The CFPB can issue cease-and-desist orders against banks and other entities that violate consumer financial laws. The CFPB may also institute a civil action against an entity in violation of federal consumer financial law in order to impose a civil penalty or injunction. The CFPB has examination and enforcement authority over all banks with respect to extensionsmore than $10 billion in assets, as well as their affiliates.

Banking regulators take into account compliance with consumer protection laws when considering approval of credit to, investments in, and certain other transactions with, its parent bank holding company and the holding company’s other subsidiaries. Furthermore, bank loans and extensions of credit to affiliates also are subject to various collateral requirements.a proposed transaction.

Community Reinvestment Act.Under the Community Reinvestment Act, every FDIC-insured institution is obligated, consistent with safe and sound banking practices, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act requires the appropriate federal banking regulator, in connection with the examination of an insured institution, to assess the institution’s record of meeting the credit needs of its community and to consider this record in its evaluation of certain applications, such as a merger or the establishment of a branch. An unsatisfactory rating may be used as the basis for the denial of an application and will prevent a bank holding company of the institution from making an election to become a financial holding company.

During January 2015 we signed an Assurance of Discontinuance with the NYS Attorney General’s office related to an investigation into lending practices for minority residents within the City of Rochester. As part of the agreement, we paid NYS $150 thousand to cover its lastcosts. An additional $750 thousand in dedicated funds spread over three-years has been earmarked for ongoing business efforts consistent with the Bank’s growth initiatives in the Rochester market, and throughout Monroe County, including efforts focused on marketing to minority communities, as well as lending discounts and/or subsidies.

Examinations in 2011 by the New York Department of Financial Services and the Federal Reserve Bank of New York under the federal Community Reinvestment Act examination, the Bank received a rating of “outstanding.”

Interstate Branching. Pursuant to the Dodd-Frank Act, national and state-chartered banks may open an initial branch in a state other than its home state (e.g., a host state) by establishing a de novo branch at any location in such host state at which a bank chartered in such host state could establish a branch. Applications to establish such branches must still be filed with the appropriate primary federal regulator.rated Five Star as “outstanding”.

Privacy Rules.Federal banking regulators, as required under the Gramm-Leach-Bliley Act, have adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to non-affiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to non-affiliated third parties. The privacy provisions of the Gramm-Leach-Bliley Act affect how consumer information is transmitted through diversified financial services companies and conveyed to outside vendors.

Anti-Money Laundering and the USA Patriot Act.A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA PATRIOT Act of 2001, or the USA Patriot Act, substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. Financial institutions are also prohibited from entering into specified financial transactions and account relationships and must use enhanced due diligence procedures in their dealings with certain types of high-risk customers and implement a written customer identification program. Financial institutions must take certain steps to assist government agencies in detecting and preventing money laundering and report certain types of suspicious transactions. Regulatory authorities routinely examine financial institutions for compliance with these obligations, and failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required. Regulatory authorities have imposed cease and desist orders and civil money penalties against institutions found to be violating these obligations.

Interstate Branching.Pursuant to the Dodd-Frank Act, national and state-chartered banks may open an initial branch in a state other than its home state (e.g., a host state) by establishing a de novo branch at any location in such host state at which a bank chartered in such host state could establish a branch. Applications to establish such branches must still be filed with the appropriate primary federal regulator.

Transactions with Affiliates.FII, FSB, Five Star REIT, Inc. and SDN are affiliates within the meaning of the Federal Reserve Act. The Federal Reserve Act imposes limitations on a bank with respect to extensions of credit to, investments in, and certain other transactions with, its parent bank holding company and the holding company’s other subsidiaries. Furthermore, bank loans and extensions of credit to affiliates also are subject to various collateral requirements.

 

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Anti-Terrorism Legislation. The UnitingVarious governmental requirements, including Sections 23A and Strengthening America23B of the Federal Reserve Act and the FRB’s Regulation W, limit borrowings by Providing Appropriate Tools RequiredFII and its nonbank subsidiary from FSB, and also limit various other transactions between FII and its nonbank subsidiary, on the one hand, and FSB, on the other. For example, Section 23A of the Federal Reserve Act limits the aggregate outstanding amount of any insured depository institution’s loans and other “covered transactions” with any particular nonbank affiliate to Interceptno more than 10% of the institution’s total capital and Obstruct Terrorism Act (“USA Patriot Act”), enacted in 2001:

prohibits bankslimits the aggregate outstanding amount of any insured depository institution’s covered transactions with all of its nonbank affiliates to no more than 20% of its total capital. “Covered transactions” are defined by statute to include a loan or extension of credit, as well as a purchase of securities issued by an affiliate, a purchase of assets (unless otherwise exempted by the FRB) from providing correspondent accounts directly to foreign shell banks;

imposes due diligence requirementsthe affiliate, the acceptance of securities issued by the affiliate as collateral for a loan, and the issuance of a guarantee, acceptance or letter of credit on banks opening or holding accounts for foreign financial institutions or wealthy foreign individuals;

requires financial institutions to establishbehalf of an anti-money-laundering (“AML”) compliance program; and

generally eliminates civil liability for persons who file suspicious activity reports.

The USA Patriotaffiliate. Section 23A of the Federal Reserve Act also increases governmental powersgenerally requires that an insured depository institution’s loans to investigate terrorism, including expanded government access to account records. The Departmentits nonbank affiliates be, at a minimum, 100% secured, and Section 23B of the Federal Reserve Act generally requires that an insured depository institution’s transactions with its nonbank affiliates be on terms and under circumstances that are substantially the same or at least as favorable as those prevailing for comparable transactions with non-affiliates. The Dodd-Frank Act significantly expanded the coverage and scope of the limitations on affiliate transactions within a banking organization. For example, commencing in July 2012, the Dodd-Frank Act applies the 10% of capital limit on covered transactions to financial subsidiaries and amends the definition of “covered transaction” to include (i) securities borrowing or lending transactions with an affiliate, and (ii) all derivatives transactions with an affiliate, to the extent that either causes a bank or its affiliate to have credit exposure to the securities borrowing/lending or derivative counterparty.

Office of Foreign Assets Control Regulation.The U.S. Treasury Department’s Office of Foreign Assets Control, or OFAC, administers and enforces economic and trade sanctions against targeted foreign countries and regimes, under authority of various laws, including designated foreign countries, nationals and others. OFAC publishes lists of specially designated targets and countries. The Company is empowered to administerresponsible for, among other things, blocking accounts of, and make rules to implement the Act, which to some degree, affects our record-keepingtransactions with, such targets and countries, prohibiting unlicensed trade and financial transactions with them and reporting expenses. Should the Bank’s AML compliance programblocked transactions after their occurrence. Failure to comply with these sanctions could have serious legal and reputational consequences, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.

Insurance Regulation.SDN is required to be deemed insufficient by federal regulators, we would notlicensed or receive regulatory approval in nearly every state in which it does business. In addition, most jurisdictions require individuals who engage in brokerage and certain other insurance service activities to be ablepersonally licensed. These licensing laws and regulations vary from jurisdiction to grow through acquiring other institutions or opening de novo branches.jurisdiction. In most jurisdictions, licensing laws and regulations generally grant broad discretion to supervisory authorities to adopt and amend regulations and to supervise regulated activities.

Ability-to-Repay and Qualified Mortgage Rule.Incentive Compensation.   PursuantOur compensation practices are subject to the Dodd Frank Act, the CFPB issued a final rule on January 10, 2013 (effective on January 10, 2014), amending Regulation Z as implementedoversight by the Truth in Lending Act, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Mortgage lenders are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the mortgage lender to consider the following eight underwriting factors when making the credit decision: (1) current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations, alimony, and child support; (7) the monthly debt-to-income ratio or residual income; and (8) credit history. Alternatively, the mortgage lender can originate “qualified mortgages,” which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements.Federal Reserve. In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Qualified mortgages that are “higher-priced” (e.g. subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not “higher-priced” (e.g. prime loans) are given a safe harbor of compliance.

Incentive Compensation Policies and Restrictions. In JulyJune 2010, the federalFederal banking agencies issued comprehensive final guidance on incentive compensation policies intended to ensure that applies to allthe incentive compensation policies of banking organizations supervised bydo not undermine the agencies (thereby including both FII and the Bank). Pursuant to the guidance, to be consistent with safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should: (1)should (i) provide employees with incentives that appropriately balance riskdo not encourage risk-taking beyond the organization’s ability to effectively identify and reward; (2)manage risks, (ii) be compatible with effective internal controls and risk management;management, and (3)(iii) be supported by strong corporate governance, including active and effective oversight by the banking organization’s board of directors. Monitoring methods

Dodd-Frank requires the Federal banking agencies to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total consolidated assets (which would include the Company and processes usedthe Bank) that encourage inappropriate risks by aproviding an executive officer, employee, director or principal shareholder with excessive compensation, fees or benefits or that could lead to material financial loss to the entity. In addition, the agencies must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The initial version of these regulations was proposed by agencies in early 2011 but the regulations have not yet been finalized. The proposed regulations include the three key principles from the June 2010 regulatory guidance discussed above. If the regulations are adopted in the form initially proposed, they will impose limitations on the manner in which we may structure compensation for our executives.

The Federal Reserve Board will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization should be commensurate withbased on the sizescope and complexity of the organizationorganization’s activities and its usethe prevalence of incentive compensation.

In addition,compensation arrangements. The findings of the supervisory initiatives will be included in March 2011,reports of examination. Deficiencies will be incorporated into the federalorganization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking agencies, along with the Federal Housing Finance Agency, and the SEC, released a proposed rule intended to ensure that regulated financial institutions design theirorganization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to account for risk. Specifically, the proposed rule would require compensation practices at the Parent Companyorganization’s safety and at the Bank to be consistent with the following principles: (1) compensation arrangements appropriately balance risk and financial reward; (2) such arrangements are compatible with effective controls and risk management; and (3) such arrangements are supported by strong corporate governance. In addition, financial institutions with $1 billion or more in assets would be required to have policies and procedures to ensure compliance with the rule and would be required to submit annual reports to their primary federal regulator. The comment period has closed but a final rule has not yet been published.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 implemented a broad range of corporate governance, accounting and reporting measures for companies that have securities registered under the Exchange Act, including publicly-held bank holding companies such as FII. Specifically, the Sarbanes-Oxley Act of 2002soundness and the various regulations promulgated thereunder, established, among other things: (i) requirements for audit committees, including independence, expertise,organization is not taking prompt and responsibilities; (ii) responsibilities regarding financial statements foreffective measures to correct the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) the forfeiture of bonuses or other incentive-based compensation and profits from the sale of the reporting company’s securities by the Chief Executive Officer and Chief Financial Officer in the twelve-month period following the initial publication of any financial statements that later require restatement; (iv) the creation of an independent accounting oversight board; (v) standards for auditors and regulation of audits, including independence provisions that restrict non-audit services that accountants may provide to their audit clients; (vi) disclosure and reporting obligations for the reporting company and their directors and executive officers, including accelerated reporting of stock transactions and a prohibition on trading during pension blackout periods; (vii) a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions on non-preferential terms and in compliance with other bank regulatory requirements; and (viii) a range of civil and criminal penalties for fraud and other violations of the securities laws.deficiencies.

 

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Consumer Laws and Regulations. In addition to the laws and regulations discussed herein, the Bank is 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 and the Real Estate Settlement Procedures 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 Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing customer relations. The Check Clearing for the 21st Century Act (the “Check 21 Act”), which became effective on October 28, 2004, creates a new negotiable instrument, called a “substitute check”, which banks are required to accept as the legal equivalent of a paper check if it meets the requirements of the Check 21 Act. The Check 21 Act is designed to facilitate check truncation, to foster innovation in the check payment system, and to improve the payment system by shortening processing times and reducing the volume of paper checks.

Other Future Legislation and Changes in Regulations.In addition to the specific proposals described above, from time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and/or our operating environment in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on our financial condition or results of operations. A change in statutes, regulations or regulatory policies applicable to us or our subsidiaries could have a material effect on our business.

Impact of Inflation and Changing Prices

Our financial statements included herein have been prepared in accordance with GAAP, which requires us to measure financial position and operating results principally using historic dollars. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on our operations is reflected in increased operating costs. We believe changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are generally influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude. Interest rates are sensitive to many factors that are beyond our control, including changes in the expected rate of inflation, general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities.

Regulatory and Economic Policies

Our business and earnings are affected by general and local economic conditions and by the monetary and fiscal policies of the U.S. government, its agencies and various other governmental regulatory authorities. The FRB regulates the supply of money in order to influence general economic conditions. Among the instruments of monetary policy available to the FRB are (i) conducting open market operations in U.S. government obligations, (ii) changing the discount rate on financial institution borrowings, (iii) imposing or changing reserve requirements against financial institution deposits, and (iv) restricting certain borrowings and imposing or changing reserve requirements against certain borrowings by financial institutions and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. For that reason, the policies of the FRB could have a material effect on our earnings.

EMPLOYEES

At December 31, 2013,2015, we had 645 employees. None691 employees, none of our employeeswhom are subject to a collective bargaining agreement and managementagreement. Management believes our relations with employees are good.

 

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EXECUTIVE OFFICERS

The following table sets forth current information regarding our executive officers and certain other significant employees (ages are as of May 7, 2014, the date of the 2014 Annual Meeting of Shareholders). ITEM 1A.    RISK FACTORS

 

Name

  Age   Started
In
   

Positions/Offices

Martin K. Birmingham   47     2005    President and Chief Executive Officer since March 2013. Previously, President and Chief of Community Banking of FII and the Bank from August 2012 to March 2013. Executive Vice President and Regional President/Commercial Banking Executive Officer of the Bank from 2005 to 2009. Senior Vice President and Regional President of the Bank from 2005 to 2009. Senior Team Leader and Regional President of the Rochester Market at Bank of America (formally Fleet Boston Financial) from 2000 to 2005.
Paula D. Dolan   60     2013    Senior Vice President and Director of Human Resources of FII and the Bank since September 2013. Before joining the Company, Ms. Dolan worked at Hillside Family of Agencies (“Hillside”), starting as a consultant in 2010, and most recently as Hillside’s Manager of Compensation and Human Resource Information Systems. Previously, she was a Senior Human Resources Consultant with First Niagara Consulting/Burke Group from 2007 to 2010. Prior to working at First Niagara, Ms. Dolan held human resources positions at Unity Health Systems, HR Works, Eastman Kodak Company, Rochester Community Savings Bank and Jones & Laughlin Steel Corporation.
Sonia M. Dumbleton   52     1984    Senior Vice President, Controller and Corporate Secretary of FII and the Bank since May 2013. Senior Vice President and Controller of the Bank since 2006. Vice President and Controller of the Bank from 2001 to 2006.
Michael D. Grover   42     1999    Senior Vice President of Financial Reporting and Tax and Chief Accounting Officer of FII and the Bank since April 2013. Senior Vice President of Financial Reporting and Tax of the Bank since 2008.
Richard J. Harrison   68     2003    Executive Vice President and Chief Operating Officer of FII and the Bank since August 2012. Executive Vice President and Senior Retail Lending Administrator of the Bank since 2009. Senior Vice President and Senior Retail Lending Administrator of the Bank and its predecessor, National Bank of Geneva, from 2003 to 2009. Executive Vice President and Chief Credit Officer of Savings Bank of the Finger Lakes from 2001 to 2003. Director of Transcat, Inc., a publicly traded distributer and calibrator of hand held test and measurement equipment since 2004.
Jeffrey P. Kenefick   47     2006    Executive Vice President and Commercial Banking Executive of FII and the Bank since May 2013. Senior Vice President, Commercial Banking Executive and Regional President of the Bank from February 2006 until May 2013.
Kevin B. Klotzbach   61     2001    Executive Vice President, Chief Financial Officer and Treasurer of FII and the Bank since April 2013. Senior Vice President and Treasurer of the Bank since 2001. Prior to joining us, Mr. Klotzbach actively managed fixed income portfolios at several other financial institutions, including Merrill Lynch Asset Management and Empire of America.
R. Mitchell McLaughlin   56     1981    Executive Vice President and Information/Physical Security and Facilities Director of the Bank since January 2014. Executive Vice President and Chief Information Officer of the Bank from 2009 to January 2014. Senior Vice President and Chief Information Officer of the Bank from 2006 to 2009.
Kenneth V. Winn   56     2004    Executive Vice President and Chief Risk Officer of FII and the Bank since July 2012. Senior Vice President and Senior Credit and Compliance Administrator of the Bank since 2006.

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ITEM 1A.RISK FACTORS

An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that management believes could affect us are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below, together with all of the other information included or incorporated by reference herein. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This Annual Report on Form 10-K is qualified in its entirety by these risk factors. Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of us.

If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.

If we experience greater credit losses than anticipated, earnings may be adversely impacted.

As a lender, we are exposed to the risk that customers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making loans and could have a material adverse impact on our results of operations.

We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral, and we provide an allowance for estimated loan losses based on a number of factors. We believe that the allowance for loan losses is adequate. However, if our assumptions or judgments are wrong, the allowance for loan losses may not be sufficient to cover the actual credit losses. We may have to increase the allowance in the future in response to the request of one of our primary banking regulators, to adjust for changing conditions and assumptions, or as a result of any deterioration in the quality of our loan portfolio. The actual amount of future provisions for credit losses may vary from the amount of past provisions.

Our tax strategies and the value of our deferred tax assets could adversely affect our operating results and regulatory capital ratios.

Our tax strategies are dependent upon our ability to generate taxable income in future periods. Our tax strategies will be less effective in the event we fail to generate taxable income. Our deferred tax assets are subject to an evaluation of whether it is more likely than not that they will be realized for financial statement purposes. In making this determination, we consider all positive and negative evidence available including the impact of recent operating results as well as potential carryback of tax to prior years’ taxable income, reversals of existing taxable temporary differences, tax planning strategies and projected earnings within the statutory tax loss carryover period. If we were to conclude that a significant portion of our deferred tax assets were not more likely than not to be realized, the required valuation allowance could adversely affect our financial position, results of operations and regulatory capital ratios. In addition, the value of our deferred tax assets could be adversely affected by a change in statutory tax rates.

Geographic concentration may unfavorably impact our operations.

Substantially all of our business and operations are concentrated in the Western and Central New York region. As a result of this geographic concentration, our results depend largely on economic conditions in these and surrounding areas. Deterioration in economic conditions in our market could:

 

increase loan delinquencies;

 

increase problem assets and foreclosures;

 

increase claims and lawsuits;

 

decrease the demand for our products and services; and

 

decrease the value of collateral for loans, especially real estate, in turn reducing customers’ borrowing power, the value of assets associated with non-performing loans and collateral coverage.

Generally, we make loans to small to mid-sized businesses whose success depends on the regional economy. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. Adverse economic and business conditions in our market areas could reduce our growth rate, affect our borrowers’ ability to repay their loans and, consequently, adversely affect our business, financial condition and performance. For example, we place substantial reliance on real estate as collateral for our loan portfolio. A sharp downturn in real estate values in our market area could leave many of these loans inadequately collateralized. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, the impact on our results of operations could be materially adverse.

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We depend on the accuracy and completeness of information about or from customers and counterparties.

In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. We may also rely on representations of those customers, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could cause us to enter into unfavorable transactions, which could have a material adverse effect on our financial condition and results of operations.

Our insurance brokerage subsidiary, SDN, is subject to risk related to the insurance industry.

SDN derives the bulk of its revenue from commissions and fees earned from brokerage services. SDN does not determine the insurance premiums on which its commissions are based. Insurance premiums are cyclical in nature and may vary widely based on market conditions. As a result, insurance brokerage revenues and profitability can be volatile. As insurance companies outsource the production of premium revenue to non-affiliated brokers or agents such as SDN, those insurance companies may seek to further minimize their expenses by reducing the commission rates payable to insurance agents or brokers, which could adversely affect SDN’s revenues. In addition, there have been and may continue to be various trends in the insurance industry toward alternative insurance markets including, among other things, increased use of self-insurance, captives, and risk retention groups. While SDN has been able to participate in certain of these activities and earn fees for such services, there can be no assurance that we will realize revenues and profitability as favorable as those realized from our traditional brokerage activities.

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We are subject to environmental liability risk associated with our lending activities.

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, thereThere is a risk that hazardous or toxic substances could be found on these properties.properties we have foreclosed upon. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage regardless of whether we knew, had reason to know of, or caused the release of such substance. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.

Commercial real estate and business loans increase our exposure to credit risks.

At December 31, 2015, our portfolio of commercial real estate and business loans totaled $879.9 million, or 42.2% of total loans. We plan to continue to emphasize the origination of these types of loans, which generally expose us to a greater risk of nonpayment and loss than residential real estate or consumer loans because repayment of such loans often depends on the successful operations and income stream of the borrowers. Additionally, such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to consumer loans or residential real estate loans. A sudden downturn in the economy could result in borrowers being unable to repay their loans, thus exposing us to increased credit risk.

Our indirect lending involves risk elements in addition to normal credit risk.

A portion of our current lending involves the purchase of consumer automobile installment sales contracts from automobile dealers located in Western, Central and the Capital District of New York, and Northern and Central Pennsylvania. These loans are for the purchase of new or used automobiles. We serve customers that cover a range of creditworthiness, and the required terms and rates are reflective of those risk profiles. While these loans have higher yields than many of our other loans, such loans involve risks elements in addition to normal credit risk. PotentialAdditional risk elements associated with indirect lending include the limited personal contact with the borrower as a result of indirect lending through dealers, the absence of assured continued employment of the borrower, the varying general creditworthiness of the borrower, changes in the local economy, and difficulty in monitoring collateral.non-bank channels, namely automobile dealers. While indirect automobile loans are secured, such loans are secured by depreciating assets and characterized by LTVloan-to-value ratios that could result in us not recovering the full value of an outstanding loan upon default by the borrower. If the economiclosses from our indirect loan portfolio are higher than anticipated, that could have a material adverse effect on our financial condition and results of operations.

We accept deposits that do not have a fixed term and which may be withdrawn by the customer at any time for any reason.

At December 31, 2015, we had $2.1 billion of deposit liabilities that have no maturity and, therefore, may be withdrawn by the depositor at any time. These deposit liabilities include our checking, savings, and money market deposit accounts.

Market conditions may impact the competitive landscape for deposits in the banking industry. The unprecedented low rate environment and future actions the Federal Reserve may take may impact pricing and demand for deposits in the banking industry. The withdrawal of more deposits than we anticipate could have an adverse impact on our primary market area contracts,profitability as this source of funding, if not replaced by similar deposit funding, would need to be replaced with wholesale funding, the sale of interest earning assets, or a combination of these two actions. The replacement of deposit funding with wholesale funding could cause our overall cost of funding to increase, which would reduce our net interest income. A loss of interest earning assets could also reduce our net interest income.

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Any future FDIC insurance premium increases may adversely affect our earnings.

The amount that is assessed by the FDIC for deposit insurance is set by the FDIC based on a variety of factors. These include the depositor insurance fund’s reserve ratio, the Bank’s assessment base, which is equal to average consolidated total assets minus average tangible equity, and various inputs into the FDIC’s assessment rate calculation.

If there are additional financial institution failures we may experiencebe required to pay even higher levelsFDIC premiums than the recently increased levels. Such increases or required prepayments of delinquencies, charge-offs and repossessions.FDIC insurance premiums may adversely impact our earnings. See Part I, Item 1 “Business”, “Federal Deposit Insurance Assessments” for more information about FDIC insurance premiums.

We are highly regulated and may be adversely affected by changes in banking laws, regulations and regulatory practices.

We are subject to extensive supervision, regulation and examination. This regulatory structure gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies to address not only compliance with applicable laws and regulations (including laws and regulations governing consumer credit, fair lending, and anti-money laundering and anti-terrorism laws), but also capital adequacy, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. As part of this regulatory structure, we are subject to policies and other guidance developed by the regulatory agencies with respect to capital levels, the timing and amount of dividend payments, the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Under this structure the regulatory agencies have broad discretion to impose restrictions and limitations on our operations if they determine, among other things, that our operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.

This supervisory framework could materially impact the conduct, growth and profitability of our operations. Any failure on our part to comply with current laws, regulations, other regulatory requirements or safe and sound banking practices or concerns about our financial condition, or any related regulatory sanctions or adverse actions against us, could increase our costs or restrict our ability to expand our business and result in damage to our reputation.

The new Basel III Capital Standards may have an adverse effect on us.

In July 2013,We describe the Federal Reserve Board released its final rules which will implementsignificant federal and state banking regulations that affect us in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervisionsection captioned “Supervision and certain changes required by the Dodd-Frank Act. Under the final rule, minimum requirements will increase for both the quality and quantity of capital held by banking organizations. Consistent with the international Basel framework, the rule includes a new minimum ratio of Common Equity TierRegulation” included in Part I, Capital to Risk-Weighted Assets of 4.5% and a Common Equity Tier I Capital conservation buffer of 2.5% of risk-weighted assets that will apply to all supervised financial institutions. The rule also, among other things, raises the minimum ratio of Tier I Capital to Risk-Weighted Assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations. We must begin transitioning to the new rules effective JanuaryItem 1, 2015. The impact of the new capital rules is likely to require us to maintain higher levels of capital, which will lower our return on equity.

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New regulations could adversely impact our earnings due to, among other things, increased compliance costs or costs due to noncompliance.

In March 2013, the Consumer Financial Protection Bureau (“CFPB”) issued supervisory guidance highlighting its concern that the practice of automotive dealers being compensated for arranging customer financing through discretionary markup of wholesale rates offered by financial institutions, such as us (“dealer markup”), results in a significant risk of pricing disparity in violation of The Equal Credit Opportunity Act (“ECOA”)“Business”. The Consumer Financial Protection Bureau recommended that financial institutions under its jurisdiction take steps to ensure compliance with the ECOA, which may include imposing controls on dealer markup, monitoring and addressing the effects of dealer markup policies, and eliminating dealer discretion to markup buy rates and fairly compensating dealers using a different mechanism. In December 2013, the Consumer Financial Protection Bureau and the United States Department of Justice (the “DOJ”), based on a proxy methodology that combines geography-based and name-based probabilities, alleged that certain presumed-minority borrowers who had obtained automobile financing from a national lender were charged higher dealer markups as a result of such lender’s policy and practice of allowing dealer markup. In connection with the investigation, the lender consented to the issuance of a consent order and agreed to pay damages, to implement a compliance plan, and to pay a monetary penalty. Additional investigations and actions by the Consumer Financial Protection Bureau and the DOJ against automotive lenders are likely to occur in the future. We have evaluated our indirect lending practices in light of these events and believe that we are currently conducting our indirect lending business in compliance with ECOA. However, any investigations or allegations of wrongdoing by the Consumer Financial Protection Bureau or DOJ against us could have material adverse impact on our indirect lending business, results of operations and financial condition.

The CFPB has issued a rule, effective as of January 10, 2014, designed to clarify for lenders how they can avoid monetary damages under the Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans that satisfy this “qualified mortgage” safe-harbor will be presumed to have complied with the new ability-to-repay standard. Under the CFPB’s rule, a “qualified mortgage” loan must not contain certain specified features, including but not limited to:

excessive upfront points and fees (those exceeding 3% of the total loan amount, less “bona fide discount points” for prime loans);

interest-only payments;

negative-amortization; and

terms longer than 30 years.

Also, to qualify as a “qualified mortgage,” a borrower’s total monthly debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The CFPB’s rule on qualified mortgages could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive and/or time consuming to make these loans, which could adversely impact our growth or profitability.

With the development of the CFPB, our consumer products and services are subject to increasing regulatory oversight and scrutiny with respect to compliance under consumer laws and regulations. We may face a greater number or wider scope of investigations, enforcement actions and litigation in the future related to consumer practices, thereby increasing costs associated with responding to or defending such actions. In addition, increased regulatory inquiries and investigations, as well as any additional legislative or regulatory developments affecting our consumer businesses, and any required changes to our business operations resulting from these developments, could result in significant loss of revenue, limit the products or services we offer, require us to increase our prices and therefore reduce demand for our products, impose additional compliance costs on us, cause harm to our reputation or otherwise adversely affect our consumer businesses.

New or changing tax accounting, and regulatoryaccounting rules and interpretations could significantly impact our strategic initiatives, results of operations, cash flows, and financial condition.

The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit a company’s stockholders. These regulations may sometimes impose significant limitations on operations. The significant federal and state banking regulations that affect us are describedAccounting principles generally accepted in the section captioned “SupervisionUnited States, require us to use certain assumptions and Regulation” includedestimates in Part I, Item 1, “Business”.preparing our financial statements, including in determining credit loss reserves and reserves related to litigation, among other items. Certain of our financial instruments, including available-for-sale securities and certain loans, require a determination of their fair value in order to prepare our financial statements. Where quoted market prices are not available, we may make fair value determinations based on internally developed models or other means, which ultimately rely to some degree on management judgment. Some of these and other assets and liabilities may have no direct observable price levels, making their valuation particularly subjective, as they are based on significant estimation and judgment. In addition, sudden illiquidity in markets or declines in prices of certain loans and securities may make it more difficult to value certain balance sheet items, which may lead to the possibility that such valuations will be subject to further change or adjustment. If assumptions or estimates underlying our financial statements are incorrect, we may experience material losses. These regulations,risks, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time.

Legal and regulatory proceedings and related matters could adversely affect us and banking industry in general.

We have been, and may in the future be, subject to various legal and regulatory proceedings. It is inherently difficult to assess the outcome of these matters, and there can be no assurance that we will prevail in any proceeding or litigation. Legal and regulatory matters could result in substantial cost and diversion of our efforts, which by itself could have a material adverse effect on our financial condition and operating results. Further, adverse determinations in such matters could result in actions by our regulators that could materially adversely affect our business, financial condition or results of operations.

We establish reserves for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. We may still incur legal costs for a matter even if we have not established a reserve. In addition, due to the inherent subjectivity of the assessments and unpredictability of the outcome of legal proceedings, the actual cost of resolving a legal claim may be substantially higher than any amounts reserved for that matter. The ultimate resolution of a pending legal proceeding, depending on the remedy sought and granted, could adversely affect our results of operations and financial condition.

 

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A breach in security of our or third party information systems, including the occurrence of a cyber incident or a deficiency in cybersecurity,cyber security, may subject us to liability, result in a loss of customer business or damage to our brand image.

We rely heavily on communications, information systems (both internal and provided by third parties) and the internet to conduct our business. Our business is dependentdepends on our ability to process and monitor a large numbersvolume of daily transactions in compliance with legal, regulatory and internal standards and specifications. In addition, a significant portion of our operations relies heavily on the secure processing, storage and transmission of personal and confidential information, such as the personal information of our customers and clients. These risks may increase in the future as we continue to increase mobile payments and other internet-based product offerings and expand our internal usage of web-based products and applications.

While we have policies and procedures designed to prevent or limit the effect of a possible failure, interruption or breach of our information systems, there can be no assurance that such action will not occur or, if any does occur, that it will be adequately addressed. For example, although we maintain commercially reasonable measures to ensure the cybersecurity of our information systems, other financial service institutions and companies have reported breaches in the security of their websites or other systems. In addition, several U.S. financial institutions have recently experienced significant distributed denial-of-service attacks, some of which involved sophisticated and targeted attacks intended to disable or degrade service, or sabotage systems. Other potential attacks have attempted to obtain unauthorized access to confidential information or destroy data, often through the introduction of computer viruses or malware, cyber-attacks and other means. To date, none of these efforts hastypes of attacks have had a material effect on our business or operations. Such security attacks can originate from a wide variety of sources, including persons who are involved with organized crime or who may be linked to terrorist organizations or hostile foreign governments. Those same parties may also attempt to fraudulently induce employees, customers or other users of our systems to disclose sensitive information in order to gain access to our data or that of our customers or clients. We are also subject to the risk that our employees may intercept and transmit unauthorized confidential or proprietary information. An interception, misuse or mishandling of personal, confidential or proprietary information being sent to or received from a customer or third party could result in legal liability, remediation costs, regulatory action and reputational harm.harm, any of which could adversely affect our results of operations and financial condition.

We face competition in staying current with technological changes to compete and meet customer demands.

The financial services market, including banking services, faces rapid changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and may enable us to reduce costs. Our future success may depend, in part, on our ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in our operations. Some of our competitors have substantially greater resources to invest in technological improvements than we currently have. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. As a result, our ability to effectively compete to retain or acquire new business may be impaired, and our business, financial condition or results of operations, may be adversely affected.

We rely on other companies to provide key components of our business infrastructure.

Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of them not providing us their services for any reason or them performing their services poorly, could adversely affect our ability to deliver products and services to our customers or otherwise conduct our business efficiently and effectively. Replacing these third party vendors could also entail significant delay and expense.

Third parties perform significant operational services on our behalf. These third-party vendors are subject to similar risks as us relating to cybersecurity, breakdowns or failures of their own systems or employees. One or more of our vendors may experience a cybersecurity event or operational disruption and, if any such event does occur, it may not be adequately addressed, either operationally or financially, by the third-party vendor. Certain of our vendors may have limited indemnification obligations or may not have the financial capacity to satisfy their indemnification obligations. Financial or operational difficulties of a vendor could also impair our operations if those difficulties interfere with the vendor’s ability to serve us. If a critical vendor is unable to meet our needs in a timely manner or if the services or products provided by such a vendor are terminated or otherwise delayed and if we are not able to develop alternative sources for these services and products quickly and cost-effectively, it could have a material adverse effect on our business. Federal banking regulators recently issued regulatory guidance on how banks select, engage and manage their outside vendors. These regulations may affect the circumstances and conditions under which we work with third parties and the cost of managing such relationships.

We rely on other companies to provide key components of our business infrastructure.

Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of them not providing us their services for any reason or them performing their services poorly, could adversely affect our ability to deliver products and services to our customers or otherwise conduct our business efficiently and effectively. Replacing these third party vendors could also entail significant delay and expense.

We use financial models for business planning purposes that may not adequately predict future results.

We use financial models to aid in planning for various purposes including our capital and liquidity needs, interest rate risk, potential charge- offs, reserves, and other purposes. The models used may not accurately account for all variables that could affect future results, may fail to predict outcomes accurately and/or may overstate or understate certain effects. As a result of these potential failures, we may not adequately prepare for future events and may suffer losses or other setbacks due to these failures.

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We may not be able to attract and retain skilled people and our ongoing leadership transition may be unsuccessful.people.

Our success depends, in large part, on our ability to attract and retain skilled people. Competition for the besthighly talented people in most activities engaged in by us can be intense, and we may not be able to hire sufficiently skilled people or to retain them. Further, the rural location of our principal executive offices and many of our bank branches make it difficultchallenging for us to attract skilled people to such locations. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our markets, years of industry experience, and the difficulty of promptly finding qualified replacement personnel.

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Acquisitions may disrupt our business and dilute shareholder value.

A key component ofWe intend to continue to pursue a growth strategy for our strategy to grow and improve profitability is to expandbusiness by expanding our branch network into communities within or adjacent to markets where we currently conduct business.    We may consider acquisitions of loans or securities portfolios, lending or leasing firms, commercial and small business lenders, residential lenders, direct banks, banks or bank branches, wealth and investment management firms, securities brokerage firms, specialty finance or other financial services-related companies. We also intend to continueexpand our SDN and Courier subsidiaries by acquiring smaller insurance agencies and wealth management firms in areas which complement our current footprint. We may be unsuccessful in expanding our SDN and Courier subsidiaries through acquisition because of the growing interest in acquiring insurance brokers and wealth management firms, which could make it more difficult for us to pursue a growth strategy foridentify appropriate targets and could make such acquisitions more expensive. Even if we are able to identify appropriate acquisition targets, we may not have sufficient capital to fund acquisitions or be able to execute transactions on favorable terms. If we are unable to expand our business. As a result, negotiationsSDN and Courier operations through smaller acquisitions, we may take placenot be able to achieve all of the expected benefits of the SDN and future mergers orCourier acquisitions, involving cash, debt, or equity securities may occur at any time. We seek merger or acquisition partners that are culturally similar, have experienced management,which could adversely affect our results of operations and possess either significant market presence or have potential for improved profitability through financial management, economies of scale, or expanded services.condition.

Acquiring other banks, businesses, or branches involves potential adverse impact to our financial results and various other risks commonly associated with acquisitions, including, among other things:

 

difficulty in estimating the value of the target company;

payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term;

potential exposure to unknown or contingent liabilities of the target company;

exposure to potential asset quality issues of the target company;

there may be volatility in reported income as goodwill impairment losses could occur irregularly and in varying amounts;

challenge and expense of integrating the operations and personnel of the target company;

inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and / or other projected benefits;

potential disruption to our business;

potential diversion of our management’s time and attention;

the possible loss of key employees and customers of the target company; and

potential changes in banking or tax laws or regulations that may affect the target company.company; and
additional regulatory burdens associated with new lines of business.

We are subject to interest rate risk.

Our earnings and cash flows aredepend largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, and, in particular,particularly the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits; (ii) the fair value of our financial assets and liabilities; and (iii) the average duration of our mortgage-backed securities portfolio and other interest-earning assets. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

Although management believes we have implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, anyAny substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet.

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Our business may be adversely affected by conditions in the financial markets and economic conditions generally.

From December 2007 through June 2009, the U.S. economy was in recession. Business activity across a wide range of industries and regions in the U.S. was greatly reduced. Although economic conditions have begun to improve, certain sectors, such as real estate, remain weak and unemployment remains high. Local governments and many businesses are still in serious difficulty due to lower consumer spending and reduced tax collections.

Market conditions also led to the failure or merger of several prominent financial institutions and numerous regional and community-based financial institutions. These failures had a significant negative impact on the capitalization level of the deposit insurance fund of the FDIC, which, in turn, has led to past increases in deposit insurance premiums paid by financial institutions.

Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly dependent on the business environment in the markets where we operate, in the State of New York and in the United States as a whole. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment, natural disasters; or a combination of these or other factors.

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Our earnings are significantly affected by theThe fiscal and monetary policies of the federal government and its agencies.agencies have a significant impact on our earnings.

The policies of the Federal Reserve impact us significantly. The Federal Reserve regulates the supply of money and credit in the United States. Its policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits and can also affect the value of financial instruments we hold. Those policies determine to a significant extent our cost of funds for lending and investing. Changes in those policies are beyond our control and are difficult to predict. Federal Reserve policies can also affect our borrowers, potentially increasing the risk that they may fail to repay their loans. For example, a tightening of the money supply by the Federal Reserve could reduce the demand for a borrower’s products and services. This could adversely affect the borrower’s earnings and ability to repay its loan, which could have a material adverse effect on our financial condition and results of operations.

The soundness of other financial institutions could adversely affect us.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due us. Any such losses could have a material adverse effect on our financial condition and results of operations.

We may be required to recognize an impairment of goodwill.

Under current accounting standards, goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis or more frequently if an event occurs or circumstances change that reduce the fairThe value of a reporting unit below its carrying amount.our goodwill and other intangible assets may decline in the future.

As of December 31, 2015, we had $60.4 million of goodwill and $6.5 million of other intangible assets. Significant and sustained declines in our stock price and market capitalization, significant declines in our expected future cash flows, significant adverse changes in the business climate or slower growth rates, any or all of which could resultbe materially impacted by many of the risk factors discussed herein, may necessitate our taking charges in the future related to the impairment of our goodwill. During 2013, the annual impairment test performed asFuture regulatory actions could also have a material impact on assessments of September 30 indicated thatgoodwill for impairment. If the fair value of our singlenet assets improves at a faster rate than the market value of our reporting units, or if we were to experience increases in book values of a reporting unit exceededin excess of the increase in fair value of its assets and liabilities. Inequity, we may also have to take charges related to the event thatimpairment of our goodwill. If we were to conclude that all or a portionfuture write-down of our goodwill may be impaired, a non-cashis necessary, we would record the appropriate charge, for the amount of such impairment would be recorded to earnings, which could have a material adverse impacteffect on our results of operationsoperations.

Identifiable intangible assets other than goodwill consist of core deposit intangibles and other intangible assets (primarily customer relationships). Adverse events or financial condition. Suchcircumstances could impact the recoverability of these intangible assets including loss of core deposits, significant losses of customer accounts and/or balances, increased competition or adverse changes in the economy. To the extent these intangible assets are deemed unrecoverable, a non-cash impairment charge would be recorded which could have no impacta material adverse effect on tangible capital. At December 31, 2013,our results of operations.

During the fourth quarter of 2015, we had goodwilldetermined that the carrying value of $48.5 million, representing approximately 19% of shareholders’ equity.our Insurance reporting unit exceeded its fair value and recorded a $751 thousand impairment charge. For further discussion, see Note 1, Summary of Significant Accounting Policies, and Note 7, Goodwill and Other Intangible Assets, to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

- 23 -


A potential proxy contest for the election of directors at our annual meeting or proposals arising out of shareholder initiatives could cause us to incur substantial costs and negatively affect our business.

Over the last few years, proxy contests and other forms of shareholder activism have been directed against numerous publicly-traded community banks. On December 16, 2015, Clover Partners, L.P. (“Clover”), a holder of approximately 5% of our outstanding common stock, wrote a letter to our Board of Directors raising concerns regarding our strategic direction, expressing Clover’s desire to see the Company sold, expressing its desire for representation on our Board of Directors, and threatening a proxy contest. In the event that any significant investor makes proposals concerning our operations, governance or other matters, or seeks to change our Board of Directors, our review and consideration of such proposals may require the devotion of a significant amount of time by our management and employees and could require us to expend significant resources. Further, if our Board of Directors, in exercising its fiduciary duties, disagrees with or determines not to pursue the strategic direction suggested by an activist shareholder, our business could be adversely affected by responding to a costly and time-consuming proxy contest or other actions from an activist shareholder that will divert the attention of our management and employees, interfere with our ability to execute our strategic plan, result in the loss of business opportunities and customers, and make it more difficult for us to attract and retain qualified personnel and business partners.

We operate in a highly competitive industry and market area.

We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional and internet banks within the various markets in which we operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loan associations, credit unions, finance companies, brokerage firms, insurance companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. Also, technology has lowered barriers to entry and made it possible for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. More recently, peer to peer lending has emerged as an alternative borrowing source for our customers and many other non-banks offer lending and payment services in competition with banks. Many of ourthese competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.

Our ability to compete successfully depends on a number of factors, including, among other things:

 

the ability to develop, maintain and build upon long-term customer relationships based on top quality service, high ethical standards and safe, sound assets;

 

the ability to expand our market position;

 

the scope, relevance and pricing of products and services offered to meet customer needs and demands;

 

the rate at which we introduce new products and services relative to our competitors;

 

customer satisfaction with our level of service; and

 

industry and general economic trends.

Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations.

- 22 -


Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business.

Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue, and/or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures, theThe occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

Liquidity is essential to our businesses.

Our liquidity could be impaired by an inability to access the capital markets or unforeseen outflows of cash. This situationReduced liquidity may arise due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects third parties or us. Our efforts to monitor and manage liquidity risk may not be successful or sufficient to deal with dramatic or unanticipated reductions in our liquidity. In such events, our cost of funds may increase, thereby reducing our net interest income, or we may need to sell a portion of our investment and/or loan portfolio, which, depending upon market conditions, could result in us realizing a loss.

- 24 -


We may need to raise additional capital in the future and such capital may not be available on acceptable terms or at all.

We may need to raise additional capital in the future to provide sufficient capital resources and liquidity to meet our commitments and business needs. Our ability to raise additional capital, if needed, will depend on our financial performance and, among other things, conditions in the capital markets at that time which areis outside of our control, and our financial performance.control.

In addition, we are highly regulated, and our regulators could require us to raise additional common equity in the future. We and our regulators perform a variety of analyses of our assets, including the preparation of stress case scenarios, and as a result of those assessments we could determine, or our regulators could require us, to raise additional capital.

We cannot assure that suchrequired capital will be available on acceptable terms or at all. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, depositors of the Bank or counterparties participating in the capital markets, or a downgrade of our debt rating, may adversely affect our capital costs and ability to raise capital and, in turn, our liquidity. An inability to raise additional capital on acceptable terms when needed could have a material adverse impact on our business, financial condition, results of operations or liquidity.

We rely on dividends from our subsidiaries for most of our revenue.

We are a separate and distinct legal entity from our subsidiaries. A substantial portion of our revenue comes from dividends from our Bank subsidiary. These dividends are the principal source of funds we use to pay dividends on our common and preferred stock, and to pay interest and principal on our debt. Various federalFederal and/or state laws and regulations limit the amount of dividends that our Bank subsidiary may pay to us. Also, our right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event our Bank subsidiary is unable to pay dividends to us, we may not be able to service debt, pay obligations, or pay dividends on our common and preferred stock. The inability to receive dividends from our Bank subsidiary could have a material adverse effect on our business, financial condition, and results of operations.

We may not pay or may reduce the dividends on our common stock.

Holders of our common stock are only entitled to receive such dividends as our Board of Directors may declare out of funds legally available for such payments. Although we have historically declared cash dividends on our common stock, we are not required to do so and may reduce or eliminate our common stock dividend in the future. This could adversely affect the market price of our common stock.

We may issue debt and equity securities or securities convertible into equity securities, any of which may be senior to our common stock as to distributions and in liquidation, which could dilute our current shareholders or negatively affect the value of our common stock.

In the future, we may attempt to increase our capital resources by entering into debt or debt-like financing that is unsecured or secured by all or up to all of our assets, or by issuing additional debt or equity securities, which could include issuances of secured or unsecured commercial paper, medium-term notes, senior notes, subordinated notes, preferred stock or securities convertible into or exchangeable for equity securities. In the event of our liquidation, our lenders and holders of our debt and preferred securities would receive a distribution of our available assets before distributions to the holders of our common stock. Because our decision to incur debt and issue securities in our future offerings will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings and debt financings. Further, market conditions could require us to accept less favorable terms for the issuance of our securities in the future. We may also issue additional shares of our common stock or securities convertible into or exchangeable for our common stock that could dilute our current shareholders and effect the value of our common stock.

Our certificate of incorporation, our bylaws, and certain banking laws may have an anti-takeover effect.

Provisions of our certificate of incorporation, our bylaws, and federal and state banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions may discourage others from initiating a potential merger, takeover or other change of control transaction, which, in turn, could adversely affect the market price of our common stock.

 

- 2325 -


The market price of our common stock may fluctuate significantly in response to a number of factors.

Our quarterly and annual operating results have varied in the past and could vary significantly in the future, which makes it difficult for us to predict our future operating results. Our operating results may fluctuate due to a variety of factors, many of which are outside of our control, including the changing U.S. economic environment and changes in the commercial and residential real estate market, any of which may cause our stock price to fluctuate. If our operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:

 

volatility of stock market prices and volumes in general;

 

changes in market valuations of similar companies;

 

changes in conditions in credit markets;

 

changes in accounting policies or procedures as required by the Financial Accounting Standards Board, or FASB, or other regulatory agencies;

 

legislative and regulatory actions (including the impact of the Dodd-Frank Act and related regulations) subjecting us to additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;

 

government intervention in the U.S. financial system and the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board;

 

additions or departures of key members of management;

 

fluctuations in our quarterly or annual operating results; and

 

changes in analysts’ estimates of our financial performance.

Our certificate of incorporation, our bylaws, and certain banking laws may have an anti-takeover effect.

Provisions of our certificate of incorporation, our bylaws, and federal and state banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions may discourage others from initiating a potential merger, takeover or other change of control transaction, which, in turn, could adversely affect the market price of our common stock.

 

- 24 -ITEM 1B.    UNRESOLVED STAFF COMMENTS


ITEM 1B.UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2.PROPERTIES

ITEM 2.    PROPERTIES

We own a 27,400 square foot building in Warsaw, New York that serves as our headquarters, and principal executive and administrative offices. Additionally, we are obligated under aWe lease commitment through 2017 for a 22,200 square foot regional administrative facility located in Pittsford, New York. This lease expires in April 2017.

We are engaged in the banking business through 50 branch offices, of which 3435 are owned and 1615 are leased, in the following fifteen contiguous counties of Western and Central New York: Allegany, Cattaraugus, Cayuga, Chautauqua, Chemung, Erie, Genesee, Livingston, Monroe, Ontario, Orleans, Seneca, Steuben, Wyoming and Yates Counties. The operating leases for our branch offices expire at various dates through the year 2036 and generally include options to renew.

SDN operates from a leased 14,400 square foot office located in Williamsville, New York. The lease for such space, which is used by SDN and several of our Bank’s commercial lenders, extends through September 2021. SDN also leases one retail location.

We believe that our properties have been adequately maintained, are in good operating condition and are suitable for our business as presently conducted, including meeting the prescribed security requirements. For additional information, see Note 6, Premises and Equipment, Net, and Note 10, Commitments and Contingencies, in the accompanying financial statements included in Part II, Item 8, of this Annual Report on Form 10-K.

 

ITEM 3.LEGAL PROCEEDINGS

ITEM 3.    LEGAL PROCEEDINGS

From time to time we are a party to or otherwise involved in legal proceedings arising out of the normal course of business. Management does not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have a material adverse effect on our business, results of operations or financial condition.

 

ITEM 4.MINE SAFETY DISCLOSURES

ITEM 4.    MINE SAFETY DISCLOSURES

Not applicable.

 

- 2526 -


PART II

 

ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

ITEM 5.    MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on the NASDAQ Global Select Market under the ticker symbol “FISI.” At December 31, 2013, 13,829,355February 29, 2016, 14,485,883 shares of our common stock were outstanding and held by approximately 2,0004,600 shareholders of record. During 2013,2015, the high sales price of our common stock was $26.59$29.04 and the low sales price was $17.92.$21.67. The closing price per share of our common stock on December 31, 2013,2015, the last trading day of our fiscal year, was $24.71.$28.00. We declared dividends of $0.74$0.80 per common share during the year ended December 31, 2013.2015. See additional information regarding the market price and dividends paid in Part II, Item 6, “Selected Financial Data”.

We have paid regular quarterly cash dividends on our common stock and our Board of Directors presently intends to continue this practice, subject to our results of operations and the need for those funds for debt service and other purposes. See the discussions in the section captioned “Supervision and Regulation” included in Part I, Item 1, “Business”, in the section captioned “Liquidity and Capital Resources” included in Part II, Item 7, in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 11, Regulatory Matters, in the accompanying financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data”, all of which are included elsewhere in this report and incorporated herein by reference thereto.

Recent Sales of Unregistered Securities

We provide our directors who are not employees with a convenient way to purchase shares from us at fair market value. Each director may elect to receive half of their annual retainer in shares of our common stock on the date of our annual organizational meeting. Any portion of the annual retainer issued to our directors in the form of stock has historically been issued outside of our 2009 Directors’ Stock Incentive Plan (the “DSIP”) and without registration under the Securities Act of 1933 as amended (the “Securities Act”) in reliance on the exemption from registration pursuant to Section 4(a)(2) of the Securities Act based on our directors’ financial sophistication and knowledge of the Company. On May 8, 2013, we issued a total of 5,672 shares of our common stock as the stock component of our annual retainer to our non-employee directors without registration under the Securities Act. These shares of common stock are subject to the resale prohibition under the Securities Act and may not be sold or transferred without registration except in accordance with Rule 144 of the Securities Act.

Although any director retainer issued in the form of stock is issued outside of the DSIP, we still deduct these shares from the aggregate share limit under the DSIP. We expect that future director stock retainers will be issued pursuant to a shareholder approved plan and registered under the Securities Act.

- 26 -


Stock Performance Graph

The stock performance graph below compares (a) the cumulative total return on our common stock for the period beginning December 31, 20082010 as reported by the NASDAQ Global Select Market, through December 31, 2013,2015, (b) the cumulative total return on stocks included in the NASDAQ Composite Index over the same period, and (c) the cumulative total return, as compiled by SNL Financial L.C.LC (“SNL”), of Major Exchange (NYSE, NYSE MKT and NASDAQ) Banks with $1 billion to $5 billion in assets over the same period. Cumulative return assumes the reinvestment of dividends. The graph was prepared by SNL Financial, LC and is expressed in dollars based on an assumed investment of $100.

Total Return Performance

 

  Period Ending   Period Ending 
Index  12/31/08   12/31/09   12/31/10   12/31/11   12/31/12   12/31/13     12/31/10       12/31/11       12/31/12       12/31/13       12/31/14       12/31/15   

Financial Institutions, Inc.

   100.00     85.77     141.45     123.93     147.89     203.38     100.00       87.62       104.55       143.79       151.22       173.96    

NASDAQ Composite

   100.00     145.36     171.74     170.38     200.63     281.22     100.00       99.21       116.82       163.75       188.03       201.40    

SNL Bank $1B-$5B Index

   100.00     71.68     81.25     74.10     91.37     132.87     100.00       91.20       112.45       163.52       170.98       191.39    

 

- 27 -


ITEM 6.SELECTED FINANCIAL DATA

 

(Dollars in thousands, except selected ratios and per share data)  At or for the year ended December 31, 
   2013  2012  2011  2010  2009 

Selected financial condition data:

      

Total assets

  $2,928,636   $2,763,865   $2,336,353   $2,214,307   $2,062,389  

Loans, net

   1,806,883    1,681,012    1,461,516    1,325,524    1,243,265  

Investment securities

   859,185    841,701    650,815    694,530    620,074  

Deposits

   2,320,056    2,261,794    1,931,599    1,882,890    1,742,955  

Borrowings

   337,042    179,806    150,698    103,877    106,390  

Shareholders’ equity

   254,839    253,897    237,194    212,144    198,294  

Common shareholders’ equity (1)

   237,497    236,426    219,721    158,359    144,876  

Tangible common shareholders’ equity (2)

   187,495    186,037    182,352    120,990    107,507  

Selected operations data:

      

Interest income

  $98,931   $97,567   $95,118   $96,509   $94,482  

Interest expense

   7,337    9,051    13,255    17,720    22,217  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net interest income

   91,594    88,516    81,863    78,789    72,265  

Provision for loan losses

   9,079    7,128    7,780    6,687    7,702  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net interest income after provision for loan losses

   82,515    81,388    74,083    72,102    64,563  

Noninterest income

   24,833    24,777    23,925    19,454    18,795  

Noninterest expense

   69,441    71,397    63,794    60,917    62,777  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Income before income taxes

   37,907    34,768    34,214    30,639    20,581  

Income tax expense

   12,377    11,319    11,415    9,352    6,140  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net income

  $25,530   $23,449   $22,799   $21,287   $14,441  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Preferred stock dividends and accretion

   1,466    1,474    3,182    3,725    3,697  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net income applicable to common shareholders

  $24,064   $21,975   $19,617   $17,562   $10,744  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Stock and related per share data:

      

Earnings per common share:

      

Basic

  $1.75   $1.60   $1.50   $1.62   $0.99  

Diluted

   1.75    1.60    1.49    1.61    0.99  

Cash dividends declared on common stock

   0.74    0.57    0.47    0.40    0.40  

Common book value per share (1)

   17.17    17.15    15.92    14.48    13.39  

Tangible common book value per share (2)

   13.56    13.49    13.21    11.06    9.94  

Market price (NASDAQ: FISI):

      

High

   26.59    19.52    20.36    20.74    15.99  

Low

   17.92    15.22    12.18    10.91    3.27  

Close

   24.71    18.63    16.14    18.97    11.78  

Performance ratios:

      

Net income, returns on:

      

Average assets

   0.91  0.93  1.00  0.98  0.71

Average equity

   10.10    9.46    9.82    10.07    7.43  

Average common equity (1)

   10.23    9.53    9.47    11.14    7.61  

Average tangible common equity (2)

   13.00    11.74    11.55    14.59    10.37  

Common dividend payout ratio (3)

   42.29    35.63    31.33    24.69    40.40  

Net interest margin (fully tax-equivalent)

   3.64    3.95    4.04    4.07    4.04  

Efficiency ratio (4)

   58.48  62.87  60.55  60.36  65.52

ITEM 6.    SELECTED FINANCIAL DATA

(Dollars in thousands, except per share data)  At or for the year ended December 31, 
   2015   2014   2013   2012   2011 

Selected financial condition data:

          

Total assets

  $  3,381,024      $  3,089,521      $  2,928,636      $  2,763,865      $  2,336,353    

Loans, net

   2,056,677       1,884,365       1,806,883       1,681,012       1,461,516    

Investment securities

   1,030,112       916,932       859,185       841,701       650,815    

Deposits

   2,730,531       2,450,527       2,320,056       2,261,794       1,931,599    

Borrowings

   332,090       334,804       337,042       179,806       150,698    

Shareholders’ equity

   293,844       279,532       254,839       253,897       237,194    

Common shareholders’ equity

   276,504       262,192       237,497       236,426       219,721    

Tangible common shareholders’ equity(1)

   209,558       193,553       187,495       186,037       182,352    
          

Selected operations data:

          

Interest income

  $105,450      $101,055      $98,931      $97,567      $95,118    

Interest expense

   10,137       7,281       7,337       9,051       13,255    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   95,313       93,774       91,594       88,516       81,863    

Provision for loan losses

   7,381       7,789       9,079       7,128       7,780    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

   87,932       85,985       82,515       81,388       74,083    

Noninterest income

   30,337       25,350       24,833       24,777       23,925    

Noninterest expense

   79,393       72,355       69,441       71,397       63,794    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

   38,876       38,980       37,907       34,768       34,214    

Income tax expense

   10,539       9,625       12,377       11,319       11,415    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $28,337      $29,355      $25,530      $23,449      $22,799    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Preferred stock dividends and accretion

   1,462       1,462       1,466       1,474       3,182    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income available to common shareholders

  $26,875      $27,893      $24,064      $21,975      $19,617    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          

Stock and related per share data:

          

Earnings per common share:

          

Basic

  $1.91      $2.01      $1.75      $1.60      $1.50    

Diluted

   1.90       2.00       1.75       1.60       1.49    

Cash dividends declared on common stock

   0.80       0.77       0.74       0.57       0.47    

Common book value per share

   19.49       18.57       17.17       17.15       15.92    

Tangible common book value per share(1)

   14.77       13.71       13.56       13.49       13.21    

Market price (NASDAQ: FISI):

          

High

   29.04       27.02       26.59       19.52       20.36    

Low

   21.67       19.72       17.92       15.22       12.18    

Close

   28.00       25.15       24.71       18.63       16.14    
          

Performance ratios:

          

Net income, returns on:

          

Average assets

   0.87%     0.98%     0.91%     0.93%     1.00%  

Average equity

   9.78         10.80         10.10         9.46         9.82      

Average common equity

   9.87         10.96         10.23         9.53         9.47      

Average tangible common equity(1)

   13.16         14.12         13.00         11.74         11.55      

Average tangible assets(1)

   0.84         0.95         0.87         0.89         0.88      

Common dividend payout ratio

   41.88         38.31         42.29         35.63         31.33      

Net interest margin (fully tax-equivalent)

   3.28         3.50         3.64         3.95         4.04      

Effective tax rate

   27.1           24.7           32.7           32.6           33.4        

Efficiency ratio(2)

   61.58%     58.59%     58.48%     62.87%     60.55%  

 

(1)Excludes preferred shareholders’ equity.This is a non-GAAP measure that we believe is useful in understanding our financial performance and condition. Refer to the GAAP to Non-GAAP Reconciliation for further information.
(2)Excludes preferred shareholders’ equity, goodwill and other intangible assets.
(3)Common dividend payout ratio equals dividends declared during the year divided by earnings per share for the year.
(4)Efficiency ratio equals noninterest expense less other real estate expense and amortization and impairment of goodwill and other intangible assets as a percentage of net revenue, defined as the sum of tax-equivalent net interest income and noninterest income before net gains and impairment charges on investment securities, adjustments to contingent liabilities and proceeds from company owned life insurance included in income (all from continuing operations).amortizations of tax credit investment.

 

- 28 -


(Dollars in thousands, except per share data)  At or for the year ended December 31, 
(Dollars in thousands)  At or for the year ended December 31,
  2013 2012 2011 2010 2009   2015 2014 2013 2012 2011

Capital ratios:

            

Leverage ratio(1)

   7.63 7.71 8.63 8.31 7.96   7.41 7.35 7.63 7.71 8.63

Tier 1 capital ratio

   10.82   10.73   12.20   12.34   11.95  

Total risk-based capital ratio

   12.08   11.98   13.45   13.60   13.21  

Equity to assets (3)

   9.01   9.84   10.20   9.75   9.55  

Common equity to assets (1) (3)

   8.39   9.15   9.10   7.28   6.94  

Tangible common equity to tangible assets (2) (3)

   6.72 7.56 7.58 5.65 5.19

Common equity Tier 1 ratio(1)

   9.77   n/a   n/a   n/a   n/a  

Tier 1 capital ratio(1)

   10.50   10.47   10.82   10.73   12.20  

Total risk-based capital ratio(1)

   13.35   11.72   12.08   11.98   13.45  

Average equity to average assets

   8.86   9.08   9.01   9.84   10.20  

Common equity to assets

   8.18   8.49   8.11   8.55   9.40  

Tangible common equity to tangible assets(2)

   6.32 6.41 6.51 6.86 7.93
      

Asset quality:

            

Non-performing loans

  $16,622   $9,125   $7,076   $7,582   $8,681    $        8,440           10,153   $        16,622   $        9,125   $        7,076  

Non-performing assets

   17,083   10,062   9,187   8,895   10,442     8,603   10,347   17,083   10,062   9,187  

Allowance for loan losses

   26,736   24,714   23,260   20,466   20,741     27,085   27,637   26,736   24,714   23,260  

Net loan charge-offs

  $7,057   $5,674   $4,986   $6,962   $5,710    $7,933   6,888   $7,057   $5,674   $4,986  

Non-performing loans to total loans

   0.91 0.53 0.48 0.56 0.69   0.41 0.53 0.91 0.53 0.48

Non-performing assets to total assets

   0.58   0.36   0.39   0.40   0.51     0.25   0.33   0.58   0.36   0.39  

Net charge-offs to average loans

   0.40   0.36   0.36   0.54   0.47     0.40   0.37   0.40   0.36   0.36  

Allowance for loan losses to total loans

   1.46   1.45   1.57   1.52   1.64     1.30   1.45   1.46   1.45   1.57  

Allowance for loan losses to non-performing loans

   161 271 329 270 239   321 272 161 271 329
      

Other data:

            

Number of branches

   50   52   50   50   50     50   49   50   52   50  

Full time equivalent employees

   608   628   575   577   572     660   622   608   628   575  

 

(1)Excludes preferred shareholders’ equity.2015 ratios calculated under Basel III rules, which became effective January 1, 2015.
(2)Excludes preferred shareholders’ equity, goodwillThis is a non-GAAP measure that we believe is useful in understanding our financial performance and other intangible assets.
(3)Ratios calculated using average balancescondition. Refer to the GAAP to Non-GAAP Reconciliation for the periods shown.further information.

 

- 29 -


GAAP to Non-GAAP Reconciliation

(In thousands, except per share data) At or for the year ended December 31,
  2015 2014 2013 2012 2011

Computation of ending tangible common equity:

     

Common shareholders’ equity

  $276,504     $262,192     $237,497     $236,426     $219,721   

Less: Goodwill and other intangible assets, net

  66,946    68,639    50,002    50,389    37,369  
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tangible common shareholders’ equity

  $209,558    $193,553    $187,495    $186,037    $182,352  
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     

Computation of ending tangible assets:

     

Total assets

  $3,381,024    $3,089,521    $2,928,636    $2,763,865    $2,336,353  

Less: Goodwill and other intangible assets, net

  66,946    68,639    50,002    50,389    37,369  
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tangible assets

  $3,314,078    $3,020,882    $2,878,634    $2,713,476    $2,298,984  
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     

Tangible common equity to tangible assets(1)

  6.32%    6.41%    6.51%    6.86%    7.93%  
     

Common shares outstanding

  14,191    14,118    13,829    13,788    13,803  

Tangible common book value per share(2)

  $14.77    $13.71    $13.56    $13.49    $13.21  
     

Computation of average tangible common equity:

     

Average common equity

  $272,367    $254,533    $235,290    $230,527    $207,189  

Average goodwill and other intangible assets, net

  68,138    57,039    50,201    43,399    37,369  
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average tangible common equity

  $204,229    $197,494    $185,089    $187,128    $169,820  
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     

Computation of average tangible common equity:

     

Average assets

  $3,269,890    $2,994,604    $2,803,825    $2,519,258    $2,277,149  

Average goodwill and other intangible assets, net

  68,138    57,039    50,201    43,399    37,369  
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average tangible assets

  $    3,210,752    $    2,937,565    $    2,753,624    $    2,475,859    $    2,239,780  
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     

Net income available to common shareholders

  $26,875    $27,893    $24,064    $21,975    $19,617  

Return on average tangible common equity(3)

  13.16%    14.12%    13.00%    11.74%    11.55%  

Return on average tangible assets(4)

  0.84%    0.95%    0.87%    0.89%    0.88%  

(1)Tangible common shareholders’ equity divided by tangible assets.
(2)Tangible common shareholders’ equity divided by common shares outstanding.
(3)Net income available to common shareholders divided by average tangible common equity.
(4)Net income available to common shareholders divided by average tangible assets.

- 30 -


SELECTED QUARTERLY DATA

 

(Dollars in thousands, except per share data)  Fourth
Quarter
   Third
Quarter
   Second
Quarter
   First
Quarter
   Fourth
    Quarter    
 Third
    Quarter    
 Second
    Quarter    
 First
    Quarter    

2013

        

2015

   

Interest income

  $25,218     24,623     24,342     24,748     $27,487    27,007    25,959    24,997   

Interest expense

   1,838     1,820     1,818     1,861     2,856   2,876   2,555   1,850  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Net interest income

   23,380     22,803     22,524     22,887     24,631   24,131   23,404   23,147  

Provision for loan losses

   2,407     2,770     1,193     2,709     2,598   754   1,288   2,741  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Net interest income, after provision for loan losses

   20,973     20,033     21,331     20,178     22,033   23,377   22,116   20,406  

Noninterest income

   5,735     6,169     6,376     6,553     8,580   7,005   6,455   8,297  

Noninterest expense

   17,386     17,009     17,462     17,584     21,828   19,318   19,236   19,011  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Income before income taxes

   9,322     9,193     10,245     9,147     8,785   11,064   9,335   9,692  

Income tax expense

   2,955     3,029     3,395     2,998     2,150   2,748   2,750   2,891  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Net income

  $6,367     6,164     6,850     6,149     $6,635   8,316   6,585   6,801  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Preferred stock dividends

   366     365     367     368     365   366   366   365  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Net income applicable to common shareholders

  $6,001     5,799     6,483     5,781     $6,270   7,950   6,219   6,436  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

     

Earnings per common share (1):

             

Basic

  $0.44     0.42     0.47     0.42     $0.44   0.56   0.44   0.46  

Diluted

   0.43     0.42     0.47     0.42     0.44   0.56   0.44   0.46  

Market price (NASDAQ: FISI):

             

High

  $26.59     21.99     20.66     20.83     $29.04   25.21   25.50   25.38  

Low

   20.14     18.39     17.92     18.51     24.05   23.54   22.50   21.67  

Close

��  24.71     20.46     18.41     19.96     28.00   24.78   24.84   22.93  

Dividends declared

  $0.19     0.19     0.18     0.18     $0.20   0.20   0.20   0.20  
     

2012

        

2014

   

Interest income

  $25,087    $25,299    $23,731    $23,450     $25,984   25,129   24,883   25,059  

Interest expense

   1,999     2,200     2,343     2,509     1,846   1,871   1,780   1,784  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Net interest income

   23,088     23,099     21,388     20,941     24,138   23,258   23,103   23,275  

Provision for loan losses

   2,520     1,764     1,459     1,385     1,910   2,015   1,758   2,106  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Net interest income, after provision for loan losses

   20,568     21,335     19,929     19,556     22,228   21,243   21,345   21,169  

Noninterest income

   6,283     6,353     6,690     5,451     5,155   7,261   6,577   6,357  

Noninterest expense

   17,541     21,618     16,581     15,657     19,379   17,955   17,808   17,213  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Income before income taxes

   9,310     6,070     10,038     9,350     8,004   10,549   10,114   10,313  

Income tax expense

   2,978     1,805     3,382     3,154     84   3,365   3,082   3,094  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Net income

  $6,332    $4,265    $6,656    $6,196     $7,920   7,184   7,032   7,219  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Preferred stock dividends

   369     368     368     369     365   366   365   366  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

Net income applicable to common shareholders

  $5,963    $3,897    $6,288    $5,827     $7,555   6,818   6,667   6,853  
  

 

   

 

   

 

   

 

   

 

 

 

 

 

 

 

     

Earnings per common share (1):

             

Basic

  $0.44    $0.28    $0.46    $0.43     $0.54   0.49   0.48   0.50  

Diluted

   0.43     0.28     0.46     0.42     0.54   0.49   0.48   0.50  

Market price (NASDAQ: FISI):

             

High

  $19.39    $19.52    $17.66    $17.99     $27.02   24.94   24.88   25.69  

Low

   17.61     16.50     15.51     15.22     22.45   21.71   22.17   19.72  

Close

   18.63     18.64     16.88     16.17     25.15   22.48   23.42   23.02  

Dividends declared

  $0.16    $0.14    $0.14    $0.13     $0.20   0.19   0.19   0.19  

 

(1)Earnings per share data is computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per common share amounts may not equal the total for the year.

 

- 3031 -


20132015 FOURTH QUARTER RESULTS

Net income was $6.4$6.6 million for the fourth quarter of 20132015 compared with $6.3$7.9 million for the fourth quarter of 2012.2014. After preferred dividends, diluted earnings per share was $0.43net income available to common shareholders for the fourth quarters of 2013 and 2012.

Net interest income totaled $23.4 million for the three months ended December 31, 2013, an increase of $292 thousand or 1% over the fourth quarter of 2012. Average earning assets increased $243.72015 was $6.3 million during the fourth quarter 2013or $0.44 per diluted share, compared to the same quarter last year, the result of a $122.3$7.6 million increase in average loans combined with a $121.4 million increase in investment securities.

The net interest margin on a tax-equivalent basis was 3.61%or $0.54 per share in the fourth quarter of 2013, compared with 3.92% in2014.

Net interest income for the fourth quarter of 2012. Our yield on earning-assets decreased 37 basis points in2015 increased $493 thousand compared to the fourth quarter of 2013 compared with the same quarter last year,2014. The increase was primarily related to an increase in average interest-earning assets of $316.3 million, led by a result of cash flows being reinvested$172.3 million increase in the current lowinvestment securities and a $144.0 million increase in loans. The increase was partially offset by a lower net interest rate environment,margin, which includes the impact of our leverage strategy implemented during the first quarter of 2013. The cost of interest-bearing liabilities decreased 730 basis points compared withfrom the fourth quarter of 2012, primarily a result2014 to the fourth quarter of the continued downward re-pricing of our certificates of deposit.2015.

The provision for loan losses was $2.4$2.6 million for the fourth quarter of 20132015 compared with $2.5$1.9 million for the fourth quarter of 2012.2014. Net charge-offs for the fourth quarter of 20132015 were $2.4$2.0 million, or 0.52%0.38% annualized, of average loans, compared to $2.1$1.5 million, or 0.50%0.32% annualized, of average loans in the fourth quarter of 2012. See the sections “Allowance for Loan Losses” and “Non-performing Assets and Potential Problem Loans” for additional information on net charge-offs and non-performing loans.2014.

Noninterest income totaled $5.7was $8.6 million for the fourth quarter of 2013, a 9% decrease over2015 compared to $5.2 million in the fourth quarter of 2012. Decreases2014. The increase was driven primarily by a non-cash fair value adjustment of the contingent consideration liability in net gain on loans held for sale and net gains from the sale of investment securities were partially offset by an increase in other income and lower losses attributed to the sale of other assets when comparing the fourth quarter 2013 comparedof 2015 that resulted in noninterest income of $1.1 million related to the SDN acquisition and the amortization of a historic tax investment in a community-based project which reduced noninterest income by $2.3 million in the fourth quarter of 2014. These types of investments are amortized in the first year the project is placed in service and we recognized the amortization as contra-income, included in noninterest income, with the same quarter last year.an offsetting tax benefit that reduced income tax expense.

Noninterest expense was $17.4$21.8 million for the fourth quarter of 2013, a decrease2015 compared to $19.4 million in the fourth quarter of $1552014. Salaries and employee benefits expense, the largest noninterest expense item, was up $781 thousand or 1% from the fourth quarter of 2012. Lower salaries2014, and employee benefitsreflects a combination of additional personnel to support organic growth as part of the Company’s expansion initiatives and higher pension expense. Noninterest expense computer and data processing and advertising and promotions expense was partially offset by increasesalso included $751 thousand of goodwill impairment in occupancy and equipment expense and professional services expense when comparing the fourth quarter 2013 compared withof 2015 related to the same quarter last year.SDN acquisition, an increase of $176 thousand in professional service fees attributable to the acquisition of Courier Capital, and additional marketing services related to branding and the opening of our new CityGate branch in Rochester, NY.

Income tax expense was $2.2 million in the fourth quarter of 2015 compared to $84 thousand in the fourth quarter of 2014. The increase was driven by the favorable impact of $3.0 million in Federal and New York State historic tax credits realized in the fourth quarter of 2014, as discussed above. As a result of the historic tax credits, the effective tax rate for the fourth quartersquarter of 2013 and 2012, as pre-tax income2014 was essentially unchanged between1.0%, compared with an effective tax rate of 24.5% in the periods.fourth quarter of 2015.

 

- 3132 -


ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion and analysis of our financial position and results of operations and should be read in conjunction with the information set forth under Part I, Item 1A, “Risks Factors”, and our consolidated financial statements and notes thereto appearing under Part II, Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

INTRODUCTION

Financial Institutions, Inc. (the “Parent” and together with all its subsidiaries, “we,””our,” or “us”), is a financial holding company headquartered in New York State, providing bankingState. We offer a broad array of deposit, lending, and nonbankingother financial services to individuals, municipalities and businesses primarily in our Western and Central New York footprint. We have also expandedthrough our wholly-owned New York chartered banking subsidiary, Five Star Bank (the “Bank”). Our indirect lending network to includeincludes relationships with franchised automobile dealers in Western and Central New York, the Capital District of New York and Northern and Central Pennsylvania. ThroughWe also offer insurance services through our wholly-owned bankinginsurance subsidiary, Five Star Bank, we offerScott Danahy Naylon, LLC (“SDN”), a wide range of services, including business and consumer loan and depository services, brokerage and investment advisory services, as well as other financial services and traditional banking services.full service insurance agency.

Our primary sources of revenue are net interest income (interest earned on our loans and securities, net of interest paid on deposits and other funding sources) and noninterest income, particularly fees and other revenue from insurance and financial services provided to customers or ancillary services tied to loans and deposits. Business volumes and pricing drive revenue potential, and tend to be influenced by overall economic factors, including market interest rates, business spending, consumer confidence, economic growth, and competitive conditions within the marketplace. We are not able to predict market interest rate fluctuations with certainty and our asset/liability management strategy may not prevent interest rate changes from having a material adverse effect on our results of operations and financial condition.

EXECUTIVE OVERVIEW

Industry Overview

In December 2013,By law, the Federal Reserve establishes monetary policy to achieve maximum employment, stable prices, and moderate long-term interest rates. Information indicates that economic activity is expanding at a moderate pace. Labor market conditions have improved and a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing. At the same time, the Federal Open Market Committee of the Federal Reserve Board (“FOMC”) keptdetermined that the target range forlikelihood of inflation running persistently below 2% has diminished somewhat since early in 2014 and survey-based measures of longer-term inflation expectations have remained stable.

On December 16, 2015, the FOMC raised the federal funds rate at 0-25by 25 basis points, notingthe first rate hike in over nine years. By the time this rate hike was announced, the market had already priced in much of the impact and we experienced higher borrowing costs in the fourth quarter of 2015 leading up to the Federal Reserve’s anticipated action. The FOMC’s decision was based on their view of the considerable improvement in labor market conditions in 2015 and an expectation that a highly accommodative stanceinflation will rise, over the medium term, to its 2% objective. In December, the FOMC indicated that it expects that economic conditions will warrant only gradual increases in the federal funds rate; however, they also noted that inflation expectations still remain somewhat uncertain and the actual path of monetary policy will remain appropriate after the economy strengthens to support maximum employment and price stability. The FOMC expects to maintain the target federal funds rate at 0-25 basis points for at leastwill depend on the economic outlook as long as the unemployment rate remains above 6.5%, inflation projections are no more than 0.5% above the FOMCs 2% long-run goal and longer-term inflation expectations continue to be well-anchored. The FOMC also announced that due to cumulative progress toward maximum employment and the improvement in the labor market outlook, it will reduce the purchase of agency mortgage-backed securities to $35 billion per month, down from the previous pace of $40 billion per month. The FOMC will also reduce the purchase of longer-term Treasury securities from its previous pace of $45 billion per month to $40 billion per month. These actions are intended to lower longer-term interest rates and support the mortgage and credit markets, among other things.

The actionsinformed by the FOMC have compressed net interest income and net interest margins for the banking industry by maintaining low rates on interest-earning assets. Throughout 2013, margins in the banking industry were pressured downward as higher-yielding legacy assets rolled off and were reinvested in the current low rate environment. Low interest rates, coupled with a competitive lending environment, have proven challenging for the profitability of the banking industry. It is expected that these challenges will continue until interest rates rise.

Although the expectation for capital spending increased during 2013, it is significantly lower than the pre-recession pace of 2006-2007. Reduced capital spending has resulted in record levels of deposits and tempered small businesses demand for loans. The high level of liquidity from the amount of deposits has exacerbated the pressure on net interest margins in the banking industry, as banks are challenged to deploy the excess liquidity at profitable spreads.incoming data.

The banking industry continues to be impacted by new legislative and regulatory reform proposals. In July 2013, the Board of Governors of the Federal Reserve Bank, the FDIC, and the Office of the Comptroller of the Currency (OCC) approved the final U.S. version of the Basel III agreement. Basel III replaces the federal banking agencies’ general risk-based capital rules, includes a narrower definition of capital and requires higher minimum capital levels. Basel III will bebecame effective for “non-advanced approaches” banks, such as us, in 2015. InBasel III raised both the quality and quantity requirements for regulatory capital. Overall, the total regulatory capital ratio for the industry fell in the first quarter of 2015.

The national unemployment rate decreased from 5.6% in December 2013,2014 to 5.0% at December 2015. The unemployment rate has steadily decreased during 2015 and is at the lowest level since April 2008. The unemployment rate has now fallen below the maximum target level set by the FOMC, which supported the increase in the federal banking agencies also adopted final rules implementing a provisionfunds rate in December 2015.

Bank failures continued to slow, with six in 2015 (through September) following 18 in 2014, the lowest levels since 2007. From 2008 to 2014, 507 banks failed and went into receivership with the FDIC, causing estimated losses of the Dodd-Frank Act known as the Volcker Rule, a complex regulation that prohibits banks from engaging in proprietary trading and investments in certain asset classes. Upon initial issuance, a significant unintended consequence emerged, as banks faced impairments on certain investments that were no longer allowed to be held. While the federal banking agencies issued additional guidance in January 2014 allowing banks to retain certain investments that were originally prohibited by the Volcker Rule, it underscored the complexity of the Rule and the potential ramifications$74.01 billion to the industry. A comprehensive discussion of legislative and regulatory matters affecting us can be foundDepository Insurance Fund. This compares to only 10 bank failures in the Supervisionyears from 2003 to 2007. The FDIC’s “problem list” stood at 203 at September 30, 2015, down from a peak of 884 at the end of 2010.

In the third quarter of 2015, FDIC-insured banks reported industry revenue that was largely unchanged from the prior year. Earnings for the third quarter of 2015 were higher than the prior year quarter, driven primarily by a decrease in noninterest expense. The net interest margin for the industry remains near a historic low at 3.08% for the third quarter of 2015, a decline of 7 basis points from the prior-year quarter. A 30-year low on the net interest margin was set in the first quarter of 2015 at 3.02%. Industry-wide, provision for loan losses continued to trend upward with a five-quarter consecutive increase. Through September 2015, all FDIC-insured institutions reported a return on average assets of 1.05%, a return on average equity of 9.33%, a net charge-off ratio of 0.42% and Regulation section included in Part 1, Item 1,an efficiency ratio of this Annual Report on Form 10-K.60.0%.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Issuance of Subordinated Notes

In April 2015, the Parent issued $40.0 million of 6.0% fixed to floating rate subordinated notes due April 15, 2030 (the “Subordinated Notes”) to certain accredited investors. The Subordinated Notes bear interest at a fixed rate of 6.0% per year, payable semi-annually, for the first 10 years. From April 15, 2025 to April 15, 2030, the interest rate will reset quarterly to an annual interest rate equal to the then current three-month London Interbank Offered Rate (LIBOR) plus 3.944%, payable quarterly. We may redeem the Subordinated Notes on any quarterly interest payment date beginning on April 15, 2025 to maturity at par, plus accrued and unpaid interest. We used the net proceeds from this offering for general corporate purposes, including but not limited to, contribution of capital to the Bank to support both organic growth as well as opportunistic acquisitions. The Parent contributed $34.0 million of net proceeds from this offering to the Bank as capital to support general corporate purposes. The Subordinated Notes qualify as Tier 2 capital for regulatory purposes.

20132015 Financial Performance Review

During 20132015 we continued to strengthenexecute on our balance sheet, as measured by ongoing deposit growth and quality loandiversification strategy and saw progress in our core banking franchise with robust growth in commercialboth loans and consumer indirect lending. Our depositdeposits. We also continued to integrate the SDN insurance platform into our sales process and, lending growth isduring the resultfourth quarter, announced our agreement to purchase Courier Capital Corporation as our wealth management platform, which closed at the beginning of our execution on key strategic initiatives over the last few years. We have done all of this while controlling expenses through disciplined expense management.2016.

In 2013, we reported netNet income of $25.5for 2015 was $28.3 million, compared to $23.4$29.4 million for 2012.2014. This resulted in a 0.91%0.87% return on average assets and a 13.00%9.78% return on average tangible common equity. Net income available to common shareholders was $24.1$26.9 million or $1.75$1.90 per diluted share for 2013,2015, compared to $22.0$27.9 million or $1.60$2.00 per diluted common share for 2012.2014. We declared cash dividends of $0.74$0.80 during 2013,2015, an increase of $0.17$0.03 per common share or 30%4% compared to the prior year. In addition, we grew our base of consumer and business customers while our efficiency ratio improved to 58.48% in 2013 from 62.87% in 2012.

Fully-taxable equivalent net interest income was $94.2$98.4 million in 2013,2015, an increase of $3.4$1.8 million, or 4%2%, compared with 2012.2014. This reflected the impact of 19%9% growth in average investment securities and 10% average loan growth,interest-earning assets, offset by a 3122 basis point decline in the net interest margin to 3.64%3.28%. The loan growth reflected

During the fourth quarter of 2015, we recognized a 7% increase in average commercial loans, an 18% increase in average home equitiesnon-cash goodwill impairment charge of $751 thousand and a 13% increasenon-cash fair value adjustment of the contingent consideration liability that resulted in average automobile loans.

Noninterestnoninterest income was $24.8 million in 2013, relatively unchanged from the prior year. Service charges on deposits increased $1.3 million and ATM and debit card income increased $382 thousand in 2013, reflecting volume growth resulting from the 2012 branch acquisitions and changes we made in the second quarter of 2013 to our fee waiver process. An increase in sales volume primarily contributed to a $241 thousand increase in investment advisory income in 2013. Mortgage banking income was down $1.4 million due to a reduction in volume, lower gains on sale, and a higher percentage of originations retained on our balance sheet.

Noninterest expense was $69.4 million in 2013, a 3% decrease compared with 2012. Noninterest expense for 2012 included expenses totaling $3.0$1.1 million related to the 2012 branch acquisitionsSDN acquisition. The fair value of the consideration was recorded at the time of the SDN acquisition and $2.6was included in goodwill as a component of the purchase price.

Noninterest income totaled $30.3 million relatedfor the full year 2015, an increase of $5.0 million or 20% when compared to the retirementprior year. Insurance income increased by $2.8 million to $5.2 million during the current year as 2015 reflects the benefit of our former CEO. These expenses werea full year of revenue associated with the 2014 SDN acquisition. 2015 noninterest income reflects the $1.1 million gain due to the reduction in the estimate of the fair value of the contingent consideration liability recorded for SDN as previously mentioned. Also included in salariesnoninterest income is the amortization of a historic tax investment in a community-based project which reduced noninterest income by $390 thousand and employee$2.3 million for the years ended December 31, 2015 and 2014, respectively. These types of investments are amortized in the first year the project is placed in service and we recognized the amortization as contra-income, included in noninterest income, with an offsetting tax benefit that reduced income tax expense. Adding to these increases was a $1.2 million decline in service charges on deposits, due primarily to lower overdraft fees stemming from reduced activity.

Noninterest expense for the full year 2015 totaled $79.4 million, a $7.0 million increase compared to $72.4 million in the prior year. Salaries and benefits ($2.9 million),expense increased $3.8 million year-over-year, reflecting the full year impact of the addition of employees from SDN and increased staffing associated with the our expansion initiatives. A higher occupancy and equipment ($56 thousand), professional services ($1.1 million),expense, computer and data processing ($480 thousand), supplies and postage ($395 thousand), advertising and promotions ($56 thousand)expense, the previously mentioned goodwill impairment charge and other expense ($591 thousand) for 2012. Excluding these expenses, which we consider to be non-recurring in nature, noninterest expense increased $3.6contributed to the increase.

Income tax expense for the year was $10.5 million, or 5% when comparing 2013 to 2012.representing an effective tax rate of 27.1% compared with an effective tax rate of 24.7% in 2014. The lower effective tax rate in 2014 reflects the historic tax credit benefit described above.

Asset quality related metrics remain strong despite the increase in nonaccrual and non-performing assets in 2013. NonaccrualNon-performing loans increased $7.5decreased $1.7 million compared to a year ago to $16.6 million. Non-performing assets increased $7.0 million compared to a year ago to $17.1$8.4 million, or 0.58%0.41% of total assets. The increases primarily reflect the addition of one commercial mortgage loan with a principal balance of $6.9 million at December 31, 2013.loans. The provision for loan losses increased $2.0 million,decreased $408 thousand, or 27%5%, from 20122014 as we continue to maintain the allowance for loan losses consistent with the growth in our loan portfolio and improving trends in asset quality. Net charge-offs increased $1.4$1.0 million or 24%, from the prior year to $7.1 million.$7.9 million in 2015. Net charge-offs were an annualized 0.40% of average loans in the current year compared to 0.36%0.37% in 2012.2014.

The tangible common equity to tangible assetsCompany’s leverage ratio was 7.41% at December 31, 2013, was 6.51%, down 35 basis points from a year ago. Our2015 compared to 7.35% at December 31, 2014. The increase in the leverage ratio at year end was 7.63%, downdue to higher regulatory capital, which excludes changes in accumulated other comprehensive income. During the second quarter of 2015, the Parent contributed $34.0 million of net proceeds from 7.71% at the end of 2012.Subordinated Notes offering to the Bank as additional paid-in capital. The decrease in the tangible common equity to tangible assets andBank’s leverage ratios reflect our asset growth outpacing the increase in retained earnings. Our tier 1ratio and total risk-based capital ratiosratio were 10.82%8.09% and 12.08%12.66%, respectively, at December 31, 2013, up from 10.73% and 11.98%, respectively, at December 31, 2012.2015.

Branch Consolidations

In October 2013, we closed our Pavilion and North Java branches and transferred customer accounts and employees into nearby branches. These branch consolidations are one component of our long term strategic plan, which provides for the optimal combination of branches and online/mobile banking technologies, supported by highly experienced bankers, to offer customers convenience and high service levels while maintaining an efficient, competitive cost structure. Expenses related to the consolidation of these two branches were not material. In January 2014, we consolidated one of our supermarket branches into a nearby location in Batavia.

Dissolution of Broker-Dealer

During late 2013, our subsidiary, Five Star Investment Services, Inc. (“FSIS”) ceased operations as an active broker-dealer and the securities licenses of advisors associated with FSIS who elected to transfer, as well as their respective client accounts which had previously cleared through a third-party platform, were transferred to the LPL Financial (“LPL”) clearing platform. Following the completion of these transfer activities, FSB began offering investment and securities-related services, including brokerage and investment advice through a strategic partnership with LPL. FSB has employees who are LPL registered representatives, located throughout its branch network, offering customers insurance and investment products including stocks, bonds, mutual funds, annuities, and managed accounts through a program called Five Star Investment Services. FSIS withdrew its registration with the Financial Industry Regulatory Authority (“FINRA”) effective December 31, 2013, and is expected to be dissolved in 2014.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

2012 Branch Acquisitions2016 Outlook

During 2012, we successfully completed the acquisition of eight retail bank branch locationsWe begin 2016 in Upstate New York. Former HSBC Bank USA, N.A. branches located in Albion, Elmira, Elmira Heights,a strong financial condition and Horseheads were acquired in August, complementing the former First Niagara Bank, N.A. locations in Batavia, Brockport, Medina, and Seneca Falls acquired in June. Through the acquisition we assumed deposits of $286.8 million and acquired in-market performing loans of $75.6 million. The acquisition of these branch offices was a marked success. We were able to integrate the offices and customer accounts seamlessly. Through detailed planning, we ensured that our sales and support staff members were ready to assist customers with any questions or issues. The feedback we received from our customers was positive and executing on our detailed planning process ultimately resulted in deposit retention rates that were better than expected. We incurred approximately $3.0 million in pre-tax expense during 2012 related to the branch acquisitions.

The combined assets acquired and deposits assumed in the two transactions were recorded at their estimated fair values as follows:

Cash

  $195,778  

Loans

   75,635  

Bank premises and equipment

   1,938  

Goodwill

   11,167  

Core deposit intangible asset

   2,042  

Other assets

   601  
  

 

 

 

Total assets acquired

  $287,161  
  

 

 

 

Deposits assumed

  $286,819  

Other liabilities

   342  
  

 

 

 

Total liabilities assumed

  $287,161  
  

 

 

 

For detailed information on the accounting for the branch acquisitions, see Note 2, Branch Acquisitions, of the notes to consolidated financial statements.

2014 Expectations

momentum. Net interest income is expected to increase moderately in 2014.2016. We anticipate an increase in earning assets as we remainedremain focused on loan growth, which will be partlyprimarily funded with expected paydowns and liquidity from our securities portfolio.through deposit gathering. However, those benefits to net interest income are expected to be partially offset by continuedslight downward pressure on net interest margin. We plan to maintain a disciplined approach to loan pricing, but asset yields remain under pressure due to the low interest rate environment and flattening of the yield curve, while the opportunity for deposit repricing isremains limited.

TheWe expect our commercial loan portfolio is expected to grow in a manner consistent with our strategic initiatives and continued support of middle market small business lending. Automobile loan originations remain strong, reflecting the positive impact from our investment in automotive dealer relationships. The home equityresidential real estate portfolio, which includes both first and junior lien residential real estate related products, is expected to increase as we remain focused on the lower origination cost to customerscustomer experience and theour convenient application process has made these products an increasingly attractive alternative to conventional residential mortgage loans, accordingly we expect run-off to outpace new originations in the residential mortgage portfolio.process.

We anticipate the increase in total loans will modestly outpace growth in total deposits. This anticipated outcome reflects our continued focus on targeting loyal relationship-based deposit customers rather those that are more price sensitive. We expect to continue managing the overall cost of funds through the use ofusing short-term borrowings, as well as theour continued shift in mix of deposits towards low- and no-cost demand deposits and money market deposit accounts.

Noninterest income during 2016 is expected to be slightly higher than recent levels,2015, reflecting our continued efforts to increase both account and transaction-based fee income. Managementincome, coupled with the benefit of revenue from our fee-based subsidiaries, SDN and Courier Capital. We anticipate this will continue to explore opportunities to increase noninterestfurther reduce our reliance on traditional spread-based net interest income, from non-deposit related sources.as fee-based activities are a relatively stable revenue source during periods of changing interest rates.

Noninterest expense is expected to remain around current levels asbe higher with the addition of Courier Capital, coupled with higher salaries and benefits costs associated with our expansion initiatives, namely the opening of our second financial solution center in Rochester, New York; otherwise, we remain committed to diligent expense control during 2014.2016.

We do not expect significant changes in overall asset quality and allowance measurements.

The effective tax rate for 20142016 is expected to be slightly higher than 2015, as the lower primarily reflectingeffective tax rate in 2015 was partly driven by historic tax credits claimed in 2015. However, our 2016 effective tax rate will continue to reflect the positive impacts of tax-exempt income, tax advantaged investments, and the formation of our real estate investment trust in early 2014.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

2014 and benefits from New York State tax law changes that began going into effect during 2015.

RESULTS OF OPERATIONS FOR THE YEARS ENDED

DECEMBER 31, 20132015 AND DECEMBER 31, 20122014

Significant Items Influencing Financial Performance Comparisons

Earnings comparisons among the years ended December 31, 2013 and 2012 were impacted by the significant items summarized below.

Retirement of Former CEO. In August 2012, Peter G. Humphrey our former President and Chief Executive Officer retired. We incurred approximately $2.6 million in pre-tax expense during 2012 related to the retirement of Mr. Humphrey.

2012 Branch Acquisitions. During 2012, we completed the acquisition of eight retail bank branch locations in Upstate New York. We incurred approximately $3.0 million in pre-tax expense during 2012 related to the branch acquisitions.

Net Interest Income and Net Interest Margin

Net interest income is theour primary source of our revenue. Net interest income is the difference between interest income on interest-earning assets, such as loans and investment securities, and the interest expense on interest-bearing deposits and other borrowings used to fund interest-earning and other assets or activities. Net interest income is affected by changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, as well as the sensitivity of the balance sheet to changes in interest rates, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities and repricing frequencies.

InterestWe use interest rate spread and net interest margin are utilized to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on earning assets and the rate paid for interest-bearing liabilities that fund those assets. The net interest margin is expressed as the percentage of net interest income to average earning assets. The net interest margin exceeds the interest rate spread because noninterest-bearing sources of funds (“net free funds”), principally noninterest-bearing demand deposits and shareholders’ equity, also support earning assets. To compare tax-exempt asset yields to taxable yields, the yield on tax-exempt investment securities is computed on a taxable equivalent basis. Net interest income, interest rate spread, and net interest margin are discussed on a taxable equivalent basis.

The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, increased to 3.50% in December 2015 after remaining at 3.25% since 2008. At about the same time, the intended federal funds rate, which is the cost of immediately available overnight funds, increased to a range of 0.25% to 0.50% after remaining at zero to 0.25% since 2008.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Net Interest Income and Net Interest Margin

The following table reconciles interest income per the consolidated statements of income to interest income adjusted to a fully taxable equivalent basis for the years ended December 31 (in thousands):

   2013   2012   2011 

Interest income per consolidated statements of income

  $98,931    $97,567    $95,118  

Adjustment to fully taxable equivalent basis

   2,650     2,284     2,062  
  

 

 

   

 

 

   

 

 

 

Interest income adjusted to a fully taxable equivalent basis

   101,581     99,851     97,180  

Interest expense per consolidated statement of income

   7,337     9,051     13,255  
  

 

 

   

 

 

   

 

 

 

Net interest income on a taxable equivalent basis

  $94,244    $90,800    $83,925  
  

 

 

   

 

 

   

 

 

 

2013 Leverage Strategy

   2015   2014   2013 

Interest income per consolidated statements of income

   $        105,450      $        101,055      $        98,931   

Adjustment to fully taxable equivalent basis

   3,097      2,853      2,650   
  

 

 

   

 

 

   

 

 

 

Interest income adjusted to a fully taxable equivalent basis

   108,547      103,908      101,581   

Interest expense per consolidated statements of income

   10,137      7,281      7,337   
  

 

 

   

 

 

   

 

 

 

Net interest income on a taxable equivalent basis

   $98,410      $96,627      $94,244   
  

 

 

   

 

 

   

 

 

 

During the firstsecond quarter of 2013,2015, we utilizedused the proceeds of short-term FHLBFederal Home Loan Bank (“FHLB”) advances to purchase high-quality investment securities as part of a leverage strategy of approximately $100$50 million. Our purchase of investment securities was comprised of mortgage-backed securities, U.S. Government agencies and sponsored enterprise bonds and tax-exempt municipal bonds. All of the securities purchased were of high credit quality with a low to moderate duration. This strategy allowed us to increase net interest income by taking advantage of the positive interest rate spread between the FHLB advances and the newly acquired investment securities. While the underlying leverage strategy contributed

Net interest income on a taxable equivalent basis for 2015 increased $1.8 million or 2%, compared to a lower2014. The increase was due to an increase in average interest-earning assets of $241.4 million or 9% compared to 2014. The net interest margin it successfully increased net interest income by approximately $1.1 millionwas 3.28% for the year ended December 31, 2013.

Taxable equivalent net interest income of $94.2 million for 2013 was $3.4 million or 4% higher than 2012. The impact of a decline2015 declined compared to 3.50% in average yields on our assets was diminished by a $288.7 million or 13% increase in interest-earning assets. The average balance of loans rose $158.1 million or 10% to $1.75 billion, reflecting growth in most loan categories. Consistent with our strategic plan, we continue to pursue loan development efforts in the commercial and consumer indirect lending portfolios in accordance with prudent underwriting standards.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

The increase in taxable equivalent net interest income2014. This decrease was a function of a favorable volume variance as balance sheet changes23 basis point decrease in both volume and mix increased taxable equivalent net interest income by $10.8 million,rate spread to 3.19% during 2015, partially offset by an unfavorable rate variance that decreased taxable equivalent net interest income by $7.4 million. The change in mix and volume of earning assets increased taxable equivalent interest income by $10.8 million, while the change in volume and composition of interest-bearing liabilities decreased interest expense by $70 thousand, for a net favorable volume impact of $10.8 million on taxable equivalent net interest income. Rate changes on earning assets reduced interest income by $9.0 million, while changes in rates on interest-bearing liabilities lowered interest expense by $1.6 million, for a net unfavorable rate impact of $7.4 million.

The net interest margin for 2013 was 3.64% compared to 3.95% in 2012. As discussed in the industry overview above, the actions by the FOMC have compressed net interest income and net interest margins for the banking industry by maintaining low rates on interest-earning assets. Throughout 2013, margins in the banking industry were pressured downward as higher-yielding legacy assets rolled off and were reinvested in the current low rate environment. Low interest rates, coupled with a competitive lending environment, have proven challenging for the profitability of the banking industry. It is expected that these challenges will continue until interest rates rise.

The decrease in net interest margin was attributable to a 31 basis point lowerhigher contribution from net free funds (primarily attributable tofunds. The lower rates on interest-bearing liabilities reducing the value of noninterest-bearing deposits and other net free funds). The interest rate spread decreased by 28 basis points to 3.57% for the year ended December 31, 2013, aswas a 42net result of a 14 basis point decrease in the yield on earning assets more than offset the 14and a 9 basis point decreaseincrease in the cost of interest-bearing liabilities.

For 2013,the year ended December 31, 2015, the yield on average earning assets of 3.93%3.62% was 4214 basis points lower than 2012.2014. Loan yields decreased 4417 basis points during 2015 to 4.65%4.21%. Commercial mortgage and consumer indirect loansloan yields in particular, down 45 and 6631 basis points, respectively, continued to experienceexperienced lower yields given thebecause of competitive pricing pressures and re-pricing of loans in a low interest rate environment. The yield on investment securities dropped 25increased 2 basis points during 2015 to 2.41%, also impacted by2.46%. Overall, the low interest rate environment, prepayments of mortgage-related investment securities and the previously mentioned 2013 leverage strategy. Overall, earning asset rate changes reduced interest income by $9.0 million.

The average cost of interest-bearing deposits$2.9 million during 2015, but that was 0.36% in 2013, 14 basis points lowermore than 2012, reflecting the low interest rate environment, mitigatedoffset by a focus on product pricing to retain balances. The cost of borrowings decreased 9 basis points to 0.39% for 2013. The interest-bearing liability rate changes reducedfavorable volume variance that increased interest expenseincome by $1.6$7.5 million, during 2013.which collectively drove a $4.6 million increase in interest income.

Average interest-earning assets were $3.00 billion for 2015, an increase of $2.59 billion in 2013 were $288.7$241.4 million or 13% higher than 2012. Average investment securities increased $130.6 million while9% from the prior year, with average loans increased $158.1up $104.9 million and average securities up $136.5 million. Average loans were $1.99 billion for 2015, an increase of $104.9 million or 10%.6% from the prior year. The growth in average loans was comprised ofreflected increases in most loan categories, with consumercommercial and commercialconsumer loans up $116.9$65.1 million and $45.2$49.4 million, respectively, partially offset by a $4.1$9.6 million decrease in residential mortgage loans. Loans made up 66.2% of average interest-earning assets during 2015 compared to 68.2% during 2014. Loans generally have significantly higher yields compared to securities and federal funds sold and interest-bearing deposits and, as such, have a more positive effect on the net interest margin. The yield on average loans was 4.21% for 2015, a decrease of 17 basis points compared to 4.38% for 2014. The yield on average loans was negatively impacted by lower average spreads due to increased competition in loan pricing during 2015 compared to 2014. The increase in the volume of average loans resulted in a $4.3 million increase in interest income, partially offset by a $3.2 million decrease due to the unfavorable rate variance. Average securities were $1.01 billion for 2015, an increase of $136.5 million or 16% from the prior year. The growth in average securities was primarily a result of securities purchased with proceeds from our previously described leverage strategy and issuance of the Subordinated Notes. Securities made up 33.8% of average interest-earning assets in 2015 compared to 31.8% in 2014. The yield on average securities was 2.46% in 2015 compared to 2.44% in 2014. The increase in the volume of average securities resulted in a $3.2 million increase in interest income, coupled with a $268 thousand increase due to the favorable rate variance.

For the year ended December 31, 2015, the cost of average interest-bearing liabilities of 0.43% was 9 basis points higher than 2014. The cost of average interest-bearing deposits increased 2 basis points to 0.35% and the cost of short-term borrowings increased 4 basis points to 0.41% in 2015 compared to 2014. The cost of long-term borrowings for 2015 was 6.28% due to the issuance of the Subordinated Notes in April. Overall, interest-bearing liability rate and volume increases resulted in $2.9 million of higher interest expense.

Average interest-bearing liabilities of $2.03$2.36 billion in 20132015 were up $203.0$198.8 million or 11% versus 2012.9% higher than 2014. On average, interest-bearing deposits grew $134.5$156.4 million, while average noninterest-bearing demand deposits (a principal component of net free funds) increased by $79.1were up $53.4 million. The increase in average deposits reflects the full-year impactwas due in part to successful business development efforts and an increase in deposits from our Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) programs. For further discussion of the deposits acquired in the 2012 branch acquisitions. Average borrowings increased $68.6 million, largely dueCDARS and ICS programs, refer to the incremental“Funding Activities - Deposits” section of this Management’s Discussion and Analysis. Overall, interest-bearing deposit rate and volume changes resulted in $940 thousand of higher interest expense during 2015. Average short-term and long-term borrowings associatedwere $290.4 million in 2015, $42.4 million higher than in 2014, with the majority of the increase related to the issuance of the previously mentioned 2013 leverage strategy.Subordinated Notes. Overall, short and long-term borrowing rate and volume changes resulted in $1.9 million of higher interest expense during 2015.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The following tables present, for the periods indicated, information regarding: (i) the average balance sheet; (ii) the amount of interest income from interest-earning assets and the resulting annualized yields (tax-exempt yields have been adjusted to a tax-equivalent basis using the applicable Federal tax rate in each year); (iii) the amount of interest expense on interest-bearing liabilities and the resulting annualized rates; (iv) net interest income; (v) net interest rate spread; (vi) net interest income as a percentage of average interest-earning assets (“net interest margin”); and (vii) the ratio of average interest-earning assets to average interest-bearing liabilities. Investment securities are at amortized cost for both held to maturity and available for sale securities. Loans include net unearned income, net deferred loan fees and costs and non-accruing loans. Dollar amounts are shown in thousands.

 

 Years ended December 31, 
  Years ended December 31,  2015 2014 2013 
  2013 2012 2011      Average       Average     Average       Average Average   Average 
  Average
Balance
 Interest   Average
Rate
 Average
Balance
 Interest   Average
Rate
 Average
Balance
 Interest   Average
Rate
  Balance  Interest  Rate Balance  Interest  Rate     Balance      Interest  Rate 

Interest-earning assets:

                      

Federal funds sold and other interest-earning deposits

  $191   $—       0.19 $113   $—       0.29 $140   $—       0.20 $37   $-     0.40%   $114   $-     0.14%   $191   $   0.19%  

Investment securities:

                      

Taxable

   601,146   12,541     2.09   525,912   12,202     2.32   545,112   14,185     2.60   727,564   16,123   2.22       617,738   13,304   2.15       601,146   12,541    2.09      

Tax-exempt

   233,067   7,572     3.25   177,731   6,526     3.67   140,657   5,890     4.19   286,607   8,849   3.09       259,935   8,151   3.14       233,067   7,572    3.25      
  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total investment securities

   834,213    20,113     2.41    703,643    18,728     2.66    685,769    20,075     2.93   1,014,171   24,972   2.46       877,673   21,455   2.44       834,213   20,113    2.41      

Loans:

                      

Commercial business

   256,236    11,311     4.41    242,100    11,263     4.65    215,598    10,311     4.78   286,019   11,774   4.12       269,877   11,471   4.25       256,236   11,311    4.41      

Commercial mortgage

   438,821    21,878     4.99    407,737    22,182     5.44    370,843    21,216     5.72   522,328   24,136   4.62       473,372   23,345   4.93       438,821   21,878    4.99      

Residential mortgage

   123,277    6,174     5.01    127,363    6,637     5.21    121,742    6,868     5.64   97,651   4,460   4.57       107,254   5,122   4.78       123,277   6,174    5.01      

Home equity

   304,868    12,446     4.08    257,537    10,984     4.27    216,428    9,572     4.42   396,906   15,262   3.85       359,511   14,149   3.94       304,868   12,446    4.08      

Consumer indirect

   604,148    26,976     4.47    533,589    27,371     5.13    444,527    26,549     5.97   665,454   25,746   3.87       651,279   25,970   3.99       604,148   26,976    4.47      

Other consumer

   24,089    2,683     11.14    25,058    2,686     10.72    24,686    2,589     10.49   18,969   2,197   11.58       21,094   2,396   11.36       24,089   2,683    11.14      
  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total loans

   1,751,439    81,468     4.65    1,593,384    81,123     5.09    1,393,824    77,105     5.53   1,987,327   83,575   4.21       1,882,387   82,453   4.38       1,751,439   81,468    4.65      
  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total interest-earning assets

   2,585,843    101,581     3.93    2,297,140    99,851     4.35    2,079,733    97,180     4.67   3,001,535   108,547   3.62       2,760,174   103,908   3.76       2,585,843   101,581    3.93      
   

 

   

 

   

 

   

 

   

 

   

 

   

 

  

 

   

 

  

 

   

 

  

 

 

Less: Allowance for loan losses

   26,000       24,305       21,567      27,599     27,455     26,000    

Other noninterest-earning assets

   243,982       246,423       218,983      295,954     261,885     243,982    
  

 

     

 

     

 

     

 

    

 

    

 

   

Total assets

  $2,803,825      $2,519,258      $2,277,149      $3,269,890     $2,994,604     $2,803,825    
  

 

     

 

     

 

     

 

    

 

    

 

   

Interest-bearing liabilities:

                      

Deposits:

                      

Interest-bearing demand

  $488,047    729     0.15   $423,096    598     0.14   $383,122    614     0.16   $543,690   754   0.14       $504,584   607   0.12       $488,047   729    0.15      

Savings and money market

   727,737    978     0.13    586,329    998     0.17    451,030    1,056     0.23   908,614   1,166   0.13       783,784   913   0.12       727,737   978    0.13      

Certificates of deposit

   621,455    4,893     0.79    693,353    6,866     0.99    712,411    9,764     1.37  

Time deposits

 616,747   5,386   0.87       624,299   4,846   0.78       621,455   4,893    0.79      
  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total interest-bearing deposits

   1,837,239    6,600     0.36    1,702,778    8,462     0.50    1,546,563    11,434     0.74   2,069,051   7,306   0.35       1,912,667   6,366   0.33       1,837,239   6,600    0.36      

Short-term borrowings

   190,310    737     0.39    121,735    589     0.48    99,122    500     0.50   262,494   1,081   0.41       247,956   915   0.37       190,310   737    0.39      

Long-term borrowings

   —      —       —      —      —       —      15,905    1,321     8.31   27,886   1,750   6.28        -      -      -        -      -      -      
  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total borrowings

   190,310    737     0.39    121,735    589     0.48    115,027    1,821     1.58   290,380   2,831   0.98       247,956   915   0.37       190,310   737    0.39      
  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total interest-bearing liabilities

   2,027,549    7,337     0.36    1,824,513    9,051     0.50    1,661,590    13,255     0.80   2,359,431   10,137   0.43       2,160,623   7,281   0.34       2,027,549   7,337    0.36      
   

 

   

 

   

 

   

 

   

 

   

 

   

 

  

 

   

 

  

 

   

 

  

 

 

Noninterest-bearing deposits

   509,383       430,240       368,268      599,334     545,904     509,383    

Other liabilities

   14,207       16,506       15,041      21,418     16,203     14,207    

Shareholders’ equity

   252,686       247,999       232,250      289,707     271,874     252,686    
  

 

     

 

     

 

     

 

    

 

    

 

   

Total liabilities and shareholders’ equity

  $2,803,825      $2,519,258      $2,277,149      $3,269,890     $2,994,604     $2,803,825    
  

 

     

 

     

 

     

 

    

 

    

 

   

Net interest income (tax-equivalent)

   $94,244      $90,800      $83,925      $98,410     $96,627     $94,244    
   

 

     

 

     

 

     

 

    

 

    

 

  

Interest rate spread

      3.57     3.85     3.87   3.19%     3.42%     3.57%  
     

 

     

 

     

 

    

 

    

 

    

 

 

Net earning assets

  $558,294      $472,627      $418,143      $642,104     $599,551     $558,294    
  

 

     

 

     

 

     

 

    

 

    

 

   

Net interest margin (tax-equivalent)

      3.64     3.95     4.04   3.28%     3.50%     3.64%  
     

 

     

 

     

 

    

 

    

 

    

 

 

Ratio of average interest-earning assets to average interest-bearing liabilities

   127.54     125.90     125.17    127.21%     127.75%     127.54%    
  

 

     

 

     

 

     

 

    

 

    

 

   

The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment. A discussion of the effects of changing interest rates on net interest income is set forth in Item 7A. Quantitative and Qualitative Disclosures About Market Risk included elsewhere in this report.

 

- 37 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Rate /Volume Analysis

The following table presents, on a tax-equivalent basis, the relative contribution of changes in volumes and changes in rates to changes in net interest income for the periods indicated. The change in interest not solely due to changes in volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each (in thousands):

 

  Change from 2013 to 2012 Change from 2012 to 2011  Change from 2015 to 2014 Change from 2014 to 2013
Increase (decrease) in:  Volume Rate Total Volume Rate Total      Volume           Rate             Total                  Volume           Rate             Total      

Interest income:

              

Federal funds sold and other interest-earning deposits

  $—     $—     $—     $—     $—     $—    

Investment securities:

           

Taxable

   1,643   (1,304 339   (487 (1,496 (1,983  $2,424    $395    $2,819     $351    $412    $763  

Tax-exempt

   1,861   (815 1,046   1,422   (786 636   825   (127 698    850   (271 579  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

 

 

 

  

 

 

 

 

 

Total investment securities

   3,504    (2,119  1,385    935    (2,282  (1,347 3,249   268   3,517    1,201   141   1,342  

Loans:

           

Commercial business

   640    (592  48    1,239    (287  952   672   (369 303    589   (429 160  

Commercial mortgage

   1,624    (1,928  (304  2,041    (1,075  966   2,320   (1,529 791    1,706   (239 1,467  

Residential mortgage

   (209  (254  (463  308    (539  (231 (446 (216 (662  (775 (277 (1,052

Home equity

   1,948    (486  1,462    1,763    (351  1,412   1,444   (331 1,113    2,164   (461 1,703  

Consumer indirect

   3,383    (3,778  (395  4,879    (4,057  822   558   (782 (224  2,009   (3,015 (1,006

Other consumer

   (106  103    (3  39    58    97   (245 46   (199  (339 52   (287
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

 

 

 

  

 

 

 

 

 

Total loans

   7,280    (6,935  345    10,269    (6,251  4,018   4,303   (3,181 1,122    5,354   (4,369 985  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

 

 

 

  

 

 

 

 

 

Total interest income

   10,784    (9,054  1,730    11,204    (8,533  2,671    7,552    (2,913  4,639     6,555    (4,228  2,327  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

 

 

 

  

 

 

 

 

 

Interest expense:

           

Deposits:

           

Interest-bearing demand

   96    35    131    60    (76  (16 49   98   147    24   (146 (122

Savings and money market

   214    (234  (20  271    (329  (58 154   99   253    71   (136 (65

Certificates of deposit

   (663  (1,310  (1,973  (255  (2,643  (2,898

Time deposits

 (60 600   540    22   (69 (47
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

 

 

 

  

 

 

 

 

 

Total interest-bearing deposits

   (353  (1,509  (1,862  76    (3,048  (2,972 143   797   940    117   (351 (234

Short-term borrowings

   283    (135  148    110    (21  89   56   110   166    214   (36 178  

Long-term borrowings

   —      —      —      (660  (661  (1,321 875   875   1,750     -    -    -  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

 

 

 

  

 

 

 

 

 

Total borrowings

   283    (135  148    (550  (682  (1,232 931   985   1,916    214   (36 178  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

 

 

 

  

 

 

 

 

 

       

Total interest expense

   (70  (1,644  (1,714  (474  (3,730  (4,204  1,074    1,782    2,856     331    (387  (56
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

 

 

 

  

 

 

 

 

 

Net interest income

  $10,854   $(7,410 $3,444   $11,678   $(4,803 $6,875    $6,478    $(4,695  $1,783     $6,224    $(3,841  $2,383  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

 

 

 

  

 

 

 

 

 

Provision for Loan Losses

The provision for loan losses is based upon credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimate of losses inherent in the current loan portfolio. The provision for loan losses was $9.1$7.4 million for the year ended December 31, 20132015 compared with $7.1$7.8 million for 2012.2014. See the “Allowance for Loan Losses” section of this Management’s Discussion and Analysis for further discussion.

 

- 38 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Noninterest Income

The following table summarizes our noninterest income for the years ended December 31 (in thousands):

   2013  2012  2011 

Service charges on deposits

  $9,948    8,627    8,679  

ATM and debit card

   5,098    4,716    4,359  

Investment advisory

   2,345    2,104    1,829  

Company owned life insurance

   1,706    1,751    1,424  

Loan servicing

   570    617    835  

Net gain on sale of loans held for sale

   117    1,421    880  

Net gain on disposal of investment securities

   1,226    2,651    3,003  

Impairment charges on investment securities

   —      (91  (18

Net (loss) gain on sale and disposal of other assets

   (103  (381  67  

Other

   3,926    3,362    2,867  
  

 

 

  

 

 

  

 

 

 

Total noninterest income

  $24,833    24,777    23,925  
  

 

 

  

 

 

  

 

 

 

Service charges on deposits were $9.9 million for 2013, an increase of $1.3 million or 15%, compared to 2012. ATM and debit card income was $5.1 million for 2013, an increase of $382 thousand or 8%, compared to 2012. These increases reflect volume related growth in fees resulting from the 2012 branch acquisitions coupled with the second quarter 2013 retail checking account repositioning that involved simplifying the suite of products offered to customers and modifications to the fee structure for our accounts. Our fee waiver process was also reevaluated, which resulted in a reduction in the number of fee waivers and an increase in service charges.

Management continues to focus on diversifying its sources of revenue to further reduce our reliance on traditional spread-based interest income, as fee-based activities are a relatively stable revenue source during periods of changing interest rates.

Investment advisory income was $2.3 million for 2013, up $240 thousand or 11%, compared to 2012, as fees and commissions fluctuate with sales volume, which increased during 2013 as a result of favorable market conditions and new business opportunities.

Loan servicing income represents fees earned primarily for servicing mortgage loans sold to third parties, net of amortization expense and impairment losses, if any, associated with capitalized loan servicing assets. Loan servicing income was $570 thousand in 2013, down $47 thousand or 8%, compared to 2012. The decrease was a result of more rapid amortization of servicing rights due to loans paying off and lower fees collected due to a decrease in the sold and serviced portfolio partially offset by adjustments to the valuation allowance for capitalized mortgage servicing assets.

Gains from the sale of loans held for sale decreased $1.3 million in 2013 compared to 2012. The decrease was primarily due to a reduction in origination volume and margins resulting from higher interest rates in addition to a higher percentage of originations held on the balance sheet.

Net gains from the sales of investment securities were $1.2 million for the year ended December 31, 2013, compared to $2.7 million for the year ended December 31, 2012. During 2013, we recognized gains totaling $1.2 million from the sale of four pooled trust-preferred securities. Net gains for 2012 included $2.6 million from the sale of five pooled trust-preferred securities. The amount and timing of our sale of investments securities is dependent on a number of factors, including our prudent efforts to realize gains while managing duration, premium and credit risk.

Other noninterest income increased $564 thousand or 17% for the year ended December 31, 2013, compared to 2012. Merchant services income, rental income and income from our investment in several limited partnerships comprised the majority of the year-over-year increase.

- 39 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

Noninterest Expense

The following table summarizes our noninterest expense for the years ended December 31 (in thousands):

   2013   2012   2011 

Salaries and employee benefits

  $37,828     40,127     35,743  

Occupancy and equipment

   12,366     11,419     10,868  

Professional services

   3,836     4,133     2,617  

Computer and data processing

   2,848     3,271     2,437  

Supplies and postage

   2,342     2,497     1,778  

FDIC assessments

   1,464     1,300     1,513  

Advertising and promotions

   896     929     1,259  

Loss on extinguishment of debt

   —       —       1,083  

Other

   7,861     7,721     6,496  
  

 

 

   

 

 

   

 

 

 

Total noninterest expense

  $69,441     71,397     63,794  
  

 

 

   

 

 

   

 

 

 

Salaries and employee benefits decreased $2.3 million or 6% when comparing 2013 to 2012. Included in salaries and employee benefits for the year ended December 31, 2012 are pre-tax costs of approximately $2.9 million that were incurred in association with the 2012 branch acquisitions and retirement of our former CEO. After adjusting for these expenses, the increase in salaries and employee benefits for 2013 when compared to the prior year is primarily attributable to annual merit increases. The number of full time equivalent employees decreased to 608 at December 31, 2013 from 628 at December 31, 2012.

Occupancy and equipment increased by $947 thousand or 8% when comparing 2013 to 2012. The increase was primarily related to the growth in the branch network related to the branch acquisitions combined with increased snow removal costs.

Professional services expense of $3.8 million in 2013 decreased $297 thousand or 7% from 2012. Excluding the expenses related to the 2012 branch acquisitions, the increase in professional fees was due in part to executive management transitions and other corporate governance initiatives.

Computer and data processing and supplies and postage expense decreased, collectively, by $578 thousand when comparing 2013 to 2012. Excluding the expenses related to the 2012 branch acquisitions, the increase was primarily due to higher printing costs resulting from the previously mentioned retail checking account repositioning.

FDIC assessments increased $164 thousand or 13% for the year ended December 31, 2013, compared to 2012. The increased assessments are a direct result of the growth in our balance sheet.

The efficiency ratio for the year ended December 31, 2013 was 58.48% compared with 62.87% for 2012. The 2012 efficiency ratio was elevated as a result of the aforementioned expenses associated with our 2012 branch acquisitions and the retirement of our former CEO. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same volume of income, while a decrease would indicate a more efficient allocation of resources.

Income Taxes

We recognized income tax expense of $12.4 million for 2013 compared to $11.3 million for 2012. The higher tax provision was primarily attributable to a $3.1 million increase in in pre-tax income when comparing 2013 to 2012. Our effective tax rate was 32.7% for 2013 compared to 32.6% for 2012. Effective tax rates are impacted by items of income and expense that are not subject to federal or state taxation. Our effective tax rates reflect the impact of these items, which include, but are not limited to, interest income from tax-exempt securities and earnings on company owned life insurance.

- 40 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

RESULTS OF OPERATIONS FOR THE YEARS ENDED

DECEMBER 31, 2012 AND DECEMBER 31, 2011

Net Interest Income and Net Interest Margin

Net interest income was $88.5 million in 2012, compared to $81.9 million in 2011. The taxable equivalent adjustments of $2.3 million and $2.0 million for 2012 and 2011, respectively, resulted in fully taxable equivalent net interest income of $90.8 million in 2012 and $83.9 million in 2011.

Taxable equivalent net interest income of $90.8 million for 2012 was $6.9 million or 8% higher than 2011. The impact of a decline in average yields on our assets was diminished by a $217.4 million or 10% increase in interest-earning assets. The average balance of loans rose $199.6 million or 14% to $1.593 billion, reflecting growth in every loan category.

The increase in taxable equivalent net interest income was a function of a favorable volume variance as balance sheet changes in both volume and mix increased taxable equivalent net interest income by $11.7 million, partially offset by an unfavorable rate variance that decreased taxable equivalent net interest income by $4.8 million. The change in mix and volume of earning assets increased taxable equivalent interest income by $11.2 million, while the change in volume and composition of interest-bearing liabilities decreased interest expense by $474 thousand, for a net favorable volume impact of $11.7 million on taxable equivalent net interest income. Rate changes on earning assets reduced interest income by $8.5 million, while changes in rates on interest-bearing liabilities lowered interest expense by $3.7 million, for a net unfavorable rate impact of $4.8 million.

The net interest margin for 2012 was 3.95% compared to 4.04% in 2011. The decrease in net interest margin was attributable to a 7 basis point lower contribution from net free funds (primarily attributable to lower rates on interest-bearing liabilities reducing the value of noninterest-bearing deposits and other net free funds). The interest rate spread decreased by 2 basis points to 3.85% for the year ended December 31, 2012, as a 32 basis point decrease in the yield on earning assets more than offset the 30 basis point decrease in the cost of interest-bearing liabilities. The Federal Reserve left the Federal funds rate unchanged at 0.25% during 2011 and 2012.

For 2012, the yield on average earning assets of 4.35% was 32 basis points lower than 2011. Loan yields decreased 44 basis points to 5.09%. Commercial mortgage and consumer indirect loans in particular, down 28 and 84 basis points, respectively, continued to experience lower yields given the competitive pricing pressures and re-pricing of loans in a low interest rate environment. The yield on investment securities dropped 27 basis points to 2.66%, also impacted by the lower interest rate environment, prepayments of mortgage-related investment securities and the impact of investing the excess cash related to our branch acquisitions into low yielding securities. Overall, earning asset rate changes reduced interest income by $8.5 million.

The cost of average interest-bearing liabilities of 0.50% in 2012 was 30 basis points lower than 2011. The average cost of interest-bearing deposits was 0.50% in 2012, 24 basis points lower than 2011, reflecting the sustained low-rate environment. The cost of borrowings decreased 110 basis points to 0.48% for 2012, primarily a result of the redemption of our 10.20% junior subordinated debentures during the third quarter of 2011. The interest-bearing liability rate changes reduced interest expense by $3.7 million during 2012.

Average interest-earning assets of $2.297 billion in 2012 were $217.4 million or 10% higher than 2011. Average investment securities increased $17.9 million while average loans increased $199.6 million or 14%. The growth in average loans was comprised of increases in all loan categories, with consumer loans up $130.5 million, commercial loans up $63.4 million and residential mortgage loans up $5.6 million.

Average interest-bearing liabilities of $1.825 billion in 2012 were up $162.9 million or 10% versus 2011. On average, interest-bearing deposits grew $156.2 million, while average noninterest-bearing demand deposits increased by $62.0 million. Average borrowings increased $6.7 million, representing a $22.6 million increase and $15.9 million decrease in short-term and long-term borrowings, respectively.

Provision for Loan Losses

The provision for loan losses was $7.1 million for the year ended December 31, 2012 compared with $7.8 million for 2011.

Noninterest Income

The following table summarizes our noninterest income for the years ended December 31 (in thousands):

  2015 2014 2013

Service charges on deposits

  $7,742    $8,954    $9,948  

Insurance income

  5,166    2,399    262  

ATM and debit card

  5,084    4,963    5,098  

Investment advisory

  2,193    2,138    2,345  

Company owned life insurance

  1,962    1,753    1,706  

Investments in limited partnerships

  895    1,103    857  

Loan servicing

  503    568    570  

Net gain on sale of loans held for sale

  249    313    117  

Net gain on disposal of investment securities

  1,988    2,041    1,226  

Net gain (loss) on sale and disposal of other assets

  27    69    (103

Amortization of tax credit investment

  (390  (2,323  -  

Other

  4,918    3,372    2,807  
 

 

 

 

 

 

 

 

 

 

 

 

Total noninterest income

  $           30,337    $          25,350    $          24,833  
 

 

 

 

 

 

 

 

 

 

 

 

Service charges on deposits decreased slightly during 2012were $7.7 million for 2015, a decrease of $1.2 million or 14%, compared to 2011.2014. The decrease was primarily due to a decrease in the amount of checking account overdraft activity.

Insurance income increased by $2.8 million to $5.2 million during 2015. The increase reflects the contributions from SDN, which was acquired at the beginning of August last year as part of our strategy to diversify business lines and increase noninterest income through additional fee-based services.

Company owned life insurance increased by $209 thousand or 12% in 2015. The increase was primarily due to new policies purchased during the third and fourth quarters of 2014.

We have investments in limited partnerships, primarily small business investment companies, and account for these investments under the equity method. Income from investments in limited partnerships was $895 thousand and $1.1 million for the years ended December 31, 2015 and 2014, respectively. The income from these equity method investments fluctuates based on the performance of the underlying investments.

During the year ended December 31, 2015 we recognized gains of $2.0 million from the sale of AFS securities with an amortized cost totaling $52.3 million. The securities sold were comprised of 5 agency securities and 13 mortgage backed securities. During the year ended December 31, 2014 we recognized gains of $2.0 million from the sale of AFS securities with an amortized cost totaling $79.6 million. The amount and timing of our sale of investments securities is dependent on a number of factors, including our efforts to realize gains while prudently managing duration, premium and credit risk.

We recognized $390 thousand and $2.3 million for the years ended December 31, 2015 and 2014, respectively, of amortization of a historic tax investment in a community-based project. The amortization was included in noninterest income, recorded as contra-income, with an offsetting tax benefit that reduced income tax expense. These types of investments are, for the most part, fully amortized in the first year the project is placed in service.

Other noninterest income increased $1.5 million for the year ended December 31, 2015, compared to 2014. Included in other noninterest income is a $1.1 million non-cash fair value adjustment of the contingent consideration liability related to the SDN acquisition. For additional discussion related to the fair value adjustment of the contingent consideration liability see Note 2, Business Combinations, of the notes to consolidated financial statements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Noninterest Expense

The following table summarizes our noninterest expense for the years ended December 31 (in thousands):

  2015 2014 2013

Salaries and employee benefits

  $42,439    $38,595    $37,828  

Occupancy and equipment

  13,856    12,829    12,366  

Professional services

  4,502    4,760    3,836  

Computer and data processing

  3,186    3,016    2,848  

Supplies and postage

  2,155    2,053    2,342  

FDIC assessments

  1,719    1,592    1,464  

Advertising and promotions

  1,120    805    896  

Goodwill impairment

  751    -    -  

Other

  9,665    8,705    7,861  
 

 

 

 

 

 

 

 

 

 

 

 

Total noninterest expense

  $          79,393    $          72,355    $          69,441  
 

 

 

 

 

 

 

 

 

 

 

 

Salaries and employee benefits increased by $3.8 million or 10% when comparing 2015 to 2014.    An increase of $3.1 million in salaries expense was primarily due to the full year impact of the addition of employees from SDN and increased staffing associated with our expansion initiatives. An increase of $757 thousand in employee benefits was primarily due to higher expense related to our defined benefit plans and payroll-related taxes. We recognized a combined net periodic pension and post-retirement expense of $731 thousand during 2015 compared to $222 thousand during 2014. The number of full time equivalent employees increased to 660 at December 31, 2015 from 622 at December 31, 2014.

Occupancy and equipment increased by $1.0 million or 8% when comparing 2015 to 2014. The increase was primarily related to higher contractual service expenses and incremental expenses from the SDN facility.

Professional services expense of $4.5 million in 2015 decreased $258 thousand or 5% from 2014. The prior year included additional expense for professional services associated with the acquisition of SDN.

Computer and data processing increased by $170 thousand or 6% when comparing 2015 to 2014. We continue to see an increase in this area due to ongoing regulatory compliance and information technology projects.

Advertising and promotions expense increased by $315 thousand when comparing 2015 to 2014. The increase is primarily attributable to additional marketing services, including branding initiatives and the opening of our new CityGate branch in Rochester, NY. We proactively market our products but vary the timing based on projected benefits and needs.

FDIC assessments increased $127 thousand or 8% for the year ended December 31, 2015 compared to 2014.    The increase in assessments is a direct result of the growth in our balance sheet.

We recognized $751 thousand of goodwill impairment in the fourth quarter of 2015 related to the SDN acquisition. For additional discussion related to the goodwill impairment see Note 7, Goodwill and Other Intangible Assets, of the notes to consolidated financial statements.

Other noninterest expense increased $960 thousand or 11% when comparing 2015 to 2014.    The increase was largely due to higher intangible asset amortization and other incremental expenses due to the full year impact of SDN.

The efficiency ratio for the year ended December 31, 2015 was 61.58% compared with 58.59% for 2014. The efficiency ratio is calculated by dividing total noninterest expense, excluding other real estate expense and amortization and impairment of goodwill and other intangible assets, by net revenue, defined as the sum of tax-equivalent net interest income and noninterest income before net gains on investment securities, adjustments to contingent liabilities and amortizations of tax credit investment. The broadening of our financial services and accompanying increased spending has resulted in a shift in our efficiency ratio as a measure of productivity. As we begin to provide more diversified financial services our efficiency ratio is expected to be in the low 60% range. This approach will decrease our sensitivity to traditional banking revenues which are subject to interest rate changes.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Income Taxes

We recorded income tax expense of $10.5 million for 2015, compared to $9.6 million for 2014. Our effective tax rate was 27.1% for 2015 compared to 24.7% for 2014. Effective tax rates are impacted by items of income and expense that are not subject to federal or state taxation. Our effective tax rates reflect the impact of these items, which include, but are not limited to, interest income from tax-exempt securities and earnings on company owned life insurance. In addition, the lower effective tax rate in 2014 reflects the previously mentioned historic tax credit benefit.

In March 2014, the New York legislature approved changes in the state tax law to be phased-in over two years, beginning in 2015. The primary changes that impact us include the repeal of the Article 32 franchise tax on banking corporations (“Article 32”) for 2015, expanded nexus standards for 2015 and a reduction in the corporate tax rate for 2016. We expect the repeal of Article 32 and the expanded nexus standards to lower our taxable income apportioned to New York in 2015 compared to 2014. In addition, the New York state income tax rate will be reduced from 7.1% to 6.5% in 2016.

RESULTS OF OPERATIONS FOR THE YEARS ENDED

DECEMBER 31, 2014 AND DECEMBER 31, 2013

Net Interest Income and Net Interest Margin

Net interest income was $93.8 million in 2014, compared to $91.6 million in 2013. The taxable equivalent adjustments of $2.8 million and $2.6 million for 2014 and 2013, respectively, resulted in fully taxable equivalent net interest income of $96.6 million in 2014 and $94.2 million in 2013.

During the first quarter of 2014, we utilized the proceeds of short-term Federal Home Loan Bank (“FHLB”) advances to purchase investment securities of approximately $50 million (the “2014 leverage strategy”). During the second quarter of 2014 we sold approximately $42 million of securities purchased in the first quarter and utilized the proceeds to fund growth in our home equity portfolio. During the third quarter of 2014, we utilized the proceeds of short-term FHLB advances to purchase an additional $25 million of investment securities. Our purchases of investment securities were comprised of high-quality mortgage-backed securities, U.S. Government agencies and sponsored enterprise bonds and tax-exempt municipal bonds. All of the securities purchased were of high credit quality with a low to moderate duration. This strategy allowed us to increase net interest income by taking advantage of the positive interest rate spread between the FHLB advances and the newly acquired investment securities.

Taxable-equivalent net interest income for 2014 increased $2.4 million or 3%, compared to 2013. The increase primarily related to an increase in the numberaverage volume of customer accounts, including those addedinterest-earning assets. The average volume of interest-earning assets for 2014 increased $174.3 million or 7% compared to 2013. The increase in earning assets was primarily due to a $130.9 million increase in average loans and a $43.5 million increase in average investment securities.

The net interest margin for 2014 was 3.50% compared to 3.64% in 2013. The net interest margin during 2014 was positively impacted by an increase in the yield on average securities, which resulted from an increase in the branch acquisitionsrelative proportion of higher-yielding tax-exempt municipal securities relative to lower-yielding taxable securities, combined with a decrease in June and Augustthe cost of 2012, helped offset decreasesaverage interest-bearing liabilities. The net interest margin was negatively impacted by a decrease in service charge income relatedthe average yield on loans. These items are more fully discussed below. The yield on average interest-earning assets decreased 17 basis points to 3.76% during 2014 from 3.93% during 2013 while the cost of average interest-bearing liabilities decreased 2 basis points from 0.36% during 2013 to 0.34% during 2014. The yield on average interest-earning assets is primarily impacted by changes in customer behaviormarket interest rates as well as changes in the volume and regulatory changes that includedrelative mix of interest-earning assets. As stated above, market interest rates have remained at historically low levels during the requirement that customers opt-in for overdraft coverage for certain typesreported periods.

The average balance of electronic banking activities.

ATM and debit card income was $4.7securities increased $43.5 million for 2012, an increase of $357 thousand or 8%,5% in 2014, compared to 2011.2013. Securities made up 31.8% of average interest-earning assets in 2014 compared to 32.3% in 2013. The yield on average securities was 2.44% in 2014 compared to 2.41% in 2013. The yield on average securities increased popularity3 basis points during 2014 compared to 2013 as we increased the relative proportion of electronic bankinginvestments held in higher-yielding, tax-exempt municipal securities. The relative proportion of higher-yielding, tax-exempt municipal securities to total average securities totaled 29.6% in 2014 compared to 27.9% in 2013. The yield on average taxable securities was 2.15% in 2014 compared to 2.09% in 2013, while the taxable-equivalent yield on average tax-exempt securities was 3.14% in 2014 compared to 3.25% in 2013.

The average volume of loans increased $130.9 million or 7% in 2014, compared to 2013. Loans made up 68.2% of average interest-earning assets during 2014 compared to 67.7% during 2013. Loans generally have significantly higher yields compared to securities and transaction processing resultedfederal funds sold and interest-bearing deposits and, as such, have a more positive effect on the net interest margin. The yield on average loans was 4.38% during 2014 compared to 4.65% during 2013. The yield on average loans decreased 27 basis points during 2014 compared to 2013. The yield on average loans was negatively impacted by lower average spreads due to increased competition in higher ATM and debit card point-of-sale usage income.loan pricing during 2014 compared to 2013.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Investment advisory income was up $275 thousandAverage deposits increased $111.9 million or 15%,5% in 2014, compared to 2011. Investment advisory income fluctuates mainly due to sales volume, which continued to increase during 2012 as a result of improving market and economic conditions and our renewed focus on this line of business.

The full-year impact of an additional $18.02013. Average interest-bearing deposits increased $75.4 million of company owned life insurance purchased during the third quarter of 2011 was largely responsible for the $327 thousand increase in company owned life insurance income for 2012.

Loan servicing income was down $218 thousand or 26% for the year ended December 31, 20122014 compared to 2011. Loan servicing income decreased as a result2013, while average non-interest-bearing deposits increased $36.5 million in 2014 compared to 2013. The ratio of more rapid amortizationaverage interest-bearing deposits to total average deposits was 77.8% in 2014 compared to 78.3% in 2013. The cost of servicing rights dueaverage interest-bearing deposits was 0.33% in 2014 compared to loans paying off, lower fees collected due to a0.36% in 2013. The decrease in the sold and serviced portfolio and write-downsaverage cost of interest-bearing deposits during the comparable periods was primarily the result of decreases in interest rates offered on capitalized mortgage servicing assets.

Net gain on loans held for sale was $1.4 million in 2012, an increase of $541 thousand or 61%, compared to 2011, mainlycertain deposit products due to increased origination volume related primarily to refinancing activity, a result ofthe low interest rates.rate environment. Additionally, the relative proportion of higher-cost time deposits to total average interest-bearing deposits decreased to 32.6% in 2014 from 33.8% in 2013.

Net gains from the sales of investment securities were $2.7Provision for Loan Losses

The provision for loan losses was $7.8 million for the year ended December 31, 2012,2014 compared with $9.1 million for 2013.

Noninterest Income

Service charges on deposits were $9.0 million for 2014, a decrease of $1.0 million or 10%, compared to $3.02013. Service charges on deposit accounts for 2013 reflected a retail checking account repositioning that involved simplifying the suite of products offered to customers and modifications to the fee structure for our accounts.

ATM and debit card income for 2014 decreased $135 thousand or 3% compared to 2013. The decrease is primarily attributable to lower transaction volumes due to card reissuances associated with third-party security breaches.

Insurance income of $2.4 million for 2014 was up $2.1 million from 2013, reflecting 5 months of income from the SDN acquisition.

Investment advisory income was $2.1 million for 2014, down $207 thousand or 9%, compared to 2013, as fees and commissions fluctuate with sales volume. Sales volume during 2014 was negatively impacted by a longer-than-anticipated conversion to a new clearing platform that began in late 2013.

Income from investments in limited partnerships was $1.1 million and $857 thousand for the years ended December 31, 2014 and 2013, respectively.

Gains from the sale of loans held for sale increased $196 thousand in 2014 compared to 2013. The increase was primarily due to higher margins due to the timing of sales and fluctuation of interest rates during the year.

During the year ended December 31, 2011. During 2012,2014 we recognized gains totaling $2.6of $2.0 million from the sale of fiveAFS securities with an amortized cost totaling $79.6 million. The securities sold were comprised of one pooled trust-preferredtrust preferred security, three mortgage backed securities and 20 agency securities. NetDuring 2013, we recognized gains for 2011 included $2.3totaling $1.2 million from the sale of four pooled trust-preferred securities and $730 thousand fromsecurities.

During the salefourth quarter of eight mortgage-backed securities.

Due to their proximity to our existing locations,2014 we consolidated four branchesrecorded $2.3 million for the amortization, recognized as partcontra-income, of the branch acquisitions. The majority of the loss on the disposal of other assets for 2012 was due to write-off of leasehold improvements and other fixed assets for these branches that were closed.a historic tax investment in a community-based project.

Other noninterest income increased $495$565 thousand or 17%20% for the year ended December 31, 2012,2014, compared to 2011. Income from our investment in several limited partnerships2013. Merchant services income, dividends on FHLB stock and dividends from FHLB stockcredit card correspondent income comprised the majority of the year-over-year increase.increases.

Noninterest Expense

Salaries and employee benefits increased by $767 thousand or 2% when comparing 2014 to 2013.    An increase of $1.5 million in salaries expense was $40.1 million for 2012, up $4.4 million or 12% from 2011. As discussed earlier, salariesprimarily due to the acquisition of SDN and the hiring of additional loan officers, partially offset by a decrease in severance expense. A decrease of $765 thousand in employee benefits for 2012 included pre-tax costswas primarily due to lower expense related to our defined benefit retirement plan, partially offset by higher medical expenses. We recognized a combined net periodic pension and post-retirement expense of approximately $2.6 million that were incurred in association with the retirement of our former CEO. After adjusting for these expenses, the increase in salaries and employee benefits for 2012 when$222 thousand during 2014 compared to the prior year is attributable to higher pension costs along with increased staffing levels. Full$1.7 million during 2013. The number of full time equivalent employees increased by 9% to 628622 at December 31, 20122014 from 575608 at December 31, 2011, primarily due to the branch acquisitions.2013.

Occupancy and equipment increased by $551$463 thousand or 5%4% when comparing 20122014 to 2011.2013. The increase was primarily related to higher contractual service expenses and incremental expenses from the growth in the branch network related to the branch acquisitions.SDN facility.

Professional services expense of $4.1$4.8 million in 20122014 increased $1.5 million$924 thousand or 58%24% from 2011. Professional fees increased primarily2013. The increases were largely due to legal expensesprofessional services associated with the acquisition of SDN, the hiring of additional loan officers and related to the branch acquisitions. The management transition described earlier also contributed to the increase in professional fees.personnel as part of our expansion initiatives and other special projects.

Computer and data processing increased by $168 thousand or 6% when comparing 2014 to 2013. During late 2013, we ceased operations of our broker-dealer subsidiary and suppliestransferred the existing business to an outsourced clearing platform, resulting in higher third-party processing expense.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Supplies and postage and advertising and promotions expense increased,decreased, collectively, by $1.6 million$380 thousand when comparing 20122014 to 2011.2013. The year-over-year increase was due toprior year amounts included expenses for additional print materials related to our retail checking account repositioning incurred during the branch acquisition transactions.first quarter of 2013.

FDIC assessments decreased $213increased $128 thousand or 9% for the year ended December 31, 2012,2014, compared to 2011, primarily2013.    The increase in assessments is a result of changes implemented by the FDIC in the method of calculating assessment rates which became effective in the second quarter of 2011.

Advertising and promotions costs were $330 thousand or 26% lower in 2012 compared to 2011 due to the timing of marketing campaigns and promotions, coupled with cost management strategies.

We redeemed all of our 10.20% junior subordinated debentures during the third quarter of 2011. As adirect result of the redemption, we recognized a loss on extinguishment of debt of $1.1 million, consisting of a redemption premium of $852 thousand and a write-off of the remaining unamortized issuance costs of $231 thousandgrowth in 2011.our balance sheet.

Other noninterest expense increased $1.2 million$844 thousand or 19% during 2012 compared11% when comparing 2014 to 2011.2013.    The increases in other noninterest expenses were primarily relatedincrease was largely due to higher intangible asset amortization due to the branchSDN acquisition, transactions.combined with an increase in electronic banking activities and deposit expenses.

The efficiency ratio for the year ended December 31, 20122014 was 62.87%58.59% compared with 60.55%58.48% for 2011. The higher efficiency ratio is attributable to the additional expenses related to the branch acquisitions and retirement of our former CEO, as previously discussed.2013.

Income Taxes

We recognizedrecorded income tax expense of $11.3$9.6 million for 20122014, compared to $11.4of $12.4 million for 2011. The lower tax provision was primarily attributable to a decrease in our2013. Our effective tax rate to 32.6%was 24.7% for 20122014 compared to 33.4%32.7% for 2011.2013. The lower effective tax rate in 2012 was2014 reflects the historic tax credit benefit described above combined with New York State tax savings generated by our real estate investment trust, which became effective during February 2014 and is discussed below.

During February 2014, the Bank formed a resultwholly-owned subsidiary, Five Star REIT, Inc. (the “REIT”), to acquire a portion of the greater impactBank’s assets, which were primarily qualifying mortgage related loans. The Bank made an initial contribution of tax-exempt incomemortgage related loans to the REIT in return for common stock of the REIT. The REIT has and expects to continue purchasing mortgage related loans from the Bank on lower taxable income.a periodic basis going forward. The REIT entered into service agreements with the Bank for administrative and investment services. The formation of the REIT reduced 2014 tax expense by approximately $950 thousand.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

ANALYSIS OF FINANCIAL CONDITION

OVERVIEW

At December 31, 2013,2015, we had total assets of $2.93$3.38 billion, an increase of 6%9% from $2.76$3.09 billion as of December 31, 2012,2014, largely attributable to our continued loan growth.growth and higher investment security balances. Net loans were $1.81$2.06 billion as of December 31, 2013,2015, up $125.9$172.3 million or 8%9%, when compared to $1.68$1.88 billion as of December 31, 2012.2014. The increase in net loans was primarily attributedattributable to organic growth in the continued expansion of the indirect lending program and commercial business development efforts.portfolio. Non-performing assets totaled $17.1$8.6 million as of December 31, 2013, up $7.02015, down $1.7 million from a year ago. Total deposits amounted to $2.32$2.73 billion as of December 31, 2013,2015, up $58.3$280.0 million or 3%11%, compared to December 31, 2012.2014. As of December 31, 2013,2015, borrowed funds totaled $337.0$332.1 million, compared to $179.8$334.8 million as of December 31, 2012. Book2014. Common book value per common share was $17.17$19.49 and $17.15$18.57 as of December 31, 20132015 and 2012,2014, respectively. As of December 31, 20132015 our total shareholders’ equity was $254.8$293.8 million compared to $253.9$279.5 million a year earlier.

INVESTING ACTIVITIES

The following table summarizes the composition of theour available for sale and held to maturity security portfolios (in thousands).

 

  Investment Securities Portfolio Composition At December 31,  Investment Securities Portfolio Composition
At December 31,
 
  2013   2012   2011  2015 2014 2013 
  Amortized
Cost
   Fair Value   Amortized
Cost
   Fair Value   Amortized
Cost
   Fair Value    Amortized  
Cost
 Fair
     Value     
   Amortized  
Cost
 Fair
     Value     
   Amortized  
Cost
 Fair
     Value     
 

Securities available for sale:

                  

U.S. Government agency and government-sponsored enterprise securities

  $135,840    $134,452    $128,097    $131,695    $94,947    $97,712    $260,748     $260,863     $160,334     $160,475     $135,840     $134,452   

State and political subdivisions

   —       —       188,997     195,210     119,099     124,424  

Mortgage-backed securities:

                  

Agency mortgage-backed securities

   482,308     473,082     479,913     494,770     390,375     401,596   282,873    282,505    458,959    460,570    482,308    473,082   

Non-Agency mortgage-backed securities

   —       1,467     73     1,098     327     2,089       809        1,218        1,467   

Asset-backed securities

   18     399     121     1,023     297     1,697       218        231    18    399   
  

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total available for sale securities

   618,166     609,400     797,201     823,796     605,045     627,518   543,621    544,395    619,293    622,494    618,166    609,400   

Securities held to maturity:

                  

State and political subdivisions

   249,785     250,657     17,905     18,478     23,297     23,964   294,423    300,981    277,273    281,384    249,785    250,657   

Mortgage-backed securities

 191,294    189,083    17,165    17,311           
 

 

  

 

  

 

  

 

  

 

  

 

 

Total held to maturity securities

 485,717    490,064    294,438    298,695    249,785    250,657   
  

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total investment securities

  $867,951    $860,057    $815,106    $842,274    $628,342    $651,482    $  1,029,338     $  1,034,459     $  913,731     $  921,189     $  867,951     $  860,057   
  

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Our investment policy is contained within our 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, we consider the ability of an investment to provide earnings consistent with factors of quality, maturity, marketability, pledgeable nature and risk diversification. Our Treasurer, guided by ALCO, is responsible for investment portfolio decisions within the established policies.

During the third quarter of 2013,years ended December 31, 2015 and 2014, we transferred $227.3$165.2 million and $12.8 million, respectively, of available for sale state and municipal debt(“AFS”) mortgage backed securities to the held to maturity (“HTM”) category, reflecting our intent to hold those securities to maturity. Transfers of investment securities into the held to maturity category from the available for sale category are made at fair value at the date of transfer. The related $78$1.1 million and $51 thousand of net unrealized holding gainslosses that were included in the transfertransfers during the years ended December 31, 2015 and 2014, respectively, are retained in accumulated other comprehensive income and in the carrying value of the held to maturity securities. This amountThese amounts will be amortized as an adjustment to interest income over the remaining life of the securities. This will offset the impact of amortization of the net premium created in the transfer.transfers. There were no gains or losses recognized as a result of this transfer.

The available for sale (“AFS”)Our AFS investment securities portfolio decreased $214.4$78.1 million or 26%, from $823.8to $544.4 million at December 31, 2012 to $609.42015 from $622.5 million at December 31, 2013.2014. The decrease was largely attributabledue to the transfer of available for sale state and municipal debt securities from the AFS portfolio to the held to maturity category during the third quarter of 2013, combined with scheduled principal paydowns on amortizing securities and a change in the net unrealized gain/loss on the AFS portfolio.

TheHTM portfolio described above. Our AFS portfolio had a net unrealized lossesgain totaling $8.8$774 thousand at December 31, 2015 compared to a net unrealized gain of $3.2 million at December 31, 2013 compared to net unrealized gains of $26.6 million at December 31, 2012. The unrealized loss on the AFS portfolio was predominantly caused by changes in market interest rates.2014. The fair value of most of the investment securities in the AFS portfolio fluctuates as market interest rates change. The transfertransfers of securities from available for saleAFS to held to maturity isHTM are expected to reduce the fair value fluctuations in the available for sale portfolio.

During the year ended December 31, 2015, we recognized gains of $2.0 million from the sale of AFS securities with an amortized cost totaling $52.3 million. The securities sold were comprised of 5 agency securities and 13 mortgage backed securities.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

As previously discussed, we utilized the proceeds from short-term FHLB advances to purchase high-quality investment securities as part of our leverage strategy of approximately $100 million implemented during the first quarter of 2013. Our purchase of investment securities was comprised of mortgage-backed securities, U.S. Government agencies and sponsored enterprise bonds and tax-exempt municipal bonds. This strategy allowed us to increase net interest income by taking advantage of the positive interest rate spread between the FHLB advances and the newly acquired investment securities.

Impairment Assessment

We review investment securities on an ongoing basis for the presence of OTTIother-than-temporary impairment (“OTTI”) with formal reviews performed quarterly. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses or the security is intended to be sold or will be required to be sold. The amount of the impairment related to non-credit related factors is recognized in other comprehensive income. Evaluating whether the impairment of a debt security is other than temporary involves assessing i.) the intent to sell the debt security or ii.) the likelihood of being required to sell the security before the recovery of its amortized cost basis. In determining whether the other-than-temporary impairmentOTTI includes a credit loss, we use our best estimate of the present value of cash flows expected to be collected from the debt security considering factors such as: a.) the length of time and the extent to which the fair value has been less than the amortized cost basis, b.) adverse conditions specifically related to the security, an industry, or a geographic area, c.) the historical and implied volatility of the fair value of the security, d.) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future, e.) failure of the issuer of the security to make scheduled interest or principal payments, f.) any changes to the rating of the security by a rating agency, and g.) recoveries or additional declines in fair value subsequent to the balance sheet date.

As of December 31, 2013, management does2015, we do not have the intent to sell any of theour securities in a loss position and believeswe believe that it is not likely that itwe will be required to sell any such securities before the anticipated recovery of amortized cost. The unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date, repricing date or if market yields for such investments decline. Management doesWe do not believe any of the securities in a loss position are impaired due to reasons of credit quality. Accordingly, as of December 31, 2013, management has2015, we concluded that unrealized losses on itsour investment securities are temporary and no further impairment loss has been realized in our consolidated statements of income. The following discussion provides further details of our assessment of the securities portfolio by investment category.

U.S. Government Agencies and Government Sponsored Enterprises (“GSE”).As of December 31, 2013,2015, there were 1829 securities in an unrealized loss position in the U.S. Government agencies and GSE portfolio with unrealized losses totaling $2.8$1.0 million. Of these, three6 were in an unrealized loss position for 12 months or longer and had an aggregate fair value of $2.7$26.3 million and unrealized losses of $14$314 thousand. The decline in fair value is attributable to changes in interest rates, and not credit quality, and because we do not have the intent to sell these securities and it is likely that we will not be required to sell the securities before their anticipated recovery, we do not consider these securities to be other-than-temporarily impaired at December 31, 2013.2015.

State and Political Subdivisions.As of December 31, 2013,2015, the state and political subdivisions (“municipals”municipal securities”) portfolio totaled $249.8$294.4 million, all of which was classified as held to maturity.HTM. As of that date, each of the 234 municipals7 municipal securities in an unrealized loss position had been in an unrealized loss position for less than 12 months. Those securities had an aggregate fair value of $72.3$3.1 million and unrealized losses totaling $468$4 thousand.

Because theThe decline in fair value is attributable to changes in interest rates, and not credit quality, and because we do not have the intent to sell these securities and it is not likely that we will be required to sell the securities before their anticipated recovery, we do not consider these securities to be other-than-temporarily impaired at December 31, 2013.2015.

Agency Mortgage-backed Securities.With the exception of the non-Agency mortgage-backed securities (“non-Agency MBS”) discussed below, all of the mortgage-backed securities held by us as of December 31, 2013,2015, were issued by U.S. Government sponsored entities and agencies (“Agency MBS”), primarily FNMA.FNMA and FHLMC. The contractual cash flows of our Agency MBS are guaranteed by FNMA, FHLMC or GNMA. The GNMA mortgage-backed securities are backed by the full faith and credit of the U.S. Government.

As of December 31, 2013,2015, there were 7952 securities in the AFS Agency MBS portfolio that were in an unrealized loss position. Of these, 114 were in an unrealized loss position for 12 months or longer and had an aggregate fair value of $48.2$9.6 million and unrealized losses of $2.8$199 thousand. As of December 31, 2015, each of the 64 securities in the HTM Agency MBS portfolio that were in an unrealized loss position had been in an unrealized loss position for less than 12 months. Those securities had an aggregate fair value of $164.3 million and unrealized losses totaling $2.3 million.

Given the high credit quality inherent in Agency MBS, we do not consider any of the unrealized losses as of December 31, 20132015 on such MBS to be credit related or other-than-temporary. As of December 31, 2013,2015, we did not intend to sell any of Agency MBS that were in an unrealized loss position, all of which were performing in accordance with their terms.

Non-Agency Mortgage-backed Securities.Our non-Agency MBS portfolio consists of positions in two privately issued whole loan collateralized mortgage obligations with a fair value and net unrealized gains of $1.5 million$809 thousand as of December 31, 2013.2015. As of that date, each of the two non-Agency MBS were rated below investment grade. None of these securities were in an unrealized loss position.

Asset-backed Securities (“ABS”).  Our ABS portfolio consisted of one security with a fair value and unrealized gain of $218 thousand as of December 31, 2015. As of December 31, 2015, the ABS security was rated below investment grade.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Asset-backed Securities (“ABS”). As of December 31, 2013, the fair value of our ABS portfolio totaled $399 thousand and consisted of positions in two securities, one of which is a pooled trust preferred security (“TPS”) issued by a U.S. financial institution and backed by preferred debt issued by dozens of companies, primarily banks. As a result of some issuers defaulting and others electing to defer interest payments, we considered the TPS to be non-performing and stopped accruing interest on these investments during 2009. As of December 31, 2013, each of the securities in the ABS portfolio was rated below investment grade. None of these securities were in an unrealized loss position.

During 2013, we recognized gains totaling $1.2 million from the sale of four TPS. The four securities had a fair value of $550 thousand at December 31, 2012. We continue to monitor the market for these securities and evaluate the potential for future dispositions.

Other Investments. As aAsa member of the FHLB, the Bank is required to hold FHLB stock. The amount of required FHLB stock is based on the Bank’s asset size and the amount of borrowings from the FHLB. We have assessed the ultimate recoverability of our FHLB stock and believe that no impairment currently exists. As a member of the FRB system, we are required to maintain a specified investment in FRB stock based on a ratio relative to our capital. At December 31, 2013,2015, our ownership of FHLB and FRB stock totaled $15.8$15.1 million and $3.9$4.9 million, respectively and is included in other assets and recorded at cost, which approximates fair value.

LENDING ACTIVITIES

Total loans were $1.83$2.08 billion at December 31, 2013,2015, an increase of $127.9$171.8 million or 8%9% from December 31, 2012.2014. Commercial loans increased $63.1$7.5 million or 9% and represented 40.1%38.9% of total loans at the end of 2013.2014. Residential mortgage loans were $113.0$100.1 million, down $20.5$12.9 million or 15%11% and represented 6.2%5.2% of total loans at December 31, 2013,2014, while consumer loans increased $85.3$83.9 million to represent 53.7%55.9% of total loans at December 31, 2013 compared to 52.8% at December 31, 2012.2014. The composition of our loan portfolio, excluding loans held for sale and including net unearned income and net deferred fees and costs, is summarized as follows (in thousands):

 

   Loan Portfolio Composition At December 31, 
   2013  2012  2011  2010  2009 
   Amount   Percent  Amount   Percent  Amount   Percent  Amount   Percent  Amount   Percent 

Commercial business

  $265,766     14.5 $258,675     15.2 $233,836     15.7 $211,031     15.7 $206,383     16.3

Commercial mortgage

   469,284     25.6    413,324     24.2    393,244     26.5    352,930     26.2    330,748     26.2  
  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

 

Total commercial

   735,050     40.1    671,999     39.4    627,080     42.2    563,961     41.9    537,131     42.5  

Residential mortgage

   113,045     6.2    133,520     7.8    113,911     7.7    129,580     9.6    144,215     11.4  

Home equity

   326,086     17.8    286,649     16.8    231,766     15.6    208,327     15.5    200,684     15.9  

Consumer indirect

   636,368     34.7    586,794     34.4    487,713     32.9    418,016     31.1    352,611     27.9  

Other consumer

   23,070     1.2    26,764     1.6    24,306     1.6    26,106     1.9    29,365     2.3  
  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

 

Total consumer

   985,524     53.7    900,207     52.8    743,785     50.1    652,449     48.5    582,660     46.1  
  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

 

Total loans

   1,833,619     100.0  1,705,726     100.0  1,484,776     100.0  1,345,990     100.0  1,264,006     100.0

Allowance for loan losses

   26,736      24,714      23,260      20,466      20,741    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total loans, net

  $1,806,883     $1,681,012     $1,461,516     $1,325,524     $1,243,265    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

As of December 31, 2013 and 2012, the residential mortgage portfolio included $19.3 million and $28.2 million, respectively, of loans acquired with the 2012 branch acquisitions and $93.7 million and $105.3 million of organic loans, respectively. The decrease in organic residential mortgage loans from $113.9 million to $105.3 million to $93.7 million for the periods ending December 31, 2011, 2012 and 2013, respectively, and the increase in consumer indirect loans from $487.7 million to $586.8 million to $636.4 million for the same periods reflects a strategic shift to increase our consumer indirect loan portfolio, while placing less emphasis on expanding our residential mortgage loan portfolio, coupled with our practice of selling the majority of our fixed-rate residential mortgages in the secondary market with servicing rights retained.

  Loan Portfolio Composition
At December 31,
  2015 2014 2013 2012 2011
  Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent

Commercial business

  $313,758    15.0%  $267,409    14.0%  $265,766    14.5%  $258,675    15.2%  $233,836    15.7%
Commercial mortgage 566,101  27.2     475,092  24.9     469,284  25.6     413,324  24.2     393,244  26.5    
  

 

 

     

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial

   879,859    42.2    742,501    38.9    735,050    40.1    671,999    39.4    627,080    42.2 

Residential mortgage

   98,309    4.7    100,101    5.2    113,045    6.2    133,520    7.8    113,911    7.7 

Home equity

   410,112    19.7    386,615    20.2    326,086    17.8    286,649    16.8    231,766    15.6 

Consumer indirect

   676,940    32.5    661,673    34.6    636,368    34.7    586,794    34.4    487,713    32.9 

Other consumer

   18,542    0.9    21,112    1.1    23,070    1.2    26,764    1.6    24,306    1.6 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer

   1,105,594    53.1    1,069,400    55.9    985,524    53.7    900,207    52.8    743,785    50.1 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   2,083,762    100.0%   1,912,002    100.0%   1,833,619    100.0%   1,705,726    100.0%   1,484,776    100.0%

Allowance for loan losses

   27,085      27,637      26,736      24,714      23,260   
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total loans, net

  $ 2,056,677     $ 1,884,365     $  1,806,883     $ 1,681,012     $ 1,461,516   
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Commercial loans increased during 20132015 as we continued our commercial business development efforts. The credit risk related to commercial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations or on the value of underlying collateral.

We participate in various lending programs in which guarantees are supplied by U.S. government agencies, such as the SBA, U.S. Department of Agriculture, Rural Economic and Community Development and Farm Service Agency, among others. As of December 31, 2013,2015, the principal balance of such loans (included in commercial loans) was $56.3$54.3 million and the guaranteed portion amounted to $38.5$35.9 million. Most of these loans were guaranteed by the SBA.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Commercial business loans were $265.8$313.8 million at the end of 2013,2015, up $7.1$46.3 million or 3%17% since the end of 2012,2014, and comprised 14.5%15.0% of total loans outstanding at December 31, 2013.2015, compared to 14.0% at December 31, 2014. We typically originate business loans of up to $15.0 million for small to mid-sized businesses in our market area for working capital, equipment financing, inventory financing, accounts receivable financing, or other general business purposes. Loans of this type are in a diverse range of industries. Within the commercial business classification, loans to finance agricultural production totaled approximately 8%7% of commercial business loans as of December 31, 2013.2015. As of December 31, 2013,2015, commercial business SBA loans accounted for a total of $35.5$35.4 million or 13%11% of our commercial business loan portfolio.

Commercial mortgage loans totaled $469.3$566.1 million at December 31, 2013,2015, up $56.0$91.0 million or 14%19% from December 31, 2012,2014, and comprised 25.6%27.2% of total loans, compared to 24.2%24.9% at December 31, 2012.2014. Commercial mortgage includesloans include both owner occupied and non-owner occupied commercial real estate loans. Approximately 44%41% and 46%45% of theour commercial mortgage portfolio at December 31, 20132015 and 2012,2014, respectively, was owner occupied commercial real estate. The majority of our commercial real estate loans are secured by office buildings, manufacturing facilities, distribution/warehouse facilities, and retail centers, which are generally located in our local market area. As of December 31, 2013,2015, commercial mortgage SBA loans accounted for a total of $16.2$14.0 million or 3%2% of our commercial mortgage loan portfolio.

OurWe determine our current lending standards for commercial real estate and real estate construction lending are determined by property type and specifically address many criteria, including: maximum loan amounts, maximum loan-to-value (“LTV”), requirements for pre-leasing and / or pre-sales, minimum debt-service coverage ratios, minimum borrower equity, and maximum loan to cost. Currently, the maximum standard for LTV is 85%, with lower limits established for certain higher risk types, such as raw land which has a 65% LTV maximum.

- 46 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

Residential mortgage loans totaled $113.0$98.3 million at the end of 2013,2015, down $20.5$1.8 million or 15%2% from the end of the prior year and comprised 6.2%4.7% of total loans outstanding at December 31, 20132015 and 7.8%5.2% at December 31, 2012.2014. Residential mortgage loans include conventional first lien home mortgages and wemortgages. We generally limit the maximum loan to 85% of collateral value without credit enhancement (e.g. PMIpersonal mortgage insurance). As part of management’s historical practice of originating and servicing residential mortgage loans, the majority of our fixed-rate residential mortgage loans are sold in the secondary market with servicing rights retained. Residential mortgage products continue to be underwritten using FHLMC and FNMA secondary marketing guidelines.

As of December 31, 2015 and 2014, our residential mortgage portfolio included $12.8 million and $15.7 million, respectively, of loans acquired during the 2012 branch acquisitions and $85.5 million and $84.4 million of organic loans, respectively. Over the past several years we’ve placed less emphasis on expanding our residential mortgage loan portfolio while strategically increasing our consumer indirect and home equity loan portfolios. In addition, it has been our practice to sell the majority of our fixed-rate residential mortgages in the secondary market with servicing rights retained.

Consumer loans totaled $985.5 million$1.11 billion at December 31, 2013,2015, up $85.3$36.2 million or 10%3% compared to 2012,2014, and represented 53.7%53.1% of the 20132015 year-end loan portfolio versus 52.8%55.9% at year-end 2012.2014. Loans in this classification include indirect consumer, home equity and other consumer installment loans. Credit risk for these types of loans is generally influenced by general economic conditions, the characteristics of individual borrowers, and the nature of the loan collateral. Risks of loss are generally on smaller average balances per loan spread over many borrowers. Once charged off, there is usually less opportunity for recovery on these smaller retail loans. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and guaranty positions.

Consumer indirect loans amounted to $636.4 million at December 31, 2013 up $49.6 million or 8% compared to 2012, and represented 34.7% of the 2013 year-end loanThe home equity portfolio versus 34.4% at year-end 2012. The loans are primarily for the purchase of automobiles (both new and used) and light duty trucks primarily to individuals, but also to corporations and other organizations. The loans are originated through dealerships and assigned to us with terms that typically range from 36 to 84 months. During the year ended December 31, 2013, we originated $306.4 million in indirect loans with a mix of approximately 47% new auto and 53% used vehicles. This compares with $324.6 million in indirect loans with a mix of approximately 49% new auto and 51% used vehicles for the same period in 2012. The decrease in loans for new autos reflects changes in market conditions in 2013. We do business with over 400 franchised auto dealers located in Western, Central, and the Capital District of New York, and Northern Pennsylvania.

Home equity consists of home equityboth lines as well as home equityof credit and loans. Home equities amounted to $326.1$410.1 million at December 31, 20132015 up $39.4$23.5 million or 14%6% compared to 2012,2014, and represented 17.8%19.7% of the 20132015 year-end loan portfolio versus 16.8%20.2% at year-end 2012.2014. The portfolio had a weighted average LTV at origination of approximately 55%58% and 54%57% at December 31, 20132015 and 2012,2014, respectively. Approximately 76%82% and 69% f80% of the loans in the home equity portfolio were first lien positions at December 31, 20132015 and 2012,2014, respectively. We continue to grow our home equity portfolio as the lower origination cost and convenience to customers has made these products an increasingly attractive alternative to conventional residential mortgage loans.

Our underwriting guidelines for home equity products includes a combination of borrower FICO (credit score), the LTV of the property securing the loan and evidence of the borrower having sufficient income to repay the loan. Currently, for home equity products, the maximum acceptable LTV is 90%. The average FICO score for new home equity production was 758753 and 751 during the years ended December 31, 2015 and 2014, respectively.

Consumer indirect loans amounted to $676.9 million at December 31, 2015 up $15.3 million or 2% compared to 2014, and represented 32.5% of the 2015 year-end loan portfolio versus 34.6% at year-end 2014. The loans are primarily for the purchase of automobiles (both new and used) and light duty trucks primarily by individuals, but also by corporations and other organizations. The loans are originated through dealerships and assigned to us with terms that typically range from 36 to 84 months. During the year ended December 31, 2015, we originated $296.9 million in both 2013indirect loans with a mix of approximately 40% new vehicles and 2012.

60% used vehicles. This compares with $305.6 million in indirect loans with a mix of approximately 41% new vehicles and 59% used vehicles for the same period in 2014. We do business with over 400 franchised auto dealers located in Western, Central, and the Capital District of New York, and Northern and Central Pennsylvania. The average FICO score for new indirect loan production was 728 and 722 during the years ended December 31, 2015 and 2014, respectively. Other consumer loans totaled $23.1$18.5 million at December 31, 2013,2015, down $3.7$2.6 million or 14%12% compared to 2012,2014, and represented 1.2%less than one percent of the 20132015 year-end loan portfolio versus 1.6%1.1% at year-end 2012.2014. Other consumer loans consistsconsist of personal loans (collateralized and uncollateralized) and deposit account collateralized loans.

- 46 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early identification of potential problems, an appropriate allowance for loan losses, and sound nonaccrual and charge off policies.

An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are made. Credit risk is controlled by detailed underwriting procedures, comprehensive loan administration, and periodic review of borrowers’ outstanding loans and commitments. Borrower relationships are formally reviewed and graded on an ongoing basis for early identification of potential problems. Further analyses by customer, industry, and geographic location are performed to monitor trends, financial performance, and concentrations.

TheOur loan portfolio is widely diversified by types of borrowers, industry groups, and market areas within our core footprint. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to numerous borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2013,2015, no significant concentrations, as defined above, existed in our portfolio in excess of 10% of total loans.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Loans Held for Sale and Loan Servicing Rights.  Loans held for sale (not included in the loan portfolio composition table) were entirely comprised of residential real estate mortgages and totaled $3.4$1.4 million and $1.5 million$755 thousand as of December 31, 20132015 and 2012,2014, respectively.

We sell certain qualifying newly originated or refinanced residential real estate mortgages on the secondary market. Residential real estate mortgages serviced for others, which are not included in the consolidated statements of financial condition, amounted to $237.9$196.0 million and $273.3$215.2 million as of December 31, 20132015 and 2012,2014, respectively.

Allowance for Loan Losses

The following table summarizes the activity in the allowance for loan losses (in thousands).

 

   Loan Loss Analysis Year Ended December 31, 
   2013  2012  2011  2010  2009 

Allowance for loan losses, beginning of year

  $24,714   $23,260   $20,466   $20,741   $18,749  

Charge-offs:

      

Commercial business

   1,070    729    1,346    3,426    2,360  

Commercial mortgage

   553    745    751    263    355  

Residential mortgage

   411    326    152    290    225  

Home equity

   391    305    449    259    195  

Consumer indirect

   8,125    6,589    4,713    4,669    3,637  

Other consumer

   928    874    877    909    1,058  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Total charge-offs

   11,478    9,568    8,288    9,816    7,830  

Recoveries:

      

Commercial business

   349    336    401    326    428  

Commercial mortgage

   319    261    245    501    150  

Residential mortgage

   54    130    90    21    12  

Home equity

   157    44    44    36    20  

Consumer indirect

   3,161    2,769    2,066    1,485    1,030  

Other consumer

   381    354    456    485    480  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Total recoveries

   4,421    3,894    3,302    2,854    2,120  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net charge-offs

   7,057    5,674    4,986    6,962    5,710  

Provision for loan losses

   9,079    7,128    7,780    6,687    7,702  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Allowance for loan losses, end of year

  $26,736   $24,714   $23,260   $20,466   $20,741  
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net charge-offs to average loans

   0.40  0.36  0.36  0.54  0.47

Allowance to end of period loans

   1.46  1.45  1.57  1.52  1.64

Allowance to end of period non-performing loans

   161  271  329  270  239

- 47 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

  Loan Loss Analysis
Year Ended December 31,
 
        2015                2014                2013                2012                2011         

Allowance for loan losses, beginning of year

  $  27,637        $  26,736        $  24,714        $  23,260        $  20,466      

Charge-offs:

     

Commercial business

  1,433        204        1,070        729        1,346      

Commercial mortgage

  895        304        553        745        751      

Residential mortgage

  175        190        411        326        152      

Home equity

  421        340        391        305        449      

Consumer indirect

  9,156        10,004        8,125        6,589        4,713      

Other consumer

  878        972        928        874        877      
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Total charge-offs

  12,958        12,014        11,478        9,568        8,288      

Recoveries:

     

Commercial business

  212        201        349        336        401      

Commercial mortgage

  146        143        319        261        245      

Residential mortgage

  82        39        54        130        90      

Home equity

  63        56        157        44        44      

Consumer indirect

  4,200        4,321        3,161        2,769        2,066      

Other consumer

  322        366        381        354        456      
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Total recoveries

  5,025        5,126        4,421        3,894        3,302      
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net charge-offs

  7,933        6,888        7,057        5,674        4,986      

Provision for loan losses

  7,381        7,789        9,079        7,128        7,780      
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Allowance for loan losses, end of year

  $27,085        $27,637        $26,736        $24,714        $23,260      
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 
     

Net charge-offs to average loans

  0.40%     0.37%     0.40%     0.36%     0.36%   

Allowance to end of period loans

  1.30%     1.45%     1.46%     1.45%     1.57%   

Allowance to end of period non-performing loans

  321%     272%     161%     271%     329%   

The following table sets forth the allocation of the allowance for loan losses by loan category as of 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 (in thousands).

 

  Allowance for Loan Losses by Loan Category At December 31,  Allowance for Loan Losses by Loan Category
At December 31,
 
  2013 2012 2011 2010 2009  2015 2014 2013 2012 2011 
  Loan Loss
Allowance
   Percentage
of loans by
category
to total
loans
 Loan Loss
Allowance
   Percentage
of loans by
category
to total
loans
 Loan Loss
Allowance
   Percentage
of loans by
category
to total
loans
 Loan Loss
Allowance
   Percentage
of loans by
category
to total
loans
 Loan Loss
Allowance
   Percentage
of loans by
category
to total
loans
  Loan
Loss
  Allowance  
 Percentage
of loans by

category to
 total loans 
 Loan
Loss
 Allowance 
 Percentage
of loans by
category to
 total loans 
 Loan
Loss
  Allowance  
 Percentage
of loans by
category to

 total loans 
 Loan
Loss
  Allowance  
 Percentage
of loans by
category to

 total loans 
 Loan
Loss
  Allowance  
 Percentage
of loans by
category to

 total loans 
 

Commercial business

  $4,273     14.5 $4,884     15.2 $4,036     15.7 $3,712     15.7 $4,407     16.3 $5,540   15.0%   $5,621   14.0%   $4,273   14.5%   $4,884   15.2%   $4,036   15.7%  

Commercial mortgage

   7,743     25.6   6,581     24.2   6,418     26.5   6,431     26.2   6,638     26.2   9,027   27.2       8,122   24.9       7,743   25.6       6,581   24.2       6,418   26.5      

Residential mortgage

   676     6.2   740     7.8   858     7.7   1,013     9.6   1,251     11.4   464   4.7       570   5.2       676   6.2       740   7.8       858   7.7      

Home equity

   1,367     17.8   1,282     16.8   1,242     15.6   972     15.5   1,043     15.9   1,228   19.7       1,485   20.2       1,367   17.8       1,282   16.8       1,242   15.6      

Consumer indirect

   12,230     34.7   10,715     34.4   10,189     32.9   7,754     31.1   6,837     27.9   10,458   32.5       11,383   34.6       12,230   34.7       10,715   34.4       10,189   32.9      

Other consumer

   447     1.2   512     1.6   517     1.6   584     1.9   565     2.3   368   0.9       456   1.1       447   1.2       512   1.6       517   1.6      
  

 

   

 

  

 

   

 

  

 

   

 

  

 

   

 

  

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total

  $26,736     100.0 $24,714     100.0 $23,260     100.0 $20,466     100.0 $20,741     100.0 $27,085   100.0%   $27,637   100.0%   $26,736   100.0%   $24,714   100.0%   $23,260   100.0%  
  

 

   

 

  

 

   

 

  

 

   

 

  

 

   

 

  

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

- 48 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

Management believes that the allowance for loan losses at December 31, 20132015 is adequate to cover probable losses in the loan portfolio at that date. Factors beyond our control, however, such as general national and local economic conditions, can adversely impact the adequacy of the allowance for loan losses. As a result, no assurance can be given that adverse economic conditions or other circumstances will not result in increased losses in the portfolio or that the allowance for loan losses will be sufficient to meet actual loan losses. See Part I, Item 1A “Risk Factors” for the risks impacting this estimate. Management presents a quarterly review of the adequacy of the allowance for loan losses to the Audit Committee of our Board of Directors based on the methodology that is described in further detail in Part I, Item I “Business” under the section titled “Lending Activities”. See also “Critical Accounting Estimates” for additional information on the allowance for loan losses.

Non-performing Assets and Potential Problem Loans

The following table sets forth information regarding non-performing assets (in thousands):

 

  Non-performing Assets At December 31,   Non-performing Assets
At December 31,
 
  2013 2012 2011 2010 2009   2015   2014   2013   2012   2011 

Non-accruing loans:

                

Commercial business

  $3,474   $3,413   $1,259   $947   $650     $3,922         $4,288         $3,474         $3,413         $1,259      

Commercial mortgage

   9,663   1,799   2,928   3,100   2,288     947         3,020         9,663         1,799         2,928      

Residential mortgage

   1,078   2,040   1,644   2,102   2,376     1,325         1,194         1,078         2,040         1,644      

Home equity

   925   939   682   875   880     758         463         925         939         682      

Consumer indirect

   1,471   891   558   514   621     1,467         1,169         1,471         891         558      

Other consumer

   5   25    —     41   7     13         11         5         25         -      
  

 

  

 

  

 

  

 

  

 

   

 

   

 

   

 

   

 

   

 

 

Total non-accruing loans

   16,616    9,107    7,071    7,579    6,822     8,432         10,145         16,616         9,107         7,071      

Restructured accruing loans

   —      —      —      —      —       -         -         -         -         -      

Accruing loans contractually past due over 90 days

   6    18    5    3    1,859     8         8         6         18         5      
  

 

  

 

  

 

  

 

  

 

   

 

   

 

   

 

   

 

   

 

 

Total non-performing loans

   16,622    9,125    7,076    7,582    8,681     8,440         10,153         16,622         9,125         7,076      

Foreclosed assets

   333    184    475    741    746     163         194         333         184         475      

Non-performing investment securities

   128    753    1,636    572    1,015     -         -         128         753         1,636      
  

 

  

 

  

 

  

 

  

 

   

 

   

 

   

 

   

 

   

 

 

Total non-performing assets

  $17,083   $10,062   $9,187   $8,895   $10,442     $        8,603         $    10,347         $    17,083         $    10,062         $        9,187      
  

 

  

 

  

 

  

 

  

 

   

 

   

 

   

 

   

 

   

 

 
          

Non-performing loans to total loans

   0.91  0.53  0.48  0.56  0.69   0.41%     0.53%     0.91%     0.53%     0.48%  

Non-performing assets to total assets

   0.58  0.36  0.39  0.40  0.51   0.25%     0.33%     0.58%     0.36%     0.39%  

Non-performing assets include non-performing loans, foreclosed assets and non-performing investment securities. Non-performing assets at December 31, 20132015 were $17.1$8.6 million, an increasea decrease of $7.0$1.7 million from the $10.1$10.3 million balance at December 31, 2012.2014. The primary component of non-performing assets is non-performing loans, which were $16.6$8.4 million or 0.91%0.41% of total loans at December 31, 2013, an increase2015, a decrease of $7.5$1.7 million from $9.1$10.1 million or 0.53% of total loans at December 31, 2012.

- 48 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

2014.

Approximately $10.7$2.0 million, or 64%24%, of the $16.6$8.4 million in non-performing loans as of December 31, 20132015 were current with respect to payment of principal and interest, but were classified as non-accruing because repayment in full of principal and/or interest was uncertain. ForThe amount of interest income forgone totaled $432 thousand and $527 thousand for non-accruing loans outstanding as of December 31, 2013, the amount of interest income forgone totaled $531 thousand.2015 and 2014, respectively. Included in nonaccrual loans are troubled debt restructurings (“TDRs”) of $8.9$2.4 million and $3.0 million at December 31, 2013.2015 and 2014, respectively. We had no TDRs that were accruing interest as of December 31, 2013. The increase in non-performing loans and TDRs was primarily due to a single commercial mortgage loan with a principal balance of $6.9 million at December 31, 2013. This loan was modified as a troubled debt restructuring and placed on nonaccrual status during the fourth quarter 2013. The Company had internally downgraded the loan to substandard status from special mention during the third quarter 2013. The loan, which is secured by income property and guaranteed by the owners, was current per the terms of the restructured loan agreement as of December 31, 2013.2015 or 2014.

Foreclosed assets consist of real property formerly pledged as collateral tofor loans, which we have acquired through foreclosure proceedings or acceptance of a deed in lieu of foreclosure. Foreclosed asset holdings represented four properties totaling $333$163 thousand at December 31, 20132015 and fivefour properties totaling $184$194 thousand at December 31, 2012.

Non-performing investment securities for which we have stopped accruing interest were $128 thousand at December 31, 2013, compared to $753 thousand at December 31, 2012. Non-performing investment securities are included in non-performing assets at fair value and are comprised of pooled trust preferred securities. There have been no securities transferred to non-performing status since the first quarter of 2009. During 2013, we recognized gains totaling $1.2 million from the sale of four TPS. The four securities had a fair value of $550 thousand at December 31, 2012. We continue to monitor the market for these securities and evaluate the potential for future dispositions.2014.

Potential problem loans are loans that are currently performing, but information known about possible credit problems of the borrowers causes managementus to have concern as to the ability of such borrowers to comply with the present loan payment terms and may result in disclosure of such loans as nonperforming at some time in the future. These loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and/or personal or government guarantees. Management considersWe consider loans classified as substandard, which continue to accrue interest, to be potential problem loans. We identified $9.7$12.1 million and $13.8$13.7 million in loans that continued to accrue interest which were classified as substandard as of December 31, 20132015 and 2012,2014, respectively. The decrease in potential problem loans relates primarily to a $3.4 million credit relationship which migrated to non-performing during the first quarter of 2013.

- 49 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

FUNDING ACTIVITIES

Deposits

The following table summarizes the composition of our deposits (dollars in thousands).

 

  At December 31,  At December 31,
  2013 2012 2011  2015 2014 2013
  Amount   Percent Amount   Percent Amount   Percent      Amount       Percent       Amount       Percent       Amount       Percent  

Noninterest-bearing demand

  $535,472     23.1 $501,514     22.2 $393,421     20.3  $641,972  23.5  %    $571,260  23.3  %    $535,472  23.1  % 

Interest-bearing demand

   470,733     20.3   449,744     19.9   362,555     18.8   523,366  19.2  490,190  20.0  470,733  20.3 

Savings and money market

   717,928     30.9   655,598     28.9   474,947     24.6   928,175  34.0  795,835  32.5  717,928  30.9 

Certificates of deposit < $100,000

   369,915     16.0   432,506     19.2   486,496     25.2  

Certificates of deposit of $100,000 or more

   226,008     9.7   222,432     9.8   214,180     11.1  

Time deposits < $250,000

 545,044  19.9  526,782  21.5  522,417  22.5 

Time deposits of $250,000 or more

 91,974  3.4  66,460  2.7  73,506  3.2 
  

 

   

 

  

 

   

 

  

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total deposits

  $2,320,056     100.0 $2,261,794     100.0 $1,931,599     100.0  $  2,730,531  100.0  %    $  2,450,527  100.0  %    $  2,320,056  100.0  % 
  

 

   

 

  

 

   

 

  

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

 

We offer a variety of deposit products designed to attract and retain customers, with the primary focus on building and expanding long-term relationships. At December 31, 2013,2015, total deposits were $2.32$2.73 billion, representing an increase of $58.3$280.0 million for the year. Public deposit balances increased $79.2 million during 2013 due largely to the seasonality of municipal cash flows and successful business development efforts in our newly acquired branches. Time deposits were approximately 26%23% and 29%24% of total deposits at December 31, 20132015 and 2012,2014, respectively. Depositors remain hesitant to invest in time deposits, such as certificates of deposit, for long periods due to the low interest rate environment. This has resulted in lower amounts being placed in time deposits for generally shorter terms.

Nonpublic deposits, the largest component of our funding sources, totaled $1.79$2.05 billion and $1.81$1.84 billion at December 31, 20132015 and 2012,2014, respectively, and represented 77% and 80%75% of total deposits as of the end of each period, respectively.period. We have managed this segment of funding through a strategy of competitive pricing that minimizes the number of customer relationships that have only a single service high cost deposit account.

- 49 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

As an additional source of funding, we offer a variety of public (municipal) deposit products to the many towns, villages, counties and school districts within our market. Public deposits generally range from 20% to 28%30% of our total deposits. There is a high degree of seasonality in this component of funding, because the level of deposits varies with the seasonal cash flows for these public customers. We maintain the necessary levels of short-term liquid assets to accommodate the seasonality associated with public deposits. Total public deposits were $533.5$675.7 million and $454.2$607.5 million at December 31, 20132015 and 2012,December 31, 2014, respectively, and represented 23% and 20%25% of total deposits as of the end of each period, respectively.period. The increase in public deposits during 2015 was due largely to successful business development efforts.

We had no traditional brokered deposits at December 31, 20132015 or 2012;December 31, 2014; however, we do participate in the Certificate of Deposit Account Registry Service (“CDARS”)CDARS and Insured Cash Sweep (“ICS”)ICS programs, which enable depositors to receive FDIC insurance coverage for deposits otherwise exceeding the maximum insurable amount. CDARS and ICS deposits are considered brokered deposits for regulatory reporting purposes. Through these programs, deposits in excess of the maximum insurable amount are placed with multiple participating financial institutions. Reciprocal CDARS deposits and ICS deposits totaled $61.3$92.9 million and $56.4$146.6 million, respectively, at December 31, 2013.2015, compared to $79.7 million and $67.1 million, respectively, at December 31, 2014.

- 50 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

Borrowings

There were noThe Company classifies borrowings as short-term or long-term borrowings outstanding asin accordance with the original terms of December 31, 2013 and 2012.the agreement. Outstanding short-term borrowings are summarized as follows as of December 31 (in thousands):

 

  2013   2012           2015                   2014         

Short-term borrowings:

        

Short-term FHLB borrowings

   $293,100       $295,300    

Repurchase agreements

  $39,042    $40,806     -       39,504    

Short-term FHLB borrowings

   298,000     139,000  
  

 

   

 

   

 

   

 

 

Total short-term borrowings

  $337,042    $179,806     293,100       334,804    

Long-term borrowings:

    

Subordinated notes, net

   38,990       -    
  

 

   

 

   

 

   

 

 

Total borrowings

   $332,090       $334,804    
  

 

   

 

 

We classifyShort-term borrowings as short-term or long-term in accordance with the original terms of the agreement.

We have credit capacity with the FHLB and can borrow through facilities that include amortizing and term advances or repurchase agreements. We had approximately $12 million of immediate credit capacity with the FHLB as of December 31, 2013. We had approximately $480 million in secured borrowing capacity at the Federal Reserve Bank (“FRB”) Discount Window, none of which was outstanding at December 31, 2013. The FHLB and FRB credit capacity are collateralized by securities from our investment portfolio and certain qualifying loans. We had approximately $120 million of credit available under unsecured federal funds purchased lines with various banks as of December 31, 2013. Additionally, we had approximately $61 million of unencumbered liquid securities available for pledging.

Federal funds purchased are short-term borrowings that typically mature within one to ninety days. Short-term repurchase agreements are secured overnight borrowings with customers. We discontinued the customer repurchase agreement product during the second quarter of 2015 and transferred most of those customers into the ICS deposit product. Short-term FHLB borrowings have original maturities of less than one year and include overnight borrowings which we typically utilize to address short term funding needs as they arise. Short-term FHLB borrowings at December 31, 20132015 consisted of $198.0$116.8 million in overnight borrowings and $100.0$176.3 million in short-term advances. Short-term FHLB borrowings at December 31, 20122014 consisted of $99.0$129.0 million in overnight borrowings and $40.0$166.3 million in short-term advances. The FHLB borrowings are collateralized by securities from the Company’s investment portfolio and certain qualifying loans. At December 31, 2015 and 2014, the Company’s borrowings had a weighted average rate of 0.53% and 0.35%, respectively.

As previously discussed, duringWe have credit capacity with the first quarterFHLB and can borrow through facilities that include amortizing and term advances or repurchase agreements. We had approximately $76 million of 2013immediate credit capacity with the FHLB as of December 31, 2015. We had approximately $497 million in secured borrowing capacity at the Federal Reserve Bank (“FRB”) discount window, none of which was outstanding at December 31, 2015. The FHLB and FRB credit capacity are collateralized by securities from our investment portfolio and certain qualifying loans. We had $120 million of credit available under unsecured federal funds purchased lines with various banks as of December 31, 2015. Additionally, we leveraged our balance sheet throughhad approximately $237 million of unencumbered liquid securities available for pledging.

The Parent has a revolving line of credit with a commercial bank allowing borrowings up to $20.0 million in total as an additional source of working capital. At December 31, 2015, no amounts have been drawn on the executionline of short-term FHLB advances in order to acquire investment securities to take advantage of the positive interest rate spread and increase net interest income.credit.

The following table summarizes information relating to our short-term borrowings (dollars in thousands).

 

  At or for the Year Ended December 31,       At or for the Year Ended December 31,     
  2013 2012 2011   2015   2014   2013 

Year-end balance

  $337,042   $179,806   $150,698     $    293,100          $   334,804           $  337,042       

Year-end weighted average interest rate

   0.38 0.54 0.39   0.53      0.35 %       0.38   

Maximum outstanding at any month-end

  $337,042   $229,598   $188,355     $351,600          $334,804           $337,042       

Average balance during the year

  $190,310   $121,735   $99,122     $262,494          $247,956           $190,310       

Average interest rate for the year

   0.39 0.48 0.50   0.41      0.37 %       0.39   

There were no long-termLong-term borrowings outstanding at December 31, 2013 and 2012. In August 2011,

On April 15, 2015, we redeemed allissued $40.0 million of our 10.20% junior subordinated debenturesSubordinated Notes in a registered public offering. The Subordinated Notes bear interest at a redemption price equaling 105.1%fixed rate of 6.0% per year, payable semi-annually, for the principal amount redeemed,first 10 years. From April 15, 2025 to the April 15, 2030 maturity date, the interest rate will reset quarterly to an annual interest rate equal to the then current three-month London Interbank Offered Rate (LIBOR) plus all3.944%, payable quarterly. The Subordinated Notes are redeemable by the us at any quarterly interest payment date beginning on April 15, 2025 to maturity at par, plus accrued and unpaid interest. As a resultProceeds, net of the redemption, we recognized a loss on extinguishment of debt issuance costs of $1.1 million, consistingwere $38.9 million. The net proceeds from this offering were used for general corporate purposes, including but not limited to, contribution of capital to the redemption premium of $852 thousandBank to support both organic growth and the write-off of the remaining unamortized issuance costs of $231 thousand.opportunistic acquisitions. The Subordinated Notes qualify as Tier 2 capital for regulatory purposes.

 

- 5051 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Shareholders’ Equity

Total shareholders’ equity was $254.8$293.8 million at December 31, 2013,2015, an increase of $942 thousand$14.3 million from $253.9$279.5 million at December 31, 2012.2014. Net income for the year increased shareholders’ equity by $25.5$28.3 million, respectively, which waswere partially offset by common and preferred stock dividends declared of $11.6$12.7 million. Accumulated other comprehensive incomeloss included in shareholders’ equity decreased $13.4increased $2.3 million during the year due primarily to higherlower net unrealized lossesgains on securities available for sale. The decrease of $1.3 million in treasury stock during 2015 was primarily due to the issuance of restricted stock awards with an aggregate grant date fair value of $1.1 million. For detailed information on shareholders’ equity, see Note 12, Shareholders’ Equity, of the notes to consolidated financial statements.

FII and the Bank are subject to various regulatory capital requirements. At December 31, 2013,2015, both FII and the Bank exceeded all regulatory requirements. For detailed information on regulatory capital requirements, see Note 11, Regulatory Matters, of the notes to consolidated financial statements.

GOODWILL AND OTHER INTANGIBLE ASSETS

The carrying value of goodwill totaled $48.5 million as of December 31, 2013 and 2012. We performed a qualitative assessment of goodwill at the reporting unit level, the Bank, to determine if it was more likely than not that the fair value of the reporting unit is less than its carrying value. In performing a qualitative analysis, factors considered include, but are not limited to, business strategy, financial performance and market and regulatory dynamics. The results of the qualitative assessment for 2013 indicated that it was not more likely than not that the fair value of the reporting unit is less than its carrying value. Consequently, no additional quantitative two-step impairment test was required, and no impairment was recorded in 2013.

The change in the balance for goodwill during the years ended December 31 was as follows (in thousands):

   2013   2012 

Goodwill, beginning of year

  $48,536    $37,369  

Branch acquisitions

   —       11,167  

Impairment

   —       —    
  

 

 

   

 

 

 

Goodwill, end of year

  $48,536    $48,536  
  

 

 

   

 

 

 

Declines in the market value of our publicly traded stock price or declines in our ability to generate future cash flows may increase the potential that goodwill recorded on our consolidated statements of financial condition be designated as impaired and that we may incur a goodwill write-down in the future.

Our other intangible assets consisted entirely of a core deposit intangible asset. Changes in the accumulated amortization and net book value were as follows (in thousands):

   2013  2012 

Gross carrying amount

  $2,042   $2,042  

Accumulated amortization

   (576  (189
  

 

 

  

 

 

 

Net book value

  $1,466   $1,853  
  

 

 

  

 

 

 

Amortization during the year

  $387   $189  

There were no core deposit intangible assets or amortization expense for the year ended December 31, 2011.

For further discussion, see Note 1, Summary of Significant Accounting Policies, and Note 7, Goodwill and Other Intangible Assets, to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

- 51 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

LIQUIDITY AND CAPITAL RESOURCES

The objective of maintaining adequate liquidity is to assure that we meet our financial obligations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the repayment of matured borrowings, the ability to fund new and existing loan commitments and the ability to take advantage of new business opportunities. We achieve liquidity by maintaining a strong base of core customer funds, maturing short-term assets, our ability to sell or pledge securities, lines-of-credit, and access to the financial and capital markets.

Liquidity for the Bank is managed through the monitoring of anticipated changes in loans, the investment portfolio, core deposits and wholesale funds. The strength of the 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 and the FRB.

The primary sources of liquidity for FII are dividends from the Bank and access to financial and capital markets. Dividends from the Bank are limited by various regulatory requirements related to capital adequacy and earnings trends. The Bank relies on cash flows from operations, core deposits, borrowings and short-term liquid assets.

Our cashCash and cash equivalents were $59.7$60.1 million as of December 31, 2013, down $744 thousand2015, an increase of $1.9 million from $60.4$58.2 million as of December 31, 2012. Our net2014. Net cash provided by operating activities totaled $37.2$43.1 million and the principal source of operating activity cash flow was net income adjusted for noncash income and expense items. Net cash used in investing activities totaled $242.2$305.9 million, which included outflows of $131.9$180.1 million for net loan originations and $107.3$118.6 million from net investment securities transactions. Net cash provided by financing activities of $204.3$264.8 million was attributed to a $58.3$280.0 million increase in deposits and a $157.2net proceeds of $38.9 million increase in short-term borrowings,from the Subordinated Notes issuance, partly offset by $11.2$12.7 million in dividend payments.payments and a $41.7 million decrease in short-term borrowings.

Contractual Obligations and Other Commitments

The following table summarizes the maturities of various contractual obligations and other commitments (in thousands):

 

  At December 31, 2013   At December 31, 2015 
  Within 1
year
   Over 1 to
3 years
   Over 3 to
5 Years
   Over 5
years
   Total       Within 1    
year
       Over 1 to 3    
years
       Over 3 to 5    
Years
         Over 5      
years
         Total       

On-Balance sheet:

                    

Certificates of deposit (1)

  $448,997    $100,861    $46,045    $20    $595,923  

Time deposits (1)

    $450,885        $143,604        $42,482        $47        $     637,018    

Supplemental executive retirement plans

   197     618     618     1,093     2,526     309       736       661       987       2,693    

Earn-out liabilities

   -       2,200       -       -       2,200    
          

Off-Balance sheet:

                    

Limited partnership investments (2)

  $356    $713    $356    $—      $1,425      $266        $532        $267        $-          $1,065    

Commitments to extend credit (3)

   431,236     —       —       —       431,236     514,818       -       -       -         514,818    

Standby letters of credit (3)

   5,498     3,091     29     —       8,618     8,254       2,963       529       -         11,746    

Operating leases

   1,440     2,654     1,504     3,796     9,394     1,644       2,291       1,752       3,160       8,847    

 

(1)

Includes the maturity of certificates of deposittime deposits amounting to $100$250 thousand or more as follows: $67.9$50.3 million in three months or less; $32.3$14.9 million between three months and six months; $79.6$18.7 million between six months and one year; and $46.2$8.1 million over one year.

(2)

We have committed to capital investments in several limited partnerships of up to $6.0 million, of which we have contributed $4.6$4.9 million as of December 31, 2013,2015, including $121$122 thousand during 2013.2015.

(3)

We do not expect all of the commitments to extend credit and standby letters of credit to be funded. Thus, the total commitment amounts do not necessarily represent our future cash requirements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Off-Balance Sheet Arrangements

With the exception of obligations in connection with our irrevocable loan commitments, operating leases and limited partnership investments as of December 31, 2013,2015, we had no other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. For additional information on off-balance sheet arrangements, see Note 1, Summary of Significant Accounting Policies and Note 10, Commitments and Contingencies, in the notes to the accompanying consolidated financial statements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Security Yields and Maturities Schedule

The following table sets forth certain information regarding the amortized cost (“Cost”), weighted average yields (“Yield”) and contractual maturities of our debt securities portfolio as of December 31, 2013.2015. Mortgage-backed securities are included in maturity categories based on their stated maturity date. Actual maturities may differ from the contractual maturities presented because borrowers may have the right to call or prepay certain investments. We have stopped accruing interest on our asset-backed securities. No tax-equivalent adjustments were made to the weighted average yields (in(dollars in thousands).

 

  Due in one year
or less
 Due from one to
five years
 Due after five
years through ten
years
 Due after ten years Total   Due in one year 
or less
  Due from one to 
five years
 Due after five
 years through 
ten years
     Due after ten    
years
 Total 
  Cost   Yield Cost   Yield Cost   Yield Cost   Yield Cost   Yield  Cost   Yield   Cost   Yield   Cost   Yield   Cost   Yield       Cost       Yield   

Available for sale debt securities:

                          

U.S. Government agencies and government-sponsored enterprises

  $23,996     0.07 $27,185     2.16 $74,177     1.74 $10,482     0.89 $135,840     1.46  $25,179    0.68%    $58,575    1.52%    $170,548    2.40%    $6,446    0.98%    $260,748    2.00%  

Mortgage-backed securities

   209     3.16   978     3.59   164,187     1.95   316,934     2.35   482,308     2.22      3.53      115,478    1.86      105,424    2.65      61,968    2.25      282,873    2.24     

Asset-backed securities

   —       —      —       —      —       —     18     —     18     —    
  

 

    

 

    

 

    

 

    

 

   
   24,205     0.10    28,163     2.21    238,364     1.88    327,434     2.30    618,166     2.05   

 

   

 

   

 

   

 

   

 

  
 25,182    0.68      174,053    1.74      275,972    2.50      68,414    2.13      543,621    2.12     

Held to maturity debt securities:

                          

State and political subdivisions

   25,289     1.46    109,911     1.55    114,543     2.25    42     5.54    249,785     1.86   22,188    1.49      172,094    1.95      100,141    2.08           -      294,423    1.96     

Mortgage-backed securities

      -           -      16,221    1.48      175,073    2.22      191,294    2.16     
  

 

    

 

    

 

    

 

    

 

    

 

   

 

   

 

   

 

   

 

  
  $49,494     0.79 $138,074     1.69 $352,907     2.00 $327,476     2.30 $867,951     2.00 22,188    1.49      172,094    1.95      116,362    1.99      175,073    2.22      485,717    2.03     
  

 

    

 

    

 

    

 

    

 

    

 

   

 

   

 

   

 

   

 

  
  $ 47,370    1.06%    $ 346,147    1.84%    $ 392,334    2.35%    $243,487    2.19%    $ 1,029,338    2.08%  
 

 

   

 

   

 

   

 

   

 

  

Contractual Loan Maturity Schedule

The following table summarizes the contractual maturities of our loan portfolio at December 31, 2013.2015. Loans, net of deferred loan origination costs, include principal amortization and non-accruing loans. Demand loans having no stated schedule of repayment or maturity and overdrafts are reported as due in one year or less (in thousands).

 

  Due in less
than one
year
   Due from
one to five
years
   Due after
five years
   Total   Due in less
 than one year 
     Due from one  
to five years
     Due after five  
years
         Total       

Commercial business

  $143,899    $99,208    $22,659    $265,766     $115,254       $135,643       $62,861       $313,758    

Commercial mortgage

   154,586     220,073     94,625     469,284     138,643       280,262       147,196       566,101    

Residential mortgage

   19,426     48,468     45,151     113,045     17,717       41,080       39,512       98,309    

Home equity

   57,727     150,071     118,288     326,086     64,499       175,367       170,246       410,112    

Consumer indirect

   252,946     375,198     8,224     636,368     269,154       395,496       12,290       676,940    

Other consumer

   9,991     11,537     1,542     23,070     7,673       9,495       1,374       18,542    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total loans

  $638,575    $904,555    $290,489    $1,833,619     $612,940       $1,037,343       $433,479       $2,083,762    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

        

        

Loans maturing after one year:

                

With a predetermined interest rate

    $661,458    $149,218    $810,676       $748,822       $218,835       $967,657    

With a floating or adjustable rate

     243,097     141,271     384,368       288,521       214,644       503,165    
    

 

   

 

   

 

     

 

   

 

   

 

 

Total loans maturing after one year

    $904,555    $290,489    $1,195,044       $      1,037,343       $        433,479       $      1,470,822    
    

 

   

 

   

 

     

 

   

 

   

 

 

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Capital Resources

The FRB has adopted a system using risk-based capital guidelines to evaluate the capital adequacy of bank holding companies on a consolidated basis. The final rules implementing the Basel Committee on Banking Supervision’s (“BCBS”) capital guidelines requirefor U.S. banks became effective for the Company on January 1, 2015, with full compliance with all of the final requirements phased in over a minimum Tiermulti-year schedule, to be fully phased-in by January 1, leverage ratio2019. As of 4.00%, a minimum Tier 1December 31, 2015, the Company’s capital ratiolevels remained characterized as “well-capitalized” under the new rules. We continue to evaluate the potential impact that regulatory rules may have on our liquidity and capital management strategies, including Basel III and those required under the Dodd-Frank Act. See Note 11, Regulatory Matters of 4.00%the notes to consolidated financial statements and a minimum total risk-based capital ratio of 8.00%.the “Basel III Capital Rules” section below for further discussion. The following table reflects the Company’s ratios and their components as of December 31 (in thousands):

 

   2013  2012 

Total shareholders’ equity

  $254,839   $253,897  

Less: Unrealized (loss) gain on securities available for sale, net of tax

   (5,293  16,060  

Net unrecognized gain on available for sale securities transferred to held to maturity, net of tax

   (44  —    

Unrecognized net periodic pension & postretirement benefits (costs), net of tax

   (4,850  (12,807

Disallowed goodwill and other intangible assets

   50,002    50,389  
  

 

 

  

 

 

 

Tier 1 capital

  $215,024   $200,255  
  

 

 

  

 

 

 

Adjusted average total assets (for leverage capital purposes)

  $2,816,491   $2,596,122  
  

 

 

  

 

 

 

Tier 1 leverage ratio (Tier 1 capital to adjusted average total assets)

   7.63  7.71

Total Tier 1 capital

  $215,024   $200,255  

Plus: Qualifying allowance for loan losses

   24,854    23,355  
  

 

 

  

 

 

 

Total risk-based capital

  $239,878   $223,610  
  

 

 

  

 

 

 

Net risk-weighted assets

  $1,986,473   $1,867,032  
  

 

 

  

 

 

 

Tier 1 capital ratio (Tier 1 capital to net risk-weighted assets)

   10.82  10.73

Total risk-based capital ratio (Total risk-based capital to net risk-weighted assets)

   12.08  11.98
             2015                   2014         

Common shareholders’ equity

   $276,504      $262,192   

Less:

 

Goodwill and other intangible assets(1)

   61,217      68,639   
 

Net unrealized (loss) gain on investment securities(2)

   (696)     1,625   
 

Net periodic pension & postretirement benefits plan adjustments

   (10,631)     (10,636)  
 

Other

   201        
   

 

 

   

 

 

 

 Common equity Tier 1 (“CET1”) capital

   226,413      n/a   

Plus:

 

Preferred stock

   17,340      17,340   

Less:

 

Other

   301        
   

 

 

   

 

 

 

Tier 1 Capital

   243,452      219,904   

Plus:

 

Qualifying allowance for loan losses

   27,085      26,262   
 

Subordinated Notes

   38,990        
   

 

 

   

 

 

 

Total regulatory capital(3)

   $309,527      $246,166   
  

 

 

   

 

 

 

Adjusted average total assets (for leverage capital purposes)(3)

   $    3,287,646      $    2,993,050   
  

 

 

   

 

 

 

Total risk-weighted assets(3)

   $    2,318,536      $    2,099,626   
  

 

 

   

 

 

 
     

Regulatory Capital Ratios(3)

    

Tier 1 leverage (Tier 1 capital to adjusted average assets)

   7.41%      7.35%   

CET1 capital (CET1 capital to total risk-weighted assets)

   9.77         n/a      

Tier 1 capital (Tier 1 capital to total risk-weighted assets)

   10.50         10.47      

Total risk-based capital (Total regulatory capital to total risk-weighted assets)

   13.35         11.72      

(1)

December 31, 2015 calculated net of deferred tax liabilities.

(2)

Includes unrealized gains and losses related to the Company’s reclassification of available for sale investment securities to the held to maturity category.

(3)

December 31, 2015 calculated under Basel III rules, which became effective January 1, 2015.

Basel III Capital Rules

In July 2013, the FRB and the FDIC approved the final rules implementing the BCBS’s capital guidelines for U.S. banks. Under the final rules, minimum requirements will increase for both the quantity and quality of capital held by the Company. The rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of total capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer is also established above the regulatory minimum capital requirements. This capital conservation buffer will be phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and will increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Strict eligibility criteria for regulatory capital instruments were also implemented under the final rules. The final rules also revise the definition and calculation of Tier 1 capital, total capital, and risk-weighted assets.

The phase-in period for the final rules became effective for the Company on January 1, 2015, with full compliance with all of the final rules’ requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. As of December 31, 2015, the Company’s capital levels remained characterized as “well-capitalized” under the new rules.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

CRITICAL ACCOUNTING ESTIMATES

Our consolidated financial statements are prepared in accordance with GAAP 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 our 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.

We have numerous accounting policies, of which the most significant are presented in Note 1, Summary of Significant Accounting Policies, 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, valuation of goodwill and deferred tax assets, the valuation of securities and determination of OTTI, and accounting for defined benefit plans require particularly subjective or complex judgments important to our financial position and results of operations, and, as such, are considered to be critical accounting policies as discussed below. These estimates and assumptions are based on management’s best estimates and judgment and are evaluated on an ongoing basis using historical experience and other factors, including the current economic environment. We adjust these estimates and assumptions when facts and circumstances dictate. Illiquid credit markets and volatile equity have combined with declines in consumer spending to increase the uncertainty inherent in these estimates and assumptions. As future events cannot be determined with precision, actual results could differ significantly from our estimates.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Adequacy of the 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, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses. Because current economic conditions and borrower strength can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the appropriateness of the allowance for loan losses, could change significantly. As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses. Such agencies may require additions to the allowance for loan losses or may require that certain loan balances be charged off or downgraded into criticized loan categories when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. We believe the level of the allowance for loan losses is appropriate as recorded in the consolidated financial statements.

For additional discussion related to our accounting policies for the allowance for loan losses, see the sections titled “Allowance for Loan Losses” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 1, Summary of Significant Accounting Policies, of the notes to consolidated financial statements.

Valuation of Goodwill

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 has an indefinite useful life and is not amortized, but is tested for impairment. GAAP requires goodwill to be tested for impairment at our reporting unit level on an annual basis which for us is September 30th, and more frequently if events or circumstances indicate that there may be impairment. Currently, ourWe test goodwill is evaluated at the entity levelfor impairment as there is only one reporting unit.of September 30 of each year.

Impairment exists when a reporting unit’s carrying value of goodwill exceeds its implied fair value. In testing goodwill for impairment, GAAP permits us to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If, after assessing the totality of events and circumstances, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying value, then performing the two-step impairment test would be unnecessary. However, if we conclude otherwise, we would then be required to perform the first step (Step 1) of the goodwill impairment test, and continue to the second step (Step 2), if necessary. Step 1 compares the fair value of a reporting unit with its carrying value, including goodwill. If the carrying value of the reporting unit exceeds its fair value, Step 2 of the goodwill impairment test is performed to measure the value of impairment loss, if any.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Valuation of Deferred Tax Assets

The determination of deferred tax expense or benefit is based on changes in the carrying amounts of assets and liabilities that generate temporary differences. The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient future taxable income based on estimates and assumptions (after consideration of historical taxable income as well as tax planning strategies). If these estimates and related assumptions change, we may be required to record valuation allowances against our deferred tax assets resulting in additional income tax expense in the consolidated statements of income. Management evaluatesWe evaluate deferred tax assets on a quarterly basis and assessesassess the need for a valuation allowance, if any. A valuation allowance is established when management believes that it is more likely than not that some portion of its deferred tax assets will not be realized. Changes in valuation allowance from period to period are included in our tax provision in the period of change. For additional discussion related to our accounting policy for income taxes see Note 15, Income Taxes, of the notes to consolidated financial statements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Valuation and Other Than Temporary Impairment of Securities

We record all of our securities that are classified as available for sale at fair value. The fair value of equity securities are determined using public quotations, when available. Where quoted market prices are not available, fair values are estimated based on dealer quotes, pricing models, discounted cash flow methodologies, or similar techniques for which the determination of fair value may require significant judgment or estimation. Fair values of public bonds and those private securities that are actively traded in the secondary market have been determined through the use of third-party pricing services using market observable inputs. Private placement securities and other corporate fixed maturities for which we do not receive a public quotation are valued using a variety of acceptable valuation methods. Market rates used are applicable to the yield, credit quality and average maturity of each security. Private equity securities may also utilize internal valuation methodologies appropriate for the specific asset. Fair values might also be determined using broker quotes or through the use of internal models or analysis.

Securities are evaluated quarterly to determine whether a decline in their fair value is other than temporary. Management utilizes criteria such as, the current intent or requirement to hold or sell the security, the magnitude and duration of the decline and, when appropriate, consideration of negative changes in expected cash flows, creditworthiness, near term prospects of issuers, the level of credit subordination, estimated loss severity, and delinquencies, to determine whether a loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable. Declines in the fair value of investment securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit issues or concerns, or the security is intended to be sold. The amount of impairment related to non-credit related factors on securities not intended to be sold is recognized in other comprehensive income.

Defined Benefit Pension Plan

Management is required to make various assumptions in valuing itsWe have a defined benefit pension plan assetscovering substantially all employees, subject to the limitations related to the plan closure effective December 31, 2006. Effective January 1, 2016, the defined benefit pension plan was amended to modify the current benefit formula and liabilities. Theseto open the plan up to eligible employees who were hired on and after January 1, 2007. Prior to January 1, 2016, benefits under the plan were generally based on years of service, age and compensation. Assumptions are made concerning future events that will determine the amount and timing of required benefit payments, funding requirements and defined benefit pension expense. The major assumptions include, but are not limited to, the weighted average discount rate used in determining the current benefit obligation, the weighted average expected long-term rate of return on plan assets, the rate of compensation increase and the estimated mortality rate. The weighted average discount rate usedwas based upon the projected benefit cash flows and the market yields of high grade corporate bonds that are available to valuepay such cash flows as of the measurement date, December 31. The weighted average expected long-term rate of return is estimated based on current trends experienced by the assets in the plan as well as projected future rates of return on those assets and reasonable actuarial assumptions for long term inflation, and the real and nominal rate of investment return for a specific mix of asset classes. The current target asset allocation model for the plans is detailed in Note 17 to the consolidated financial statements. The expected returns on these various asset categories are blended to derive one long-term return assumption. The assets are invested in certain liabilitiescollective investment and themutual funds, common stocks, U.S. Treasury and other U.S. government agency securities, and corporate and municipal bonds and notes. The rate of compensation increase. We use a third-party specialist to assistincrease is based on reviewing the compensation increase practices of other plan sponsors in making these estimatessimilar industries and assumptions. Changes in these estimates andgeographic areas as well as the expectation of future increases. Mortality rate assumptions are reasonably possiblebased on mortality tables published by third-parties such as the Society of Actuaries (“SOA”), considering other available information including historical data as well as studies and publications from reputable sources. We review the pension plan assumptions on an annual basis with our actuarial consultants to determine if the assumptions are reasonable and adjust the assumptions to reflect changes in future expectations.

The assumptions used to calculate 2015 expense for the defined benefit pension plan were a weighted average discount rate of 3.86%, a weighted average long-term rate of return on plan assets of 6.50% and a rate of compensation increase of 3.00%. Defined benefit pension expense in 2016 is expected to increase to $1.6 million from the $778 thousand recorded in 2015, primarily driven by an increase in the number of plan participants, partially offset by an increase in the discount rate assumption.

Due to the long-term nature of pension plan assumptions, actual results may havediffer significantly from the actuarial-based estimates. Differences resulting in actuarial gains or losses are required to be recorded in shareholders’ equity as part of accumulated other comprehensive loss and amortized to defined benefit pension expense in future years. For 2015, the actual return on plan assets in the qualified defined benefit pension plan was a material impactloss of $480 thousand, compared to an expected return on ourplan assets of $4.8 million. Total pretax losses recognized in accumulated other comprehensive loss at December 31, 2015 were $17.7 million for the defined benefit pension plan. Actuarial pretax net gains recognized in other comprehensive income for the year ended December 31, 2015 were $52 thousand for the defined benefit pension plan.

Defined benefit pension expense is recorded in “Salaries and employee benefits” expense on the consolidated financial statements results of income or liquidity.income.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 1, Summary of Significant Accounting Policies - Recent Accounting Pronouncements, in the notes to consolidated financial statements for a discussion of recent accounting pronouncements.

 

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ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Asset-Liability Management

The principal objective of our interest rate risk management is to evaluate the interest rate risk inherent in assets and liabilities, determine the appropriate level of risk to us given our business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with the guidelines approved by our Board of Directors. Management is responsible for reviewing with the Board of Directors our activities and strategies, the effect of those strategies on the net interest income, the fair value of the portfolio and the effect that changes in interest rates will have on the portfolio and exposure limits. Management has developed an Asset-Liability Management and Investment Policy that meets the strategic objectives and regularly reviews the activities of the Bank.

Portfolio Composition

Our balance sheet assets are a mix of fixed and variable rate assets with consumer indirect loans, commercial loans, and MBSs comprising a significant portion of our assets. Our consumer indirect loan portfolio comprised 22%20% of assets and is primarily fixed rate loans with relatively short durations. Our commercial loan portfolio totaled 25%26% of assets and is a combination of fixed and variable rate loans, lines and mortgages. The MBS portfolio, including collateralized mortgages obligations, totaled 16%14% of assets with durations averaging three to five years.

Our liabilities are made up primarily of deposits, which account for 87%88% of total liabilities. Of these deposits, the majority, or 54%55%, is in nonpublic variable rate and noninterest bearing products including demand (both noninterest and interest- bearing), savings and money market accounts. In addition, fixed rate nonpublic certificate of deposit products make up 23%20% of total deposits. The bank also has a significant amount of public deposits, which represented 23%25% of total deposits as of December 31, 2013.2015.

Net Interest Income at Risk

A primary tool used to manage interest rate risk is “rate shock” simulation to measure the rate sensitivity. Rate shock simulation is a modeling technique used to estimate the impact of changes in rates on net interest income as well as economic value of equity. At December 31, 2013,2015, we are generallywere slightly asset sensitive, meaning that in most cases, net interest income tends to rise as interest rates rise and decline as interest rates fall.increases in rising rate conditions.

Net interest income at risk is measured 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. The following table sets forth the estimated changes to net interest income over the 12-month period ending December 31, 20142016 assuming instantaneous changes in interest rates for the given rate shock scenarios (dollars in thousands):

 

  Changes in Interest Rate   Changes in Interest Rate 
  -100 bp +100 bp +200 bp +300 bp      -100 bp         +100 bp         +200 bp         +300 bp    

Change in net interest income

  $(1,764 $698   $1,939   $1,251  

Estimated change in net interest income

   $    (1,555)        $994        $2,237        $1,120     

% Change

   (1.88)%  0.74 2.06 1.33   (1.56)%     1.00%     2.24%     1.12%  

In addition to the changes in interest rate scenarios listed above, other scenarios are typically modeled to measure interest rate risk. These scenarios vary depending on the economic and interest rate environment.

The simulationssimulation referenced above areis based on management’sour 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.

Economic Value of Equity At Risk

The economic (or “fair”) value of financial instruments on our balance sheet will also vary under the interest rate scenarios previously discussed. This is measured by simulating changes in our economic value of equity (“EVE”), which is calculated by subtracting the estimated fair value of liabilities from the estimated fair value of assets. Fair values for financial instruments are estimated by discounting projected cash flows (principal and interest) at current replacement rates for each account type, while fair values of non-financial assets and liabilities are assumed to equal book value and do not vary with interest rate fluctuations. An economic value simulation is a static measure for balance sheet accounts at a given point in time, but this measurement can change substantially over time as the characteristics of our balance sheet evolve and as interest rate and yield curve assumptions are updated.

 

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The amount of change in economic value under different interest rate scenarios depends on the characteristics of each class of financial instrument, including the stated interest rate or spread relative to current market rates or spreads, the likelihood of prepayment, whether the rate is fixed or floating, and the maturity date of the instrument. As a general rule, fixed-rate financial assets become more valuable in declining rate scenarios and less valuable in rising rate scenarios, while fixed-rate financial liabilities gain in value as interest rates rise and lose value as interest rates decline. The longer the duration of the financial instrument, the greater the impact a rate change will have on its value. In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and decay rates for non-maturity deposits are projected based on historical data (back-testing).

The analysis that follows presents the estimated EVE resulting from market interest rates prevailing at a given quarter-end (“Pre-Shock Scenario”), and under other interest rate scenarios (each a “Rate Shock Scenario”) represented by immediate, permanent, parallel shifts in interest rates from those observed at December 31, 20132015 and 2012.2014. The analysis additionally presents a measurement of the interest rate sensitivity at December 31, 20132015 and 2012.2014. EVE amounts are computed under each respective Pre- Shock Scenario and Rate Shock Scenario. An increase in the EVE amount is considered favorable, while a decline is considered unfavorable.

 

  December 31, 2013 December 31, 2012   December 31, 2015   December 31, 2014 

Rate Shock Scenario:

  EVE   Change Percentage
Change
 EVE   Change   Percentage
Change
           EVE               Change         Percentage  
Change
           EVE               Change         Percentage  
Change
 

Pre-Shock Scenario

   466,008      392,732         $497,349           $476,735        

- 100 Basis Points

  $476,323    $10,315   2.21 $420,472    $27,740     7.06   508,973       $11,624      2.34%      489,184       $12,449      2.61%   

+ 100 Basis Points

   452,155     (13,853 (2.97 396,416     3,684     0.94     480,888       (16,461)     (3.31)        466,983       (9,752)     (2.05)     

+ 200 Basis Points

   435,424     (30,584 (6.56 392,904     172     0.04     460,567       (36,782)     (7.40)        453,868       (22,867)     (4.80)     

The Pre-Shock Scenario EVE was $466.0$497.3 million at December 31, 2013,2015, compared to $392.7$476.7 million at December 31, 2012.2014. The increase in the Pre-Shock Scenario EVE at December 31, 2013,2015, compared to December 31, 20122014 resulted primarily from a more favorable valuation of non-maturity deposits that reflected alternative funding rate changes used for discounting future cash flows.

The +200 basis point Rate Shock Scenario EVE increased from $392.9$453.9 million at December 31, 20122014 to $435.4$460.6 million at December 31, 2013,2015, reflecting the more favorable valuation of non-maturity deposits. The percentage change in the EVE amount from the Pre-Shock Scenario to the +200 basis point Rate Shock Scenario decreased from 0.04% at December 31, 2012 to (6.56)(4.80)% at December 31, 2013.2014 to (7.40)% at December 31, 2015. The increasedecrease in sensitivity resulted from a reduceddecreased benefit in the valuation of non-maturity deposits and greater sensitivity for investment securitiescertain fixed rate assets in the +200 basis point Rate Shock Scenario EVE as of December 31, 2013,2015, compared to December 31, 2012.2014.

 

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Interest Rate Sensitivity Gap

The following table presents an analysis of our interest rate sensitivity gap position at December 31, 2013.2015. All interest-earning assets and interest-bearing liabilities are shown based on the earlier of their contractual maturity or re-pricing date. The expected maturities are presented on a contractual basis or, if more relevant, based on projected call dates. Investment securities are at amortized cost for both securities available for sale and securities held to maturity. Loans, net of deferred loan origination costs, include principal amortization adjusted for estimated prepayments (principal payments in excess of contractual amounts) and non-accruing loans. Because the interest rate sensitivity levels shown in the table could be changed by external factors such as loan prepayments and liability decay rates or by factors controllable by us, such as asset sales, it is not an absolute reflection of our potential interest rate risk profile (in thousands).

 

  At December 31, 2013  At December 31, 2015 
  Three
Months or
Less
 Over Three
Months
Through
One Year
 Over One
Year
Through
Five Years
 Over Five
Years
 Total  Three
Months
      or Less      
   Over Three  
Months
Through

One Year
 Over
One Year
Through

    Five Years    
 Over
    Five Years    
         Total         

INTEREST-EARNING ASSETS:

           

Federal funds sold and interest-earning deposits in other banks

  $—     $94   $—     $—     $94  

Investment securities

   71,302   133,987   387,246   275,416   867,951    $67,682      $88,037      $458,891      $414,728      $1,029,338    

Loans

   553,634   327,257   791,637   164,472   1,837,000   604,677     357,385     890,836     232,294     2,085,192    
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total interest-earning assets

  $624,936   $461,338   $1,178,883   $439,888    2,705,045    $672,359      $445,422      $1,349,727      $647,022     3,114,530    
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

  

Cash and due from banks

       59,598       60,121    

Other assets (1)

       163,993       206,373    
      

 

      

 

 

Total assets

      $2,928,636        $3,381,024    
      

 

      

 

 
     

INTEREST-BEARING LIABILITIES:

           

Interest-bearing demand, savings and money market

  $1,188,661   $—     $—     $—     $1,188,661    $1,451,541      $-      $-      $-      $1,451,541    

Certificates of deposit

   145,654    303,344    146,905    20    595,923  

Time deposits

 187,925     262,960     186,086     47     637,018    

Borrowings

   310,142    26,900    —      —      337,042   270,200     22,900      -     38,990     332,090    
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total interest-bearing liabilities

  $1,644,457   $330,244   $146,905   $20    2,121,626    $1,909,666      $285,860      $186,086      $39,037     2,420,649    
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

  

Noninterest-bearing deposits

       535,472       641,972    

Other liabilities

       16,699       24,559    
      

 

      

 

 

Total liabilities

       2,673,797       3,087,180    

Shareholders’ equity

       254,839       293,844    
      

 

      

 

 

Total liabilities and shareholders’ equity

      $2,928,636        $3,381,024    
      

 

      

 

 

Interest sensitivity gap

  $(1,019,521 $131,094   $1,031,978   $439,868   $583,419    $(1,237,307)     $159,562      $1,163,641      $607,985      $693,881    
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Cumulative gap

  $(1,019,521 $(888,427 $143,551   $583,419     $(1,237,307)     $(1,077,745)     $85,896      $693,881     
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

  

Cumulative gap ratio(2)

   38.0  55.0  106.8  127.5  35.2  %    50.9  %    103.6   %   128.7   %   

Cumulative gap as a percentage of total assets

   (34.8)%   (30.3)%   4.9  19.9  (36.6) %    (31.9) %    2.5   %   20.5   %   

 

(1)Includes net unrealized gain on securities available for sale and allowance for loan losses.
(2)Cumulative total interest-earning assets divided by cumulative total interest-bearing liabilities.

For purposes of interest rate risk management, we direct more attention on simulation modeling, such as “net interest income at risk” as previously discussed, rather than gap analysis. TheWe consider the net interest income at risk simulation modeling is considered by management to be more informative in forecasting future income at risk.

 

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Index to Consolidated Financial Statements

 

   Page

Management’s Report on Internal Control over Financial Reporting

  61

Report of Independent Registered Public Accounting Firm (on Internal Control over Financial Reporting)

  62

Report of Independent Registered Public Accounting Firm (on the Consolidated Financial Statements)

  63

Consolidated Statements of Financial Condition at December 31, 20132015 and 20122014

  64

Consolidated Statements of Income for the years ended December 31, 2013, 20122015, 2014 and 20112013

  65

Consolidated Statements of Comprehensive Income for the years ended December 31, 2013, 20122015, 2014 and 20112013

  66

Consolidated Statements of Changes in Shareholders’ Equity for the years ended December  31, 2013, 20122015, 2014 and 20112013

  67

Consolidated Statements of Cash Flows for the years ended December 31, 2013, 20122015, 2014 and 20112013

  69

Notes to Consolidated Financial Statements

  70

 

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Management’s Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting for Financial Institutions, Inc. and its subsidiaries (the “Company”), as such term is defined in Exchange Act RulesRule 13a-15(f). The Company’s system of internal control over financial reporting has been designed to provide reasonable assurance to the Company’s management and board of directors regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

Any system of internal control over financial reporting, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation and presentation.

The Company’s management has, including the Company’s principal executive officer and principal financial officer as identified below, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013.2015. To make this assessment, we used the criteria for effective internal control over financial reporting described inInternal Control - Integrated Framework (1992)(2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment and based on such criteria, we believe that, as of December 31, 2013,2015, the Company’s internal control over financial reporting was effective.

TheKPMG LLP, the Company’s independent registered public accounting firm that audited the Company’s consolidated financial statements has issued an attestation report on internal control over financial reporting as of December 31, 2013.2015. That report appears herein.

 

/s/ Martin K. Birmingham /s/ Kevin B. Klotzbach
President and Chief Executive Officer Executive Vice President and Chief Financial Officer
March 12, 20148, 2016 March 12, 20148, 2016

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Financial Institutions, Inc.:

We have audited Financial Institutions, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2013,2015, based on criteria established inInternal Control - Integrated Framework (1992) (2013)issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also includesincluded performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Financial Institutions, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013,2015, based on criteria established inInternal Control - Integrated Framework (1992) (2013)issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of Financial Institutions, Inc. and subsidiaries as of December 31, 20132015 and 2012,2014, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2013,2015, and our report dated March 12, 20148, 2016 expressed an unqualified opinion on those consolidated financial statements.statements.

/s/ KPMG LLP

Rochester, New York

March 12, 20148, 2016

 

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Report of Independent Registered Public Accounting Firm

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 (the Company) as of December 31, 20132015 and 2012,2014, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-yearthree year period ended December 31, 2013.2015. 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 the standards of the Public Company Accounting Oversight Board (United States). 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 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 consolidated financial position of Financial Institutions, Inc. and subsidiaries as of December 31, 20132015 and 2012,2014, and the results of their operations and their cash flows for each of the years in the three-yearthree year period ended December 31, 2013,2015, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’sFinancial Institutions, Inc.’s internal control over financial reporting as of December 31, 2013,2015, based on criteria established in Internal Control - Integrated Framework (1992)(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 12, 20148, 2016 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

Rochester, New York

March 12, 20148, 2016

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Financial Condition

 

(Dollars in thousands, except share and per share data)  December 31, 
   2013  2012 

ASSETS

   

Cash and cash equivalents:

   

Cash and due from banks

  $59,598   $60,342  

Federal funds sold and interest-bearing deposits in other banks

   94    94  
  

 

 

  

 

 

 

Total cash and cash equivalents

   59,692    60,436  

Securities available for sale, at fair value

   609,400    823,796  

Securities held to maturity, at amortized cost (fair value of $250,657 and $18,478, respectively)

   249,785    17,905  

Loans held for sale

   3,381    1,518  

Loans (net of allowance for loan losses of $26,736 and $24,714, respectively)

   1,806,883    1,681,012  

Company owned life insurance

   49,171    47,386  

Premises and equipment, net

   36,009    36,618  

Goodwill and other intangible assets, net

   50,002    50,389  

Other assets

   64,313    44,805  
  

 

 

  

 

 

 

Total assets

  $2,928,636   $2,763,865  
  

 

 

  

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

   

Deposits:

   

Noninterest-bearing demand

  $535,472   $501,514  

Interest-bearing demand

   470,733    449,744  

Savings and money market

   717,928    655,598  

Certificates of deposit

   595,923    654,938  
  

 

 

  

 

 

 

Total deposits

   2,320,056    2,261,794  

Short-term borrowings

   337,042    179,806  

Other liabilities

   16,699    68,368  
  

 

 

  

 

 

 

Total liabilities

   2,673,797    2,509,968  
  

 

 

  

 

 

 

Commitments and contingencies (Note 10)

   

Shareholders’ equity:

   

Series A 3% preferred stock, $100 par value; 1,533 shares authorized; 1,496 and 1,499 shares issued, respectively

   149    150  

Series B-1 8.48% preferred stock, $100 par value, 200,000 shares authorized; 171,927 and 173,210 shares issued, respectively

   17,193    17,321  
  

 

 

  

 

 

 

Total preferred equity

   17,342    17,471  

Common stock, $0.01 par value, 50,000,000 shares authorized and 14,161,597 shares issued

   142    142  

Additional paid-in capital

   67,574    67,710  

Retained earnings

   186,137    172,244  

Accumulated other comprehensive (loss) income

   (10,187  3,253  

Treasury stock, at cost — 332,242 and 373,888 shares, respectively

   (6,169  (6,923
  

 

 

  

 

 

 

Total shareholders’ equity

   254,839    253,897  
  

 

 

  

 

 

 

Total liabilities and shareholders’ equity

  $2,928,636   $2,763,865  
  

 

 

  

 

 

 

(Dollars in thousands, except share and per share data) December 31, 
          2015                  2014         

ASSETS

  

Cash and due from banks

  $60,121     $58,151   

Securities available for sale, at fair value

  544,395     622,494   

Securities held to maturity, at amortized cost (fair value of $490,064 and $298,695, respectively)

  485,717     294,438   

Loans held for sale

  1,430     755   

Loans (net of allowance for loan losses of $27,085 and $27,637, respectively)

  2,056,677     1,884,365   

Company owned life insurance

  63,045     61,004   

Premises and equipment, net

  39,445     36,394   

Goodwill and other intangible assets, net

  66,946     68,639   

Other assets

  63,248     63,281   
 

 

 

  

 

 

 

Total assets

  $3,381,024     $3,089,521   
 

 

 

  

 

 

 

    

  

LIABILITIES AND SHAREHOLDERS’ EQUITY

  

Deposits:

  

Noninterest-bearing demand

  $641,972     $571,260   

Interest-bearing demand

  523,366     490,190   

Savings and money market

  928,175     795,835   

Time deposits

  637,018     593,242   
 

 

 

  

 

 

 

Total deposits

  2,730,531     2,450,527   

Short-term borrowings

  293,100     334,804   

Long-term borrowings, net of issuance costs of $1,010

  38,990       

Other liabilities

  24,559     24,658   
 

 

 

  

 

 

 

Total liabilities

  3,087,180     2,809,989   
 

 

 

  

 

 

 

Commitments and contingencies (Note 10)

  

Shareholders’ equity:

  

Series A 3% preferred stock, $100 par value; 1,533 shares authorized; 1,492 shares issued

  149     149   

Series B-1 8.48% preferred stock, $100 par value; 200,000 shares authorized; 171,906 shares issued

  17,191     17,191   
 

 

 

  

 

 

 

Total preferred equity

  17,340     17,340   

Common stock, $0.01 par value; 50,000,000 shares authorized; 14,397,509 shares issued

  144     144   

Additional paid-in capital

  72,690     72,955   

Retained earnings

  218,920     203,312   

Accumulated other comprehensive loss

  (11,327)    (9,011)  

Treasury stock, at cost –207,317 and 279,461 shares, respectively

  (3,923)    (5,208)  
 

 

 

  

 

 

 

Total shareholders’ equity

  293,844     279,532   
 

 

 

  

 

 

 

Total liabilities and shareholders’ equity

  $3,381,024     $3,089,521   
 

 

 

  

 

 

 

See accompanying notes to the consolidated financial statements.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Income

 

(Dollars in thousands, except per share amounts)  Years ended December 31,  Years ended December 31, 
  2013 2012 2011          2015                 2014                 2013         

Interest income:

       

Interest and fees on loans

  $81,468   $81,123   $77,105    $83,575     $82,453     $81,468   

Interest and dividends on investment securities

   17,463   16,444   18,013  

Interest and dividends on investmentsecurities

 21,875    18,602    17,463   
  

 

  

 

  

 

  

 

  

 

  

 

 

Total interest income

   98,931    97,567    95,118   105,450    101,055    98,931   
  

 

  

 

  

 

  

 

  

 

  

 

 

Interest expense:

       

Deposits

   6,600    8,462    11,434   7,306    6,366    6,600   

Short-term borrowings

   737    589    500   1,081    915    737   

Long-term borrowings

   —      —      1,321   1,750           
  

 

  

 

  

 

  

 

  

 

  

 

 

Total interest expense

   7,337    9,051    13,255   10,137    7,281    7,337   
  

 

  

 

  

 

  

 

  

 

  

 

 

Net interest income

   91,594    88,516    81,863   95,313    93,774    91,594   

Provision for loan losses

   9,079    7,128    7,780   7,381    7,789    9,079   
  

 

  

 

  

 

  

 

  

 

  

 

 

Net interest income after provision for loan losses

   82,515    81,388    74,083   87,932    85,985    82,515   
  

 

  

 

  

 

  

 

  

 

  

 

 

Noninterest income:

       

Service charges on deposits

   9,948    8,627    8,679   7,742    8,954    9,948   

Insurance income

 5,166    2,399    262   

ATM and debit card

   5,098    4,716    4,359   5,084    4,963    5,098   

Investment advisory

   2,345    2,104    1,829   2,193    2,138    2,345   

Company owned life insurance

   1,706    1,751    1,424   1,962    1,753    1,706   

Investments in limited partnerships

 895    1,103    857   

Loan servicing

   570    617    835   503    568    570   

Net gain on sale of loans held for sale

   117    1,421    880   249    313    117   

Net gain on disposal of investment securities

   1,226    2,651    3,003   1,988    2,041    1,226   

Impairment charges on investment securities

   —      (91  (18

Net (loss) gain on sale and disposal of other assets

   (103  (381  67  

Net gain (loss) on sale and disposal of other assets

 27    69    (103)  

Amortization of tax credit investment

 (390)   (2,323)    -    

Other

   3,926    3,362    2,867   4,918    3,372    2,807   
  

 

  

 

  

 

  

 

  

 

  

 

 

Total noninterest income

   24,833    24,777    23,925   30,337    25,350    24,833   
  

 

  

 

  

 

  

 

  

 

  

 

 

Noninterest expense:

       

Salaries and employee benefits

   37,828    40,127    35,743   42,439    38,595    37,828   

Occupancy and equipment

   12,366    11,419    10,868   13,856    12,829    12,366   

Professional services

   3,836    4,133    2,617   4,502    4,760    3,836   

Computer and data processing

   2,848    3,271    2,437   3,186    3,016    2,848   

Supplies and postage

   2,342    2,497    1,778   2,155    2,053    2,342   

FDIC assessments

   1,464    1,300    1,513   1,719    1,592    1,464   

Advertising and promotions

   896    929    1,259   1,120    805    896   

Loss on extinguishment of debt

   —      —      1,083  

Goodwill impairment

 751           

Other

   7,861    7,721    6,496   9,665    8,705    7,861   
  

 

  

 

  

 

  

 

  

 

  

 

 

Total noninterest expense

   69,441    71,397    63,794   79,393    72,355    69,441   
  

 

  

 

  

 

  

 

  

 

  

 

 

Income before income taxes

   37,907    34,768    34,214   38,876    38,980    37,907   

Income tax expense

   12,377    11,319    11,415   10,539    9,625    12,377   
  

 

  

 

  

 

  

 

  

 

  

 

 

Net income

  $25,530   $23,449   $22,799    $28,337     $29,355     $25,530   
  

 

  

 

  

 

  

 

  

 

  

 

 

Preferred stock dividends

   1,466    1,474    1,877   1,462    1,462    1,466   

Accretion of discount on Series A preferred stock

   —      —      1,305  
  

 

  

 

  

 

  

 

  

 

  

 

 

Net income available to common shareholders

  $24,064   $21,975   $19,617    $26,875     $27,893     $24,064   
 

 

  

 

  

 

 
  

 

  

 

  

 

    

Earnings per common share (Note 16):

       

Basic

  $1.75   $1.60   $1.50    $1.91     $2.01     $1.75   

Diluted

  $1.75   $1.60   $1.49    $1.90     $2.00     $1.75   

Cash dividends declared per common share

  $0.74   $0.57   $0.47    $0.80     $0.77     $0.74   

   

Weighted average common shares outstanding:

       

Basic

   13,739    13,696    13,067   14,081    13,893    13,739   

Diluted

   13,784    13,751    13,157   14,135    13,946    13,784   

See accompanying notes to the consolidated financial statements.

 

- 65 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

 

(Dollars in thousands)  Years ended December 31, 
   2013  2012  2011 

Net income

  $25,530   $23,449   $22,799  

Other comprehensive (loss) income, before tax:

    

Securities available for sale and transferred securities:

    

Change in unrealized gain/loss during the period

   (34,135  6,682    22,350  

Change in net unrealized gain on securities transferred to held to maturity

   (72  —      —    

Reclassification adjustment for net gains included in net income

   (1,226  (2,560  (2,985
  

 

 

  

 

 

  

 

 

 

Total securities available for sale and transferred securities

   (35,433  4,122    19,365  

Pension and post-retirement obligations:

    

Net actuarial gain (loss), net of amortization

   13,223    (253  (9,930

Prior service cost, net of amortization

   (47  (47  (49
  

 

 

  

 

 

  

 

 

 

Total pension and post-retirement obligations

   13,176    (300  (9,979
  

 

 

  

 

 

  

 

 

 

Other comprehensive (loss) income, before tax

   (22,257  3,822    9,386  

Deferred tax expense (benefit) related to other comprehensive income

   8,817    (1,514  (3,719
  

 

 

  

 

 

  

 

 

 

Other comprehensive (loss) income, net of tax

   (13,440  2,308    5,667  
  

 

 

  

 

 

  

 

 

 

Comprehensive income

  $12,090   $25,757   $28,466  
  

 

 

  

 

 

  

 

 

 

(Dollars in thousands) Years ended December 31, 
          2015                  2014                  2013         

Net income

  $28,337     $29,355     $25,530   

Other comprehensive (loss) income, net of tax:

   

Net unrealized (losses) gains on securities available for sale

  (2,321)    6,962     (21,397)  

Pension and post-retirement obligations

      (5,786)    7,957   
 

 

 

  

 

 

  

 

 

 

Total other comprehensive (loss) income, net of tax

  (2,316)    1,176     (13,440)  
 

 

 

  

 

 

  

 

 

 

Comprehensive income

  $26,021     $30,531     $12,090   
 

 

 

  

 

 

  

 

 

 

See accompanying notes to the consolidated financial statements.

 

- 66 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity

Years ended December 31, 2013, 20122015, 2014 and 20112013

 

(Dollars in thousands,

except per share data)

 Preferred
Equity
 Common
Stock
 Additional
Paid-in
Capital
 Retained
Earnings
 Accumulated
Other
Comprehensive
Income (Loss)
 Treasury
Stock
 Total
Shareholders’
Equity
  Preferred

 

Equity

 Common

 

Stock

 Additional

 

Paid-in

 

Capital

 Retained

 

Earnings

 Accumulated

 

Other

 

Comprehensive

 

Income (Loss)

 Treasury

 

Stock

 Total

 

Shareholders’

 

Equity

 

Balance at January 1, 2011

 $53,785   $113   $26,029   $144,599   $(4,722 $(7,660 $212,144  

Balance at January 1, 2013

  $  17,471    $142     $  67,710     $172,244       $3,253    $ (6,923)     $  253,897  

Comprehensive income:

              

Net income

  —      —      —     22,799    —      —     22,799               25,530            25,530   

Other comprehensive income, net of tax

  —      —      —      —     5,667    —     5,667  

Issuance of common stock

  —     29   43,098    —      —      —     43,127  

Other comprehensive loss, net of tax

                 (13,440)        (13,440)  

Purchases of common stock for treasury

  —      —      —      —      —     (215 (215                     (229)   (229)  

Repurchase of Series A 3% preferred stock

 (3  —      —      —      —      —     (3 (1)                       (1)  

Repurchase of warrant issued to U.S. Treasury

  —      —     (2,080  —      —      —     (2,080

Redemption of Series A preferred stock

 (37,515  —     68    —      —      —     (37,447

Repurchase of Series B-1 8.48% preferred stock

 (99  —      —      —      —      —     (99 (128)       (2)               (130)  

Share-based compensation plans:

              

Share-based compensation

  —      —     1,105    —      —      —     1,105           407                407   

Stock options exercised

  —      —     (28  —      —     119   91           16            432   448   

Restricted stock awards issued, net

  —      —     (954  —      —     954    —             (446)           446      

Excess tax benefit on share-based compensation

  —      —     21    —      —      —     21  

Directors’ retainer

  —      —     (12   110   98  

Accretion of discount on Series A preferred stock

 1,305    —      —     (1,305  —      —      —    

Excess tax expense

         (118)               (118)  

Stock awards

                    105   112   

Cash dividends declared:

              

Series A 3% preferred – $3.00 per share

  —      —      —     (5  —      —     (5

Series A preferred – $53.24 per share

  —      —      —     (399  —      —     (399

Series B-1 8.48% preferred – $8.48 per share

  —      —      —     (1,473  —      —     (1,473

Common – $0.47 per share

  —      —      —     (6,137  —      —     (6,137

Series A 3% Preferred-$3.00 per share

             (5)           (5)  

Series B-1 8.48% Preferred-$8.48 per share

             (1,461)           (1,461)  

Common-$0.74 per share

             (10,171)           (10,171)  
 

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Balance at December 31, 2011

 $17,473   $142   $67,247   $158,079   $945   $(6,692 $237,194  

Balance at December 31, 2013

  $  17,342     $142     $  67,574     $186,137       $    (10,187)    $ (6,169)     $  254,839  

Comprehensive income:

              

Net income

  —      —      —      23,449    —      —      23,449               29,355            29,355   

Other comprehensive income, net of tax

  —      —      —      —      2,308    —      2,308                   1,176        1,176   

Common stock issued

        5,398                5,400   

Purchases of common stock for treasury

  —      —      —      —      —      (557  (557                     (194)   (194)  

Repurchase of Series B-1 8.48% preferred stock

  (2  —      —      —      —      —      (2 (2)        -               (2)  

Share-based compensation plans:

              

Share-based compensation

  —      —      526    —      —      —      526           471                471  

Stock options exercised

  —      —      (10  —      —      79    69           32            635    667  

Restricted stock awards issued, net

  —      —      (140  —      —      140    —             (520)           520       

Excess tax benefit on share-based compensation

  —      —      97    —      —      —      97  

Directors’ retainer

  —      —      (10    107    97  

Cash dividends declared:

              

Series A 3% Preferred – $3.00 per share

  —      —      —      (5  —      —      (5

Series B-1 8.48% Preferred – $8.48 per share

  —      —      —      (1,469  —      —      (1,469

Common – $0.57 per share

  —      —      —      (7,810  —      —      (7,810

Series A 3% Preferred-$3.00 per share

             (4)           (4)  

Series B-1 8.48% Preferred-$8.48 per share

             (1,458)           (1,458)  

Common-$0.77 per share

             (10,718)           (10,718)  
 

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Balance at December 31, 2012

 $17,471   $142   $67,710   $172,244   $3,253   $(6,923 $253,897  

Balance at December 31, 2014

  $  17,340     $144     $  72,955      $203,312       $(9,011)    $ (5,208)     $   279,532  
 

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Continued on next page

See accompanying notes to the consolidated financial statements.

 

- 67 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity (Continued)

Years ended December 31, 2013, 20122015, 2014 and 20112013

 

(Dollars in thousands,

except per share data)

 Preferred
Equity
  Common
Stock
  Additional
Paid-in
Capital
  Retained
Earnings
  Accumulated
Other
Comprehensive
Income (Loss)
  Treasury
Stock
  Total
Shareholders’
Equity
 

Balance at December 31, 2012

 $17,471   $142   $67,710   $172,244   $3,253   $(6,923 $253,897  

Balance carried forward

       

Comprehensive income:

       

Net income

  —      —      —      25,530    —      —      25,530  

Other comprehensive loss, net of tax

  —      —      —      —      (13,440  —      (13,440

Purchases of common stock for treasury

  —      —      —      —      —      (229  (229

Repurchase of Series A 3% preferred stock

  (1  —      —      —      —      —      (1

Repurchase of Series B-1 8.48% preferred stock

  (128  —      (2  —      —      —      (130

Share-based compensation plans:

       

Share-based compensation

  —      —      407    —      —      —      407  

Stock options exercised

  —      —      16    —      —      432    448  

Restricted stock awards issued, net

  —      —      (446  —      —      446    —    

Excess tax expense on share-based compensation

  —      —      (118  —      —      —      (118

Directors’ retainer

  —      —      7    —      —      105    112  

Cash dividends declared:

       

Series A 3% Preferred – $3.00 per share

  —      —      —      (5  —      —      (5

Series B-1 8.48% Preferred – $8.48 per share

  —      —      —      (1,461  —      —      (1,461

Common – $0.74 per share

  —      —      —      (10,171  —      —      (10,171
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Balance at December 31, 2013

 $17,342   $142   $67,574   $186,137   $(10,187 $(6,169 $254,839  
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

(Dollars in thousands,

 

except per share data)

 

    

 

    

 Preferred

 

Equity

  Common

 

Stock

  Additional

 

Paid-in

 

Capital

  Retained

 

Earnings

  Accumulated

 

Other

 

Comprehensive

 

Income (Loss)

  Treasury

 

Stock

  Total

 

Shareholders’

 

Equity

 

 

Balance at December 31, 2014

 

 

 $

 

  17,340

 

  

 

 

 $

 

144

 

  

 

 

 $

 

  72,955

 

  

 

 

 $

 

203,312

 

  

 

 

 $

 

(9,011) 

 

  

 

 

 $

 

  (5,208)

 

  

 

 

 $

 

279,532

 

  

Balance carried forward

 

       

Comprehensive income:

       

Net income

              28,337             28,337   

Other comprehensive loss, net of tax

                  (2,316)        (2,316)  

Purchases of common stock for treasury

                      (202)    (202)  

Share-based compensation plans:

       

Share-based compensation

          674                 674   

Stock options exercised

                      353     359   

Restricted stock awards issued, net

          (1,052)            1,052       

Excess tax benefit

          79                 79   

Stock awards

          28             82     110   

Cash dividends declared:

       

Series A 3% Preferred-$3.00 per share

              (4)            (4)  

Series B-1 8.48% Preferred-$8.48 per share

              (1,458)            (1,458)  

Common-$0.80 per share

              (11,267)            (11,267)  
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

 

Balance at December 31, 2015

 

 

 $

 

  17,340

 

  

 

 

 $

 

144 

 

  

 

 

 $

 

  72,690 

 

  

 

 

 $

 

218,920

 

  

 

 

 $

 

(11,327)

 

  

 

 

 $

 

  (3,923)

 

  

 

 

 $

 

293,844

 

  

 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

See accompanying notes to the consolidated financial statements.

 

- 68 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

 

(Dollars in thousands)  Years ended December 31,   Years ended December 31, 
  2013 2012 2011           2015                   2014                   2013         

Cash flows from operating activities:

          

Net income

  $25,530   $23,449   $22,799     $28,337      $29,355      $25,530   

Adjustments to reconcile net income to net cash provided by operating activities:

          

Depreciation and amortization

   4,181   3,828   3,466     5,429      4,583      4,181   

Net amortization of premiums on securities

   4,532   5,284   5,722     3,150      3,241      4,532   

Provision for loan losses

   9,079   7,128   7,780     7,381      7,789      9,079   

Share-based compensation

   407   526   1,105     674      471      407   

Deferred income tax expense

   1,547   6,343   6,510     1,798      2,154      1,547   

Proceeds from sale of loans held for sale

   26,184   55,067   32,839     16,195      16,543      26,184   

Originations of loans held for sale

   (31,657 (52,754 (31,231   (16,621)     (14,457)     (31,657)  

Increase in company owned life insurance

   (1,706 (1,751 (1,424   (1,962)     (1,753)     (1,706)  

Net gain on sale of loans held for sale

   (117 (1,421 (880   (249)     (313)     (117)  

Net gain on disposal of investment securities

   (1,226 (2,651 (3,003   (1,988)     (2,041)     (1,226)  

Impairment charges on investment securities

   —     91   18  

Net loss (gain) on sale and disposal of other assets

   103   381   (67

Amortization of tax credit investment

   390      2,323        

Goodwill impairment

   751             

Net (gain) loss on sale and disposal of other assets

   (27)     (69)     103   

Contributions to defined benefit pension plan

   —     (8,000 (10,000        (8,000)       

Loss on extinguishment of debt

   —      —     1,083  

Increase in other assets

   (6,640 (4,249 (7,756   (545)     (1,606)     (6,640)  

Increase in other liabilities

   6,981   7,429   5,057  

Increase (decrease) in other liabilities

   376      (2,991)     6,981   
  

 

  

 

  

 

   

 

   

 

   

 

 

Net cash provided by operating activities

   37,198    38,700    32,018     43,089      35,229      37,198   
  

 

  

 

  

 

   

 

   

 

   

 

 

Cash flows from investing activities:

          

Purchases of investment securities:

          

Available for sale

   (246,874  (322,191  (158,013   (271,899)     (236,043)     (246,874)  

Held to maturity

   (19,598  (15,484  (17,188   (64,397)     (63,770)     (19,598)  

Proceeds from principal payments, maturities and calls on investment securities:

          

Available for sale

   143,053    175,679    168,976     127,257      140,338      143,053   

Held to maturity

   14,784    20,819    21,986     36,162      31,026      14,784   

Proceeds from sales of securities available for sale

   1,327    2,823    44,514     54,277      81,600      1,327   

Net increase in loans, excluding sales

   (131,949  (151,311  (157,110   (180,067)     (84,812)     (131,949)  

Loans sold or participated to others

   —      —      13,033  

Purchases of company owned life insurance

   (79  (79  (18,079   (79)     (10,080)     (79)  

Proceeds from sales of other assets

   555    734    705     365      1,576      555   

Purchases of premises and equipment

   (3,411  (5,840  (3,678   (7,493)     (5,330)     (3,411)  

Net cash received in branch acquisitions

   —      195,778    —    

Cash consideration paid for acquisition, net of cash acquired

        (7,995)       
  

 

  

 

  

 

   

 

   

 

   

 

 

Net cash used in investing activities

   (242,192  (99,072  (104,854   (305,874)     (153,490)     (242,192)  
  

 

  

 

  

 

   

 

   

 

   

 

 

Cash flows from financing activities:

          

Net increase in deposits

   58,262    43,376    48,709     280,004      130,471      58,262   

Net increase in short-term borrowings

   157,236    29,108    73,588  

Repayments of long-term borrowings

   —      —      (26,767

Proceeds from issuance of common stock, net of issuance costs

   —      —      43,127  

Net (decrease) increase in short-term borrowings

   (41,704)     (2,238)     157,236   

Issuance of long-term debt

   40,000             

Debt issuance costs

   (1,060)            

Repurchase of preferred stock

        (2)     (131)  

Purchases of common stock for treasury

   (229  (557  (215   (202)     (194)     (229)  

Repurchase of preferred stock

   (131  (2  (37,549

Repurchase of warrant issued to U.S. Treasury

   —      —      (2,080

Proceeds from stock options exercised

   448    69    91     359      667      448   

Excess tax (expense) benefit on share-based compensation

   (118  97    21  

Excess tax benefit (expense) on share-based compensation

   79           (118)  

Cash dividends paid to preferred shareholders

   (1,468  (1,474  (2,118   (1,462)     (1,463)     (1,468)  

Cash dividends paid to common shareholders

   (9,750  (7,392  (5,446   (11,259)     (10,521)     (9,750)  
  

 

  

 

  

 

   

 

   

 

   

 

 

Net cash provided by financing activities

   204,250    63,225    91,361     264,755      116,720      204,250   
  

 

  

 

  

 

   

 

   

 

   

 

 

Net (decrease) increase in cash and cash equivalents

   (744  2,853    18,525  

Net increase (decrease) in cash and cash equivalents

   1,970      (1,541)     (744)  

Cash and cash equivalents, beginning of period

   60,436    57,583    39,058     58,151      59,692      60,436   
  

 

  

 

  

 

   

 

   

 

   

 

 

Cash and cash equivalents, end of period

  $59,692   $60,436   $57,583     $60,121      $58,151      $59,692   
  

 

  

 

  

 

   

 

   

 

   

 

 

See accompanying notes to the consolidated financial statements.

 

- 69 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Financial Institutions, Inc. (the “Parent”(individually referred to herein as the “Parent Company” and together with all of its subsidiaries, collectively referred to herein as the “Company”) is a financial holding company organized in 1931 under the laws of New York State (“New York” or “NYS”). ThroughAt December 31, 2015, the Company conducted its wholly-ownedbusiness through its two subsidiaries: Five Star Bank (the “Bank”), a New York chartered bank; and Scott Danahy Naylon, LLC (“SDN”), a full service insurance agency. The Company provides a full range of banking subsidiary, Five Star Bank, Financial Institutions, Inc. offers a broad array of deposit, lending and otherrelated financial services to services to individuals, municipalitiesconsumer, commercial and businesses in Westernmunicipal customers through its bank and Central New York. The Company has also expanded its indirect lending network to include relationships with franchised automobile dealers in the Capital District of New York and Northern Pennsylvania. References to “the Company” mean the consolidated reporting entities and references to “the Bank” mean Five Star Bank.nonbank subsidiaries.

The accounting and reporting policies conform to general practices within the banking industry and to U.S. generally accepted accounting principles (“GAAP”).

The Company has evaluated events and transactions for potential recognition or disclosure through the day the financial statements were issued. Other than completing the acquisition of Courier Capital Corporation (“Courier”), as described below, the Company did not have any material recognizable subsequent events.

On January 5, 2016, the Company completed its acquisition of Courier, a leading SEC-registered investment advisory and wealth management firm based in western New York, with operations in Buffalo and Jamestown. Courier will operate as a subsidiary of Financial Institutions, Inc. and an affiliate of the Bank and SDN.

The following is a description of the Company’s significant accounting policies.

(a.)  Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

(b.)  Use of Estimates

In preparing the consolidated financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities as of the date of the statement of financial condition and reported amounts of revenue and expenses during the reporting period. Material estimates relate to the determination of the allowance for loan losses, the carrying value of goodwill and deferred tax assets, the valuation and other than temporary impairment (“OTTI”) considerations related to the securities portfolio, and assumptions used in the defined benefit pension plan accounting. These estimates and assumptions are based on management’s best estimates and judgment and are evaluated on an ongoing basis using historical experience and other factors, including the current economic environment. The Company adjusts these estimates and assumptions when facts and circumstances dictate. As future events cannot be determined with precision, actual results could differ significantly from the Company’s estimates.

(c.)  Cash Flow Reporting

Cash and cash equivalents include cash and due from banks, federal funds sold and interest-bearing deposits in other banks. Net cash flows are reported for loans, deposit transactions and short-term borrowings.

Supplemental cash flow information is summarized as follows for the years ended December 31 (in thousands):

   2013  2012   2011 

Cash payments:

     

Interest expense

  $7,750   $10,438    $15,668  

Income taxes

   8,095    4,014     5,191  

Noncash investing and financing activities:

     

Real estate and other assets acquired in settlement of loans

  $726   $322    $305  

Accrued and declared unpaid dividends

   2,981    2,562     2,144  

Accretion of preferred stock discount

   —      —       1,305  

(Decrease) increase in net unsettled security purchases

   (51,112  51,135     (67

Securities transferred from available for sale to held to maturity

   227,330    —       —    

Loans transferred from held for sale to held for investment

   3,727    —       —    

Net transfer of portfolio loans to held for sale

   —      —       13,576  

Assets acquired and liabilities assumed in branch acquisition:

     

Loans and other non-cash assets, excluding goodwill and core deposit intangible asset

   —      77,912     —    

Deposits and other liabilities

   —      287,331     —    

 

- 70 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Supplemental cash flow information is summarized as follows for the years ended December 31 (in thousands):

              2015                  2014                  2013         

Cash payments:

   
  

Interest expense

   $9,323      $6,826      $7,750   
  

Income taxes

  7,494     13,665     8,095   

Noncash investing and financing activities:

   
  

Real estate and other assets acquired in settlement of loans

   $374      $394      $726   
  

Accrued and declared unpaid dividends

  3,185     3,177     2,981   
  

(Decrease) increase in net unsettled security purchases

  (478)    568     (51,112)  
  

Securities transferred from available for sale to held to maturity

  165,238     12,802     227,330   
  

Loans transferred from held for sale to held for investment

      853     3,727   
  

Common stock issued for acquisition

      5,400       
  

Assets acquired and liabilities assumed in business combinations:

   
  

Loans and other non-cash assets, excluding goodwill and core deposit intangible asset

      1,007       
  

Deposits and other liabilities

      1,112       

(d.)  Investment Securities

Investment securities are classified as either available for sale or held to maturity. Debt securities that management has the positive intent and ability to hold to maturity are classified as held to maturity and are recorded at amortized cost. Other investment securities are classified as available for sale and recorded at fair value, with unrealized gains and losses excluded from earnings and reported as a component of comprehensive income and shareholders’ equity.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Securities are evaluated periodically to determine whether a decline in their fair value is other than temporary. Management utilizes criteria such as, the current intent to hold or sell the security, the magnitude and duration of the decline and, when appropriate, consideration of negative changes in expected cash flows, creditworthiness, near term prospects of issuers, the level of credit subordination, estimated loss severity, and delinquencies, to determine whether a loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable. Declines in the fair value of investment securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit issues or concerns, or the security is intended to be sold. The amount of impairment related to non-credit related factors is recognized in other comprehensive income. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

(e.)  Loans Held for Sale and Loan Servicing Rights

The Company generally makes the determination of whether to identify a mortgage as held for sale at the time the loan is closed based on the Company’s intent and ability to hold the loan. Loans held for sale are recorded at the lower of cost or market computed on the aggregate portfolio basis. The amount, by which cost exceeds market value, if any, is accounted for as a valuation allowance with changes included in the determination of results of operations for the period in which the change occurs. The amount of loan origination costcosts and fees are deferred at origination of the loans and recognized as part of the gain or loss on sale of the loans, determined using the specific identification method, in the consolidated statements of income.

- 71 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The Company originates and sells certain residential real estate loans in the secondary market. The Company typically retains the right to service the mortgages upon sale. Mortgage-servicing rights (“MSRs”) represent the cost of acquiring the contractual rights to service loans for others. MSRs are recorded at their fair value at the time a loan is sold and servicing rights are retained. MSRs are reported in other assets in the consolidated statements of financial position and are amortized to noninterest income in the consolidated statements of 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 to estimate future net servicing income, which include estimates of the cost to service the loan, the discount rate, an inflation rate and prepayment speeds. On a quarterly basis, the Company evaluates its MSRs for impairment and charges any such impairment to current period earnings. In order to evaluate its MSRs the Company stratifies the related mortgage loans on the basis of their predominant risk characteristics, such as interest rates, year of origination and term, using discounted cash flows and market-based assumptions. Impairment of MSRs is recognized through a valuation allowance, determined by estimating the fair value of each stratum and comparing it to its carrying value. Subsequent increases in fair value are adjusted through the valuation allowance, but only to the extent of the valuation allowance. No impairment loss related to the MSRs was recognized during the years ended December 31, 2013 or 2012. The Company recognized an impairment loss related to the MSRs of $35 thousand during the year ended December 31, 2011.

Mortgage loan servicing includes collecting monthly mortgagor payments, forwarding payments and related accounting reports to investors, collecting escrow deposits for the payment of mortgagor property taxes and insurance, and paying taxes and insurance from escrow funds when due.due and administrating foreclosure actions when necessary. Loan servicing income (a component of noninterest income in the consolidated statements of income) consists of fees earned for servicing mortgage loans sold to third parties, net of amortization expense and impairment losses associated with capitalized mortgage servicing assets.

- 71 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

assets

(f.)  Loans

Loans are classified as held for investment when management has both the intent and ability to hold the loan for the foreseeable future, or until maturity or payoff. Loans are carried at the principal amount outstanding, net of any unearned income and unamortized deferred fees and costs on originated loans. Loan origination fees and certain direct loan origination costs are deferred, and the net amount is amortized into net interest income over the contractual life of the related loans or over the commitment period as an adjustment of yield. Interest income on loans is based on the principal balance outstanding computed using the effective interest method.

A loan is considered delinquent when a payment has not been received in accordance with the contractual terms. The accrual of interest income for commercial loans is discontinued when there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, while the accrual of interest income for retail loans is discontinued when loans reach specific delinquency levels. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments, unless the loan is well secured and in the process of collection. Additionally, if management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on a nonaccrual status immediately, rather than delaying such action until the loans become 90 days past due. When a loan is placed on nonaccrual status, previously accrued and uncollected interest is reversed, amortization of related deferred loan fees or costs is suspended, and income is recorded only to the extent that interest payments are subsequently received in cash and a determination has been made that the principal balance of the loan is collectible. If collectability of the principal is in doubt, payments received are applied to loan principal. A nonaccrual loan may be returned to accrual status when all delinquent principal and interest payments become current in accordance with the terms of the loan agreement, the borrower has demonstrated a period of sustained performance (generally a minimum of six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

The Company’s loan policy dictates the guidelines to be followed in determining when a loan is charged-off. All charge offs are approved by the Bank’s senior loan officers or loan committees, depending on the amount of the charge off, and are reported in aggregate to the Bank’s Board of Directors. Commercial business and commercial mortgage loans are charged-off when a determination is made that the financial condition of the borrower indicates that the loan will not be collectible in the ordinary course of business. Residential mortgage loans and home equities are generally charged-off or written down when the credit becomes severely delinquent and the balance exceeds the fair value of the property less costs to sell. Indirect and other consumer loans, both secured and unsecured, are generally charged-off in full during the month in which the loan becomes 120 days past due, unless the collateral is in the process of repossession in accordance with the Company’s policy.

- 72 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

A loan is accounted for as a troubled debt restructuring if the Company, for economic or legal reasons related to the borrower’s financial condition, grants a significant concession to the borrower that it would not otherwise consider. A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate or face amount of the loan, a reduction of accrued interest, an extension of the maturity date at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions. Troubled debt restructurings generally remain on nonaccrual status until there is a sustained period of payment performance (usually six months or longer) and there is a reasonable assurance that the payments will continue. See Allowance for Loan Losses below for further policy discussion and see Note 5 - Loans for additional information.

(g.)  Off-Balance Sheet Financial Instruments

In the ordinary course of business, the Company enters into off-balance sheet financial instruments consisting of commitments to extend credit, standby letters of credit and financial guarantees. Such financial instruments are recorded in the consolidated financial statements when they are funded or when related fees are incurred or received. The Company periodically evaluates the credit risks inherent in these commitments and establishes loss allowances for such risks if and when these are deemed necessary.

The Company recognizes as liabilities the fair value of the obligations undertaken in issuing the guarantees under the standby letters of credit, net of the related amortization at inception. The fair value approximates the unamortized fees received from the customers for issuing the standby letters of credit. The fees are deferred and recognized on a straight-line basis over the commitment period. Standby letters of credit outstanding at December 31, 20132015 had original terms ranging from one to five years.

- 72 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Feesyears.Fees received for providing loan commitments and letters of credit that result in loans are typically deferred and amortized to interest income over the life of the related loan, beginning with the initial borrowing. Fees on commitments and letters of credit are amortized to other income as banking fees and commissions over the commitment period when funding is not expected.

(h.)  Allowance for Loan Losses

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.

The allowance for loan losses is evaluated on a regular basis and is based upon periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific and general components. Specific allowances are established for impaired loans. Impaired commercial business and commercial mortgage loans are individually evaluated and measured for impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Regardless of the measurement method, impairment is based on the fair value of the collateral when foreclosure is probable. If the recorded investment in impaired loans exceeds the measure of estimated fair value, a specific allowance is established as a component of the allowance for loan losses. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged-off when deemed uncollectible.

- 73 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. The Company determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loans obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures unless the loan has been subject to a troubled debt restructure. At December 31, 2013,2015, there were no commitments to lend additional funds to those borrowers whose loans were classified as impaired.

General allowances are established for loan losses on a portfolio basis for loans that do not meet the definition of impaired. The portfolio is grouped into similar risk characteristics, primarily loan type. The Company applies an estimated loss rate, which considers both look-back and loss emergence periods, to each loan group. The loss rate is based on historical experience, with look-back periods that range from 24 to 48 months depending on the loan type, and as a result can differ from actual losses incurred in the future. The historical loss rate is adjusted by the loss emergence periods that range from 12 to 24 months depending on the loan type and for qualitative factors such asas; levels and trends of delinquent and non-accruing loans, trends in volume and terms, effects of changes in lending policy, the experience, ability and depth of management, national and local economic trends and conditions, concentrations of credit risk, interest rates, highly leveraged borrowers, information risk and collateral risk. The qualitative factors are reviewed at least quarterly and adjustments are made as needed.

While management evaluates currently available information in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution’s allowance for loan losses. Such agencies may require the financial institution to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

- 73 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(i.)   Other Real Estate Owned

Other real estate owned consists of properties acquired through foreclosure or by acceptance of a deed in lieu of foreclosure. These assets are recorded at the lower of fair value of the asset acquired less estimated costs to sell or “cost” (defined as the fair value at initial foreclosure). At the time of foreclosure, or when foreclosure occurs in-substance, the excess, if any, of the loan over the fair market value of the assets received, less estimated selling costs, is charged to the allowance for loan losses and any subsequent valuation write-downs are charged to other expense. In connection with the determination of the allowance for loan losses and the valuation of other real estate owned, management obtains appraisals for properties. Operating costs associated with the properties are charged to expense as incurred. Gains on the sale of other real estate owned are included in income when title has passed and the sale has met the minimum down payment requirements prescribed by GAAP. The balance of other real estate owned was $333$163 thousand and $184$194 thousand at December 31, 20132015 and 2012,2014, respectively.

(j.)  Company Owned Life Insurance

The Company holds life insurance policies on certain current and former employees. The Company is the owner and beneficiary of the policies. The cash surrender value of these policies is included as an asset on the consolidated statements of financial condition, and any increase in cash surrender value is recorded as noninterest income on the consolidated statements of income. In the event of the death of an insured individual under these policies, the Company would receive a death benefit which would be recorded as noninterest income.

- 74 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(k.)  Premises and Equipment

Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed on the straight-line method over the estimated useful lives of the assets. The Company generally amortizes buildings and building improvements over a period of 15 to 39 years and software, furniture and equipment over a period of 3 to 10 years. Leasehold improvements are amortized over the shorter of the lease term or the useful life of the improvements. Premises and equipment are periodically reviewed for impairment or when circumstances present indicators of impairment.

(l.)   Goodwill and Other Intangible Assets

Goodwill represents theThe excess of the purchase pricecost of an acquisition over the fair value of the net assets acquired in accordance with the purchase method of accounting for business combinations. Goodwill has an indefinite useful life and is not amortized, but is tested for impairment. GAAP requires goodwill to be tested for impairment at the Company’s reporting unit level on an annual basis, which for the Company is September 30th, and more frequently if events or circumstances indicate that there may be impairment. Currently, the Company’s goodwill is evaluated at the entity level as there is only one reporting unit.

Impairment exists when a reporting unit’s carrying valueconsists primarily of goodwill, exceeds its implied fair value. In testing goodwill for impairment, GAAP permits the Company to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If, after assessing the totality of eventscore deposit intangibles, and circumstances, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carrying value, then performing the two-step impairment test would be unnecessary. However, if the Company concludes otherwise, it would then be required to perform the first step (Step 1) of the goodwill impairment test, and continue to the second step (Step 2), if necessary. Step 1 compares the fair value of a reporting unit with its carrying value, including goodwill. If the carrying value of the reporting unit exceeds its fair value, Step 2 of the goodwill impairment test is performed to measure the amount of impairment loss, if any.

other identifiable intangible assets. Intangible assets are acquired assets that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. The Company’s intangible assets relate toconsist of core deposits. Intangibledeposits and other intangible assets with definite useful lives(primarily customer relationships). Core deposit intangible assets are amortized on an accelerated basis over their estimated life of approximately nine and a half years. Intangible assets with indefinite useful lives are not amortized until their lives are determined to be definite. IntangibleOther intangible assets are testedamortized on an accelerated basis over their weighted average estimated life of approximately twenty years. The Company reviews long-lived assets and certain identifiable intangibles for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of the assetsan asset may not be recoverable, from future undiscounted cash flows.in which case an impairment charge would be recorded.

Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis, and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The impairment testing process is conducted by assigning net assets and goodwill to each reporting unit. An initial qualitative evaluation is made to assess the likelihood of impairment and determine whether further quantitative testing to calculate the fair value is necessary. When the qualitative evaluation indicates that impairment is more likely than not, quantitative testing is required whereby the fair value of each reporting unit is calculated and compared to the recorded book value, “Step 1.” If the calculated fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired and “Step 2” is not considered necessary. If the carrying value of a reporting unit exceeds its calculated fair value, the impairment test continues (“Step 2”) by comparing the carrying value of the reporting unit’s goodwill to the implied fair value of goodwill. The implied fair value is computed by adjusting all assets are recorded atand liabilities of the reporting unit to current fair value.value with the offset adjustment to goodwill. The adjusted goodwill balance is the implied fair value of the goodwill. An impairment charge is recognized if the carrying value of goodwill exceeds the implied fair value of goodwill. See Note 7 - Goodwillfor additional information on goodwill and Other Intangible Assets.

- 74 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

other intangible assets.

(m.)  Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) Stock

The non-marketable investments in FHLB and FRB stock are included in other assets in the consolidated statements of financial condition at par value or cost and are periodically reviewed for impairment. The dividends received relative to these investments are included in other noninterest income in the consolidated statements of income.

As a member of the FHLB system, the Company is required to maintain a specified investment in FHLB of New York (“FHLBNY”) stock in proportion to its volume of certain transactions with the FHLB. FHLBNY stock totaled $15.8 million and $8.4$15.1 million as of December 31, 20132015 and 2012, respectively.2014.

As a member of the FRB system, the Company is required to maintain a specified investment in FRB stock based on a ratio relative to the Company’s capital. FRB stock totaled $4.9 million and $3.9 million as of December 31, 20132015 and 2012.2014, respectively.

(n.)  Equity Method Investments

The Company has investments in limited partnerships, primarily Small Business Investment Companies, and accounts for these investments under the equity method. These investments are included in other assets in the consolidated statements of financial condition and totaled $4.8$5.0 million and $4.7$4.9 million as of December 31, 20132015 and 2012,2014, respectively.

(o.)  Treasury Stock

Acquisitions of treasury stock are recorded at cost. The reissuance of shares in treasury is recorded at weighted-average cost.

- 75 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(p.)  Employee Benefits

The Company maintains an employer sponsored 401(k) plan where participants may make contributions in the form of salary deferrals and the Company provides matching contributions in accordance with the terms of the plan.    Contributions due under the terms of our defined contribution plans are accrued as earned by employees.

The Company also participates in a non-contributory defined benefit pension plan for certain employees who previously met participation requirements. The Company also provides post-retirement benefits, principally health and dental care, to employees of a previously acquired entity. The Company has closed the pension and post-retirement plans to new participants. The actuarially determined pension benefit is based on years of service and the employee’s highest average compensation during five consecutive years of employment. The Company’s policy is to at least fund the minimum amount required by the Employment Retirement Income Security Act of 1974. The cost of the pension and post-retirement plans are based on actuarial computations of current and future benefits for employees, and is charged to noninterest expense in the consolidated statements of income.

The Company recognizes an asset or a liability for a plans’ overfunded status or underfunded status, respectively, in the consolidated financial statements and reports changes in the funded status as a component of other comprehensive income, net of applicable taxes, in the year in which changes occur.

Effective January 1, 2016, the Company’s 401(k) plan was amended and the Company’s matching contribution was discontinued. Concurrent with the 401(k) plan amendment, the Company’s defined benefit pension plan was amended to modify the current benefit formula to reflect the discontinuance of the matching contribution in the 401(k) plan, to open the defined benefit pension plan up to eligible employees who were hired on and after January 1, 2007, and provide those new participants with a cash balance benefit formula.

(q.)  Share-Based Compensation Plans

Compensation expense for stock options and restricted stock awards is based on the fair value of the award on the measurement date, which, for the Company, is the date of grant and is recognized ratably over the service period of the award. The fair value of stock options is estimated using the Black-Scholes option-pricing model. The fair value of restricted stock awards is generally the market price of the Company’s stock on the date of grant.

Share-based compensation expense is included in the consolidated statements of income under salaries and employee benefits for awards granted to management and in other noninterest expense for awards granted to directors.

(r.)  Income Taxes

Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. A valuation allowance is recognized on deferred tax assets if, based upon the weight of available evidence, it is more likely than not that some or all of the assets may not be realized. The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

- 75 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(s.)  Comprehensive Income

Comprehensive income includes all changes in shareholders’ equity during a period, except those resulting from transactions with shareholders. In addition to net income, other components of the Company’s comprehensive income include the after tax effect of changes in net unrealized gain / loss on securities available for sale and changes in net actuarial gain / loss on defined benefit post-retirement plans. Comprehensive income is reported in the accompanying consolidated statements of changes in shareholder’sshareholders’ equity and consolidated statements of comprehensive income. See Note 13 - Accumulated Other Comprehensive Income (Loss) for additional information.

- 76 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(1.)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(t.)  Earnings Per Common Share

The Company calculates earnings per common share (“EPS”) using the two-class method in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 260, “Earnings Per Share”. The two-class method requires the Company to present EPS as if all of the earnings for the period are distributed to common shareholders and any participating securities, regardless of whether any actual dividends or distributions are made. All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities. Certain of the restricted shares issued under the Company’s share-based compensation plan are entitled to dividends at the same rate as common stock. The Company has determined that these outstanding non-vested stock awards qualify as participating securities.

Basic EPS is computed by dividing distributed and undistributed earnings available to common shareholders by the weighted average number of common shares outstanding for the period. Distributed and undistributed earnings available to common shareholders represent net income reduced by preferred stock dividends and distributed and undistributed earnings available to participating securities. Common shares outstanding include common stock and vested restricted stock awards. Diluted EPS reflects the assumed conversion of all potential dilutive securities. A reconciliation of the weighted-average shares used in calculating basic earnings per common share and the weighted average common shares used in calculating diluted earnings per common share for the reported periods is provided in Note 16 - Earnings Per Common Share.

(u.) Reclassifications

Prior years’ consolidatedCertain items in prior financial statements arehave been reclassified whenever necessary to conform to the current year’s presentation. Certain reclassifications have been made to the prior years’ financial statements in order to reflect retrospective adjustments made to the balance of goodwill at December 31, 2012 to reflect the effect of these measurement period adjustments made in accordance with accounting requirements. The reclassifications had no impact on shareholders’ equity or net income.

(v.)  Recent Accounting Pronouncements

In February 2013,May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-02,2014-09,ReportingRevenue from Contracts with Customers (Topic 606). ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of Amounts Reclassified OutASU 2014-09 is that an entity should recognize revenue to depict the transfer of Accumulated Other Comprehensive Income. ASU No. 2013-02 does not amend any existing requirementspromised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for reporting net incomethose goods or other comprehensive incomeservices. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the financial statements. ASU No. 2013-02 requires ancontract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The effective date was recently deferred for one year to disaggregate the total changeinterim and annual periods beginning on or after December 15, 2017. Early adoption is permitted as of each component of other comprehensive income (e.g., unrealized gainsthe original effective date – interim and annual periods beginning on or losses on available-for-sale investment securities) and separately present reclassification adjustments and current period other comprehensive income.after December 15, 2016. The provisionsCompany is evaluating the potential impact of ASU No. 2013-02 also requires that entities present either in a single note or parenthetically2014-09 on the face ofCompany’s financial statements.

In June 2014, the financial statements, the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source (e.g., unrealized gains or losses on available-for-sale investment securities) and the income statement line item affected by the reclassification (e.g., realized gains (losses) on sales of investment securities). If a component is not required to be reclassified to net income in its entirety (e.g., amortization of defined benefit plan items), entities would instead cross reference to the related note to the financial statements for additional information (e.g., pension footnote)FASB issued ASU 2014-12,Compensation—Stock Compensation (Topic 718). The pronouncement was issued to clarify the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. ASU 2014-12 is effective for the Company adopted the provisions of ASU No. 2013-02 effectivebeginning January 1, 2013. As the Company provided these required disclosures in the notes to the consolidated financial statements, the2016, though early adoption is permitted. The adoption of ASU No. 2013-02 had no2014-12 is not expected to have a significant impact on the Company’s consolidated statementsfinancial statements.

In January 2015, the FASB issued ASU 2015-01,Income Statement - Extraordinary and Unusual Items (Subtopic 225-20) – Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. ASU 2015-01 eliminates from U.S. GAAP the concept of extraordinary items, which, among other things, required an entity to segregate extraordinary items considered to be unusual and infrequent from the results of ordinary operations and show the item separately in the income and condition. See Note 13 - Accumulated Other Comprehensive Income (Loss) to the consolidated financial statementsstatement, net of tax, after income from continuing operations. ASU 2015-01 is effective for the disclosures required byCompany beginning January 1, 2016, though early adoption is permitted. ASU No. 2013-02.2015-01 is not expected to have a significant impact on the Company’s financial statements.

- 76 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(2.)BRANCH ACQUISITIONS

On January 19, 2012,In April 2015, the Bank entered into agreements with First Niagara Bank, National Association (“First Niagara”) to acquire four retail bank branches in Medina, Brockport, Batavia and Waterloo, New York (the “First Niagara Branches”) and four retail bank branches previously owned by HSBC Bank USA, National Association (“HSBC”) in Elmira, Elmira Heights, Horseheads and Albion, New York (the “HSBC Branches”)FASB issued ASU 2015-03,Simplifying the Presentation of Debt Issuance CostsFirst Niagara assigned its rights toUnder ASU 2015-03, the HSBC branches in connection with its acquisition of HSBC’s Upstate New York banking franchise. Under the terms of the agreements, the Bank assumed substantially all related deposits and purchased the related branch premises and certain performing loans. The transaction to acquire the First Niagara Branches was completed on June 22, 2012 and the transaction to acquire the HSBC Branches was completed on August 17, 2012. The combined assets acquired and deposits assumedCompany will present debt issuance costs in the two transactions were recorded at their estimated fair values as follows (in thousands):

Cash

  $195,778  

Loans

   75,635  

Bank premises and equipment

   1,938  

Goodwill

   11,167  

Core deposit intangible asset

   2,042  

Other assets

   601  
  

 

 

 

Total assets acquired

  $287,161  
  

 

 

 

Deposits assumed

  $286,819  

Other liabilities

   342  
  

 

 

 

Total liabilities assumed

  $287,161  
  

 

 

 

The transactions were accounted for using the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at their estimated fair values on the acquisition dates. The Company acquired the loan portfolios at a fair value discount, net of market premium, of $824 thousand. The discount represented expected credit losses, net of market interest rate adjustments. The discount on loans receivable is being amortized to interest income over the estimated remaining life of the acquired loans using the level yield method. The time deposit premium of $335 thousand is being accreted over the estimated remaining life of the related depositsbalance sheet as a reduction from the related debt liability rather than as an asset. Amortization of such costs will continue to be reported as interest expense. ASU 2015-03 will be effective for the Company beginning January 1, 2016, though early adoption is permitted. Retrospective adoption is required. The core deposit intangible asset is being amortized on an accelerated basis overCompany early adopted this standard during the estimated average lifequarter ended June 30, 2015, concurrent with the issuance of the core deposits.

DuringSubordinated Notes described in Note 9. Unamortized debt issuance costs of $1.0 million are included in the year ended December 31, 2013,net balance of long-term borrowings reported on the Company recorded a decrease to the estimated fair valueConsolidated Statements of liabilities assumed and an increase to the related deferred income taxes based upon information obtained subsequent to the acquisition. In addition to changes in those assets and liabilities, the revisions resulted in a reduction in goodwillFinancial Condition. Retrospective application of approximately $432 thousand. The final purchase price allocation was completed during the three months ended September 30, 2013, and the Company has recorded final goodwill totaling approximately $11.2 million in connection with the acquisitions. All goodwill and core deposit intangible assets arising from this acquisition are expected to be deductible for tax purposes.standard did not impact previously issued financial statements.

 

- 77 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

(2.)BUSINESS COMBINATIONS

SDN Acquisition

On August 1, 2014, the Company completed the acquisition of Scott Danahy Naylon Co., Inc., a full service insurance agency located in Amherst, New York. The acquisition of Scott Danahy Naylon Co., Inc. enhances the Company’s ability to offer clients unique, comprehensive solutions to meet their insurance and financial risk management needs. Consideration for the acquisition included both cash and stock totaling $16.9 million, including future consideration.

The transaction was accounted for using the acquisition method of accounting and as such, assets acquired, liabilities assumed and consideration exchanged were recorded at their estimated fair value on the acquisition date. Goodwill from the acquisition represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is not deductible for tax purposes. As a result of the acquisition, the Company recorded goodwill of $12.6 million and other intangible assets of $6.6 million. Goodwill was assigned to the Company’s Insurance reporting unit. Total goodwill and other intangible assets from the acquisition are inclusive of contingent earn-out payments based on revenue targets through 2017. The estimated fair value of the contingent earn-out liability at the date of acquisition was $3.2 million. Since the date of acquisition, valuation adjustments have been made resulting in a contingent earn-out liability of $2.2 million at December 31, 2015. The valuation adjustment is included in other noninterest income in the consolidated statements of income for the year ended December 31, 2015.

As more fully described in Note 7, the Company recorded a goodwill impairment charge related to the Insurance reporting unit of $751 thousand during the quarter ended December 31, 2015. See Note 7 for additional information on goodwill and other intangible assets.

Pro forma results of operations for this acquisition have not been presented because the effect of this acquisition was not material to the Company’s consolidated financial statements. The following table summarizes the consideration paid for Scott Danahy Naylon Co., Inc. and the amounts of the assets acquired and liabilities assumed as of the acquisition date.

Consideration paid:

Cash

  $8,100  

Stock

5,400  

Contingent consideration

3,227  

Fair value of total consideration transferred

16,727  

Fair value of assets acquired:

Cash

105  

Identified intangible assets

6,640  

Premises and equipment, accounts receivable and other assets

1,094  

Total identifiable assets acquired

7,839  

Fair value of liabilities assumed:

Deferred tax liability

2,556  

Other liabilities

1,173  

Total liabilities assumed

3,729  

Fair value of net assets acquired

4,110  

Goodwill resulting from acquisition

  $         12,617  

- 78 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

(3.)INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities are summarized below (in thousands).

 

  Amortized
Cost
   Unrealized
Gains
   Unrealized
Losses
   Fair Value       Amortized    
Cost
       Unrealized    
Gains
       Unrealized    
Losses
   Fair
        Value        
 

December 31, 2013

        

December 31, 2015

        

 

Securities available for sale:

        

U.S. Government agencies and government sponsored enterprises

   $260,748       $1,164       $1,049       $260,863    

Mortgage-backed securities:

        

Federal National Mortgage Association

   209,671       1,092       2,333       208,430    

Federal Home Loan Mortgage Corporation

   24,564       282       194       24,652    

Government National Mortgage Association

   26,465       943       4       27,404    

Collateralized mortgage obligations:

        

Federal National Mortgage Association

   16,998       90       154       16,934    

Federal Home Loan Mortgage Corporation

   5,175       1       91       5,085    

Privately issued

   -       809       -       809    
  

 

   

 

   

 

   

 

 

Total mortgage-backed securities

   282,873       3,217       2,776       283,314    

Asset-backed securities

   -       218       -       218    
  

 

   

 

   

 

   

 

 

Total available for sale securities

   $543,621       $4,599       $3,825       $544,395    
  

 

   

 

   

 

   

 

 

Securities held to maturity:

        

State and political subdivisions

   294,423       6,562       4       300,981    

Mortgage-backed securities:

        

Federal National Mortgage Association

   9,242       14       79       9,177    

Government National Mortgage Association

   25,607       33       159       25,481    

Collateralized mortgage obligations:

        

Federal National Mortgage Association

   56,791       -       818       55,973    

Federal Home Loan Mortgage Corporation

   80,570       -       1,120       79,450    

Government National Mortgage Association

   19,084       19       101       19,002    
  

 

   

 

   

 

   

 

 

Total mortgage-backed securities

   191,294       66       2,277       189,083    
  

 

   

 

   

 

   

 

 

Total held to maturity securities

   $485,717       $6,628       $2,281       $490,064    
  

 

   

 

   

 

   

 

 
        

December 31, 2014

        

 

Securities available for sale:

                

U.S. Government agencies and government sponsored enterprises

  $135,840    $1,414    $2,802    $134,452     $160,334       $1,116       $975       $160,475    

Mortgage-backed securities:

                

Federal National Mortgage Association

   173,507     1,511     4,810     170,208     184,857       2,344       1,264       185,937    

Federal Home Loan Mortgage Corporation

   36,737     562     205     37,094     29,478       799       7       30,270    

Government National Mortgage Association

   61,832     2,152     142     63,842     48,800       2,022       -       50,822    

Collateralized mortgage obligations:

                

Federal National Mortgage Association

   63,838     261     3,195     60,904     76,247       489       944       75,792    

Federal Home Loan Mortgage Corporation

   102,660     169     5,856     96,973     89,623       199       2,585       87,237    

Government National Mortgage Association

   43,734     913     586     44,061     29,954       598       40       30,512    

Privately issued

   —       1,467     —       1,467     -       1,218       -       1,218    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total collateralized mortgage obligations

   210,232     2,810     9,637     203,405  
  

 

   

 

   

 

   

 

 

Total mortgage-backed securities

   482,308     7,035     14,794     474,549     458,959       7,669       4,840       461,788    

Asset-backed securities

   18     381     —       399     -       231       -       231    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total available for sale securities

  $618,166    $8,830    $17,596    $609,400     $619,293       $9,016       $5,815       $622,494    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Securities held to maturity:

                

State and political subdivisions

  $249,785    $1,340    $468    $250,657     277,273       4,231       120       281,384    
  

 

   

 

   

 

   

 

 

December 31, 2012

        

Securities available for sale:

        

U.S. Government agencies and government sponsored enterprises

  $128,097    $3,667    $69    $131,695  

State and political subdivisions

   188,997     6,285     72     195,210  

Mortgage-backed securities:

                

Federal National Mortgage Association

   147,946     4,394     188     152,152     3,279       24       -       3,303    

Federal Home Loan Mortgage Corporation

   65,426     1,430     —       66,856  

Government National Mortgage Association

   56,166     3,279     —       59,445     13,886       122       -       14,008    

Collateralized mortgage obligations:

        

Federal National Mortgage Association

   60,805     1,865     2     62,668  

Federal Home Loan Mortgage Corporation

   78,581     1,911     —       80,492  

Government National Mortgage Association

   70,989     2,168     —       73,157  

Privately issued

   73     1,025     —       1,098  
  

 

   

 

   

 

   

 

 

Total collateralized mortgage obligations

   210,448     6,969     2     217,415  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total mortgage-backed securities

   479,986     16,072     190     495,868     17,165       146       -       17,311    

Asset-backed securities

   121     902     —       1,023  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total available for sale securities

  $797,201    $26,926    $331    $823,796  

Total held to maturity securities

   $294,438       $4,377       $120       $298,695    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Securities held to maturity:

        

State and political subdivisions

  $17,905    $573    $—      $18,478  
  

 

   

 

   

 

   

 

 

 

- 7879 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(3.)INVESTMENT SECURITIES (Continued)

 

Investment securities with a total fair value of $781.7 million and $768.6 million at December 31, 2015 and 2014, respectively, were pledged as collateral to secure public deposits and for other purposes required or permitted by law.

During the yearyears ended December 31, 2013,2015 and 2014, the Company transferred $227.3$165.2 million and $12.8 million, respectively, of available for sale state and municipal debtmortgage backed securities to the held to maturity category, reflecting the Company’s intent to hold those securities to maturity. Transfers of investment securities into the held to maturity category from the available for sale category are made at fair value at the date of transfer. The related $78$1.1 million and $51 thousand of unrealized holding gainslosses that were included in the transfertransfers during the years ended December 31, 2015 and 2014, respectively, are retained in accumulated other comprehensive income and in the carrying value of the held to maturity securities. This amountThese amounts will be amortized as an adjustment to interest income over the remaining life of the securities. This will offset the impact of amortization of the net premium created in the transfer.transfers. There were no gains or losses recognized as a result of this transfer.these transfers.

Interest and dividends on securities for the years ended December 31 are summarized as follows (in thousands):

 

   2013   2012   2011 

Taxable interest and dividends

  $12,541    $12,202    $14,185  

Tax-exempt interest and dividends

   4,922     4,242     3,828  
  

 

 

   

 

 

   

 

 

 

Total interest and dividends on securities

  $17,463    $16,444    $18,013  
  

 

 

   

 

 

   

 

 

 

Sales and calls of securities available for sale for the years ended December 31 were as follows (in thousands):

           2015                   2014                   2013         

Taxable interest and dividends

   $16,123       $13,304       $12,541    

Tax-exempt interest and dividends

   5,752       5,298       4,922    
  

 

 

   

 

 

   

 

 

 

Total interest and dividends on securities

   $21,875       $18,602       $17,463    
  

 

 

   

 

 

   

 

 

 

 

Sales and calls of securities available for sale for the years ended December 31 were as follows (in thousands):

 

  

           2015                   2014                   2013         

Proceeds from sales

   $54,277       $81,600       $1,327    

Gross realized gains

   2,000       2,043       1,226    

Gross realized losses

   12       2       -    

 

The scheduled maturities of securities available for sale and securities held to maturity at December 31, 2015 are shown below. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations (in thousands).

    

 

   2013   2012   2011 

Proceeds from sales

  $1,327    $2,823    $44,514  

Gross realized gains

   1,226     2,651     3,051  

Gross realized losses

   —       —       48  

The scheduled maturities of securities available for sale and securities held to maturity at December 31, 2013 are shown below. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations (in thousands).

  Amortized
Cost
   Fair Value   

      Amortized    
Cost
   Fair
        Value        
 

Debt securities available for sale:

          

Due in one year or less

  $24,205    $24,204       $25,182       $25,241    

Due from one to five years

   28,163     28,932       174,053       173,336    

Due after five years through ten years

   238,364     232,854       275,972       276,660    

Due after ten years

   327,434     323,410       68,414       69,158    
  

 

   

 

     

 

   

 

 
  $618,166    $609,400       $543,621       $544,395    
  

 

   

 

     

 

   

 

 

Debt securities held to maturity:

          

Due in one year or less

  $25,289    $25,371       $22,188       $22,261    

Due from one to five years

   109,911     110,862       172,094       175,650    

Due after five years through ten years

   114,543     114,371       116,362       119,183    

Due after ten years

   42     53       175,073       172,970    
  

 

   

 

     

 

   

 

 
  $249,785    $250,657       $485,717       $490,064    
  

 

   

 

     

 

   

 

 

 

- 7980 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(3.)INVESTMENT SECURITIES (Continued)

 

Unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31 are summarized as follows (in thousands):

 

  Less than 12 months   12 months or longer   Total      Less than 12 months         12 months or longer                     Total                  
  Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
  Fair
Value
 Unrealized
Losses
 Fair
Value
 Unrealized
Losses
 Fair
Value
 Unrealized
Losses
 

December 31, 2013

            

December 31, 2015

      

 

Securities available for sale:

                  

U.S. Government agencies and government sponsored enterprises

  $86,177    $2,788    $2,717    $14    $88,894    $2,802    $82,298      $735      $26,302      $314      $108,600      $1,049    

Mortgage-backed securities:

                  

Federal National Mortgage Association

   103,778     3,491     20,689     1,319     124,467     4,810   123,774     2,134     9,562     199     133,336     2,333    

Federal Home Loan Mortgage Corporation

   14,166     205     —       —       14,166     205   12,660     194      -      -     12,660     194    

Government National Mortgage Association

   14,226     142     —       —       14,226     142   1,405     4      -      -     1,405     4    

Collateralized mortgage obligations:

                  

Federal National Mortgage Association

   35,632     2,586     11,760     609     47,392     3,195   7,778     154      -      -     7,778     154    

Federal Home Loan Mortgage Corporation

   72,655     4,980     15,762     876     88,417     5,856   4,998     91      -      -     4,998     91    
 

 

  

 

  

 

  

 

  

 

  

 

 

Total mortgage-backed securities

 150,615     2,577     9,562     199     160,177     2,776    
 

 

  

 

  

 

  

 

  

 

  

 

 

Total available for sale securities

 232,913     3,312     35,864     513     268,777     3,825    
 

 

  

 

  

 

  

 

  

 

  

 

 

Securities held to maturity:

      

State and political subdivisions

 3,075     4      -      -     3,075     4    

Mortgage-backed securities:

      

Federal National Mortgage Association

 5,666     79      -      -     5,666     79    

Government National Mortgage Association

 8,790     159      -      -     8,790     159    

Collateralized mortgage obligations:

      

Federal National Mortgage Association

 55,973     818      -      -     55,973     818    

Federal Home Loan Mortgage Corporation

 79,323     1,120      -      -     79,323     1,120    

Government National Mortgage Association

   8,396     586     —       —       8,396     586   14,559     101      -      -     14,559     101    
  

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total collateralized mortgage obligations

   116,683     8,152     27,522     1,485     144,205     9,637  

Total mortgage-backed securities

 164,311     2,277      -      -     164,311     2,277    
 

 

  

 

  

 

  

 

  

 

  

 

 

Total held to maturity securities

 167,386     2,281      -      -     167,386     2,281    
 

 

  

 

  

 

  

 

  

 

  

 

 

Total temporarily impaired securities

  $  400,299      $      5,593      $    35,864      $      513      $ 436,163      $      6,106    
 

 

  

 

  

 

  

 

  

 

  

 

 
      

December 31, 2014

      

 

Securities available for sale:

      

U.S. Government agencies and government sponsored enterprises

  $34,995      $77      $41,070      $898      $76,065      $975    

Mortgage-backed securities:

      

Federal National Mortgage Association

 2,242     8     62,592     1,256     64,834     1,264    

Federal Home Loan Mortgage Corporation

 3,387     7      -      -     3,387     7    

Collateralized mortgage obligations:

      

Federal National Mortgage Association

 11,228     24     25,644     920     36,872     944    

Federal Home Loan Mortgage Corporation

  -      -     76,126     2,585     76,126     2,585    

Government National Mortgage Association

  -      -     2,510     40     2,510     40    
  

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total mortgage-backed securities

   248,853     11,990     48,211     2,804     297,064     14,794   16,857     39     166,872     4,801     183,729     4,840    
  

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total available for sale securities

   335,030     14,778     50,928     2,818     385,958     17,596   51,852     116     207,942     5,699     259,794     5,815    

Securities held to maturity:

                  

State and political subdivisions

   72,269     468     —       —       72,269     468   18,036     120      -      -     18,036     120    
  

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total temporarily impaired securities

  $407,299    $15,246    $50,928    $2,818    $458,227    $18,064    $69,888      $236      $207,942      $5,699      $277,830      $5,935    
  

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

 

December 31, 2012

            

U.S. Government agencies and government sponsored enterprises

  $13,265    $67    $2,967    $2    $16,232    $69  

State and political subdivisions

   8,471     72     —       —       8,471     72  

Mortgage-backed securities:

            

Federal National Mortgage Association

   25,200     188     —       —       25,200     188  

Collateralized mortgage obligations:

            

Federal National Mortgage Association

   —       —       1,173     2     1,173     2  
  

 

   

 

   

 

   

 

   

 

   

 

 

Total collateralized mortgage obligations

   —       —       1,173     2     1,173     2  
  

 

   

 

   

 

   

 

   

 

   

 

 

Total mortgage-backed securities

   25,200     188     1,173     2     26,373     190  
  

 

   

 

   

 

   

 

   

 

   

 

 

Total temporarily impaired securities

  $46,936    $327    $4,140    $4    $51,076    $331  
  

 

   

 

   

 

   

 

   

 

   

 

 

- 81 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(3.)INVESTMENT SECURITIES (Continued)

The total number of security positions in the investment portfolio in an unrealized loss position at December 31, 20132015 was 331152 compared to 52122 at December 31, 2012.2014. At December 31, 2013,2015, the Company had positions in 1410 investment securities with a fair value of $50.9$35.9 million and a total unrealized loss of $2.8$513 thousand that have been in a continuous unrealized loss position for more than 12 months. At December 31, 2015, there were a total of 142 securities positions in the Company’s investment portfolio with a fair value of $400.3 million and a total unrealized loss of $5.6 million that had been in a continuous unrealized loss position for less than 12 months. At December 31, 2014, the Company had positions in 51 investment securities with a fair value of $207.9 million and a total unrealized loss of $5.7 million that have been in a continuous unrealized loss position for more than 12 months. ThereAt December 31, 2014, there were a total of 31771 securities positions in the Company’s investment portfolio with a fair value of $407.3$69.9 million and a total unrealized loss of $15.2 million at December 31, 2013,$236 thousand that havehad been in a continuous unrealized loss position for less than 12 months. There were no unrealized losses in held to maturity securities at December 31, 2012. The unrealized loss on these investment securities was predominantly caused by changes in market interest rates subsequent to purchase. The fair value of most of the investment securities in the Company’s portfolio fluctuates as market interest rates change.

- 80 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(3.)INVESTMENT SECURITIES (Continued)

The Company reviews investment securities on an ongoing basis for the presence of other than temporary impairment (“OTTI”) with formal reviews performed quarterly. When evaluating debt securities for OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intention to sell the debt security or whether it is more likely than not that it will be required to sell the debt security before its anticipated recovery. The assessment of whether OTTI exists involves a high degree of subjectivity and judgment and is based on the information available to management.

No impairment was recorded during the year ended December 31, 2013. During the years ended December 31, 20122015, 2014 and 2011, the Company recognized OTTI charges of $91 thousand and $18 thousand, respectively, related to privately issued whole loan CMOs that were determined to be impaired due to credit quality.2013.

Based on management’s review and evaluation of the Company’s debt securities as of December 31, 2013,2015, the debt securities with unrealized losses were not considered to be OTTI. As of December 31, 2013,2015, the Company does not have the intent to sell any of the securities in a loss position and believes that it is not likely that it will be required to sell any such securities before the anticipated recovery of amortized cost. Accordingly, as of December 31, 2013,2015, management has concluded that unrealized losses on its investment securities are temporary and no further impairment loss has been realized in the Company’s consolidated statements of income.

 

(4.)LOANS HELD FOR SALE AND LOAN SERVICING RIGHTS

Loans held for sale were entirely comprised of residential real estate mortgages and totaled $3.4$1.4 million and $1.5 million$755 thousand as of December 31, 20132015 and 2012,2014, respectively.

The Company sells certain qualifying newly originated or refinanced residential real estate mortgages on the secondary market. Residential real estate mortgages serviced for others, which are not included in the consolidated statements of financial condition, amounted to $237.9$196.0 million and $273.3$215.2 million as of December 31, 20132015 and 2012,2014, respectively. In connection with these mortgage-servicing activities, the Company administered escrow and other custodial funds which amounted to approximately $4.9$4.4 million and $5.6$4.6 million as of December 31, 20132015 and 2012,2014, respectively.

The activity in capitalized mortgage servicing assets is summarized as follows for the years ended December 31 (in thousands):

 

  2013 2012 2011           2015                   2014                   2013         

Mortgage servicing assets, beginning of year

  $1,637   $1,609   $1,642     $1,335      $1,479      $1,637   

Originations

   277   554   319     166      172      277   

Amortization

   (435 (526 (352   (276)     (316)     (435)  
  

 

  

 

  

 

   

 

   

 

   

 

 

Mortgage servicing assets, end of year

   1,479    1,637    1,609     1,225      1,335      1,479   

Valuation allowance

   (3  (168  (210   (1)     (6)     (3)  
  

 

  

 

  

 

   

 

   

 

   

 

 

Mortgage servicing assets, net, end of year

  $1,476   $1,469   $1,399    $1,224      $1,329      $1,476   
  

 

  

 

  

 

   

 

   

 

   

 

 

 

- 8182 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(5.)LOANS

The Company’s loan portfolio consisted of the following at December 31 (in thousands):

 

  Principal
Amount
Outstanding
   Net Deferred
Loan (Fees)
Costs
 Loans, Net   Principal
Amount
 Outstanding 
    Net Deferred 
Loan (Fees)
Costs
     Loans, Net   

2013

     

2015

      

 

Commercial business

  $265,751    $15   $265,766     $313,475      $283      $313,758   

Commercial mortgage

   470,312     (1,028 469,284     567,481      (1,380)     566,101   

Residential mortgage

   113,101     (56 113,045     98,302           98,309   

Home equity

   320,658     5,428   326,086     402,487      7,625      410,112   

Consumer indirect

   609,390     26,978   636,368     652,494      24,446      676,940   

Other consumer

   22,893     177   23,070     18,361      181      18,542   
  

 

   

 

  

 

   

 

   

 

   

 

 

Total

  $1,802,105    $31,514    1,833,619     $2,052,600      $31,162      2,083,762   
  

 

   

 

    

 

   

 

   

Allowance for loan losses

      (26,736       (27,085)  
     

 

       

 

 

Total loans, net

     $1,806,883         $2,056,677   
     

 

       

 

 
      

2012

     

2014

      

 

Commercial business

  $258,706    $(31 $258,675     $267,377      $32      $267,409   

Commercial mortgage

   414,282     (958  413,324     476,407      (1,315)     475,092   

Residential mortgage

   133,341     179    133,520     100,241      (140)     100,101   

Home equity

   282,503     4,146    286,649     379,774      6,841      386,615   

Consumer indirect

   559,964     26,830    586,794     636,357      25,316      661,673   

Other consumer

   26,657     107    26,764     20,915      197      21,112   
  

 

   

 

  

 

   

 

   

 

   

 

 

Total

  $1,675,453    $30,273    1,705,726     $1,881,071      $30,931      1,912,002   
  

 

   

 

    

 

   

 

   

Allowance for loan losses

      (24,714       (27,637)  
     

 

       

 

 

Total loans, net

     $1,681,012         $1,884,365   
     

 

       

 

 

The Company’s significant concentrations of credit risk in the loan portfolio relate to a geographic concentration in the communities that the Company serves.

Certain executive officers, directors and their business interests are customers of the Company. Transactions with these parties are based on substantially the same terms as similar transactions with unrelated third parties and do not carry more than normal credit risk. Borrowings by these related parties amounted to $2.9$3.5 million and $292 thousand$11.9 million at December 31, 20132015 and 2012,2014, respectively. During 2013,2015, new borrowings amounted to $2.7$2.9 million (including borrowings of executive officers and directors that were outstanding at the time of their election)appointment), and repayments and other reductions were $79 thousand.$11.3 million.

 

- 8283 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(5.)LOANS (Continued)

 

Past Due Loans Aging

The Company’s recorded investment, by loan class, in current and nonaccrual loans, as well as an analysis of accruing delinquent loans is set forth as of December 31 (in thousands):

 

  30-59 Days
Past Due
   60-89 Days
Past Due
   Greater
Than
90 Days
   Total Past
Due
   Nonaccrual   Current   Total Loans   30-59 Days 
Past Due
  60-89 Days
Past Due 
 Greater
  Than 90  
Days
   Total Past  
Due
  Nonaccrual  Current  Total Loans  

2013

              

2015

       

 

Commercial business

  $558    $199    $—      $757    $3,474    $261,520    $265,751    $321      $612      $-      $933      $3,922      $308,620      $313,475    

Commercial mortgage

   800     —       —       800     9,663     459,849     470,312   68     146      -     214     947     566,320     567,481    

Residential mortgage

   542     —       —       542     1,078     111,481     113,101   203      -      -     203     1,325     96,774     98,302    

Home equity

   750     143     —       893     925     318,840     320,658   719     429      -     1,148     758     400,581     402,487    

Consumer indirect

   2,129     476     —       2,605     1,471     605,314     609,390   1,975     286      -     2,261     1,467     648,766     652,494    

Other consumer

   126     72     6     204     5     22,684     22,893   98     13     8     119     13     18,229     18,361    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total loans, gross

  $4,905    $890    $6    $5,801    $16,616    $1,779,688    $1,802,105    $3,384      $1,486      $8      $4,878      $8,432      $  2,039,290      $ 2,052,600    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 
       

2012

              

2014

       

 

Commercial business

  $160    $—      $—      $160    $3,413    $255,133    $258,706    $28      $-      $-      $28      $4,288      $263,061      $267,377    

Commercial mortgage

   331     —       —       331     1,799     412,152     414,282   83      -      -     83     3,020     473,304     476,407    

Residential mortgage

   376     —       —       376     2,040     130,925     133,341   321      -      -     321     1,194     98,726     100,241    

Home equity

   675     10     —       685     939     280,879     282,503   799     67      -     866     463     378,445     379,774    

Consumer indirect

   1,661     163     —       1,824     891     557,249     559,964   2,429     402      -     2,831     1,169     632,357     636,357    

Other consumer

   127     35     18     180     25     26,452     26,657   148     48     8     204     11     20,700     20,915    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Total loans, gross

  $3,330    $208    $18    $3,556    $9,107    $1,662,790    $1,675,453    $3,808      $517      $8      $4,333      $10,145      $1,866,593      $1,881,071    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

There were no loans past due greater than 90 days and still accruing interest as of December 31, 20132015 and December 31, 2012.2014. There were $6 thousand and $18$8 thousand in consumer overdrafts which were past due greater than 90 days as of December 31, 20132015 and December 31, 2012, respectively.2014. Consumer overdrafts are overdrawn deposit accounts which have been reclassified as loans but by their terms do not accrue interest.

Interest income on nonaccrual loans, if recognized, is recorded using the cash basis method of accounting. There was no interest income recognized on nonaccrual loans during the years ended December 31, 2013, 20122015, 2014 and 2011.2013. For the years ended December 31, 2013, 20122015, 2014 and 2011,2013, estimated interest income of $531$432 thousand, $555$527 thousand, and $438$531 thousand, respectively, would have been recorded if all such loans had been accruing interest according to their original contractual terms.

 

- 8384 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(5.)LOANS (Continued)

 

Troubled Debt Restructurings

A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company offers various types of concessions when modifying loans, however, forgiveness of principal is rarely granted. Commercial loans modified in a TDR may involve temporary interest-only payments, term extensions, reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, requesting additional collateral releasing collateral for consideration,concessions, forgiveness of principal, forebearance agreements, or substituting or adding a new borrower or guarantor.

The following presents, by loan class, information related to loans modified in a TDR during the years ended December 31 (in thousands).

 

  Number
of
Contracts
   Pre-Modification
Outstanding
Recorded
Investment
   Post-
Modification
Outstanding
Recorded
Investment
    Number of 
Contracts
  Pre-
 Modification 
Outstanding
Recorded
Investment
   Post-
 Modification 
Outstanding
Recorded
Investment
    

2013

      

2015

        

   

Commercial business

       4    $1,465    $1,456    2   $1,342         $1,342        

Commercial mortgage

   2     7,335     6,935    1   682         330        
  

 

   

 

   

 

   

 

  

 

   

 

   

Total

   6    $8,800    $8,391    3   $2,024         $1,672        
  

 

   

 

   

 

   

 

  

 

   

 

   

2012

      
        

2014

        

   

Commercial business

   3    $536    $536    1   $1,381         $1,381        

Commercial mortgage

   4     648     648    -   -         -        
  

 

   

 

   

 

   

 

  

 

   

 

   

Total

   7    $1,184    $1,184    1   $1,381         $1,381        
  

 

   

 

   

 

   

 

  

 

   

 

   

With the exception of one commercial mortgage loan modified during 2013, all of theThe loans identified as TDRs by the Company during the years ended December 31, 20132015 and 20122014 were on nonaccrual status and reported as impaired loans prior to restructuring. ForThe modifications during the year ended December 31, 2013, restructured loan modifications of commercial business2015 primarily related to extending amortization periods, forebearance agreements, requesting additional collateral and, commercial mortgage loans primarily included maturity date extensions, payment schedule modifications andin one instance, forgiveness of principal. For the year ended December 31, 2012,2014, the restructured loan modificationsmodification related to extending the amortization period of commercial business and commercial mortgage loans primarily included payment schedule modifications and releasing collateral in consideration of payment.the loan. All loans restructured during the years ended December 31, 20132015 and 20122014 were on nonaccrual status at the end of those respective years. Nonaccrual loans that are restructured remain on nonaccrual status, but may move to accrual status after they have performed according to the restructured terms for a period of time. The TDR classification did not have a material impact on the Company’s determination of the allowance for loan losses because the modified loans were either classified as substandard, with an increased risk allowance allocation, or impaired and evaluated for a specific reserve both before and after restructuring.

There were two commercial business loans with an aggregate pre-default balance of $1.3 million that went into default and were restructured during the year ended December 31, 2015. There were no loans modified as a TDR during the year ended December 31, 2014 that defaulted during the year ended December 31, 2014. For purposes of this disclosure, a loan modified as a TDR is considered to have defaulted when the borrower becomes 90 days past due. There were no loans modified as a TDR during the previous 12 months which subsequently defaulted during the year ended December 31, 2013. One commercial business loan restructured during 2012 with a balance of $52 thousand defaulted during the year ended December 31, 2012. This default did not significantly impact the Company’s determination of the allowance for loan losses.

 

- 8485 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(5.)LOANS (Continued)

 

Impaired Loans

Management has determined that specific commercial loans on nonaccrual status and all loans that have had their terms restructured in a troubled debt restructuring are impaired loans. The following table presents data on impaired loans at December 31 (in thousands):

 

  Recorded
Investment(1)
   Unpaid
Principal
Balance(1)
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
   Recorded
  Investment(1)  
   Unpaid
Principal
   Balance(1)   
   Related
  Allowance  
   Average
Recorded
  Investment  
   Interest
Income
 Recognized 
 

2013

          

2015

          

 

With no related allowance recorded:

                    

Commercial business

  $1,777    $2,273    $—      $659    $—       $1,441       $1,810       $-       $1,352       $-    

Commercial mortgage

   875     906     —       760     —       937       1,285       -       1,013       -    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
   2,652     3,179     —       1,419     —       2,378       3,095       -       2,365       -    

With an allowance recorded:

                    

Commercial business

   1,697     1,717     201     3,196     —       2,481       2,481       996       1,946       -    

Commercial mortgage

   8,788     9,188     1,057     3,758     —       10       10       10       449       -    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
   10,485     10,905     1,258     6,954     —       2,491       2,491       1,006       2,395       -    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
  $13,137    $14,084    $1,258    $8,373    $—       $4,869       $5,586       $1,006       $4,760       $-    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
          

2012

          

2014

          

 

With no related allowance recorded:

                    

Commercial business

  $963    $1,425    $—      $755    $—          $1,408       $1,741       $-       $1,431       $-    

Commercial mortgage

   911     1,002     —       1,310     —       781       920       -       1,014       -    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
   1,874     2,427     —       2,065     —       2,189       2,661       -       2,445       -    

With an allowance recorded:

                    

Commercial business

   2,450     2,450     664     2,114     —       2,880       2,880       1,556       1,998       -    

Commercial mortgage

   888     888     310     1,858     —       2,239       2,239       911       1,560       -    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
   3,338     3,338     974     3,972     —       5,119       5,119       2,467       3,558       -    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
  $5,212    $5,765    $974    $6,037    $—          $7,308       $7,780       $2,467       $6,003       $-    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

 

(1)

Difference between recorded investment and unpaid principal balance represents partial charge-offs.

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors such as the fair value of collateral. The Company analyzes commercial business and commercial mortgage loans individually by classifying the loans as to credit risk. Risk ratings are updated any time the situation warrants. The Company uses the following definitions for risk ratings:

Special Mention:Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.

Substandard:Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

- 85 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(5.)LOANS (Continued)

Doubtful:Loans classified as doubtful have all the weaknesses inherent in those classified as 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.

Loans not meeting the criteria above that are analyzed individually as part of the process described above are considered “Uncriticized” or pass-rated loans and are included in groups of homogeneous loans with similar risk and loss characteristics.

- 86 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(5.)LOANS (Continued)

The following table sets forth the Company’s commercial loan portfolio, categorized by internally assigned asset classification, as of December 31 (in thousands):

 

  Commercial
Business
   Commercial
Mortgage
   Commercial
Business
   Commercial
Mortgage
 
2013 

2015

    

 

Uncriticized

  $250,553    $449,447     $298,413       $551,603    

Special mention

   6,311     6,895     4,916       9,015    

Substandard

   8,887     13,970     10,146       6,863    

Doubtful

   —       —       -       -    
  

 

   

 

   

 

   

 

 

Total

  $265,751    $470,312     $313,475       $567,481    
  

 

   

 

   

 

   

 

 
    

2012

    

2014

    

 

Uncriticized

  $240,291    $400,576     $250,961       $460,880    

Special mention

   6,591     6,495     5,530       5,411    

Substandard

   11,824     7,211     10,886       10,116    

Doubtful

   —       —       -       -    
  

 

   

 

   

 

   

 

 

Total

  $258,706    $414,282     $267,377       $     476,407    
  

 

   

 

   

 

   

 

 

The Company utilizes payment status as a means of identifying and reporting problem and potential problem retail loans. The Company considers nonaccrual loans and loans past due greater than 90 days and still accruing interest to be non-performing. The following table sets forth the Company’s retail loan portfolio, categorized by payment status, as of December 31 (in thousands):

 

  Residential
Mortgage
   Home
Equity
   Consumer
Indirect
   Other
Consumer
    Residential 
Mortgage
   Home
Equity
     Consumer  
Indirect
   Other
  Consumer  
 

2013

        

2015

        

 

Performing

  $112,023    $319,733    $607,919    $22,882     $96,977       $401,729       $651,027       $18,340    

Non-performing

   1,078     925     1,471     11     1,325       758       1,467       21    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total

  $113,101    $320,658    $609,390    $22,893     $98,302       $402,487       $652,494       $18,361    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

2012

        
        

2014

        

 

Performing

  $131,301    $281,564    $559,073    $26,632     $99,047       $379,311       $635,188       $20,896    

Non-performing

   2,040     939     891     25     1,194       463       1,169       19    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total

  $133,341    $282,503    $559,964    $26,657     $100,241       $379,774       $636,357       $  20,915    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

 

- 8687 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(5.)LOANS (Continued)

 

Allowance for Loan Losses

The following tables set forth the changes in the allowance for loan losses for the years ended December 31 (in thousands):

 

  Commercial
Business
 Commercial
Mortgage
 Residential
Mortgage
 Home
Equity
 Consumer
Indirect
 Other
Consumer
 Total   Commercial 
Business
  Commercial 
Mortgage
   Residential  
Mortgage
 Home
Equity
  Consumer 
Indirect
 Other
  Consumer  
 Total 

2013

        

2015

       

 

Allowance for loan losses:

       

Beginning balance

  $5,621     $8,122     $570     $1,485     $11,383     $456     $27,637   

Charge-offs

 (1,433)   (895)   (175)   (421)   (9,156)   (878)   (12,958)  

Recoveries

 212    146    82    63    4,200    322    5,025   

Provision (credit)

 1,140    1,654    (13)   101    4,031    468    7,381   
 

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Ending balance

  $5,540     $9,027     $464     $1,228     $10,458     $368     $27,085   
 

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Evaluated for impairment:

       

Individually

  $996     $10     $    $    $    $    $1,006   
 

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Collectively

  $4,544     $9,017     $464     $1,228     $10,458     $368     $26,079   
 

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Loans:

       

Ending balance

  $313,475     $567,481     $98,302     $402,487     $652,494     $18,361     $2,052,600   
 

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Evaluated for impairment:

       

Individually

  $3,922     $947     $    $    $    $    $4,869   
 

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Collectively

  $309,553     $566,534     $98,302     $402,487     $652,494     $18,361     $2,047,731   
 

 

  

 

  

 

  

 

  

 

  

 

  

 

 
       

2014

       

 

Allowance for loan losses:

               

Beginning balance

  $4,884   $6,581   $740   $1,282   $10,715   $512   $24,714    $4,273     $7,743     $676     $1,367     $12,230     $447     $26,736   

Charge-offs

   (1,070 (553 (411 (391 (8,125 (928 (11,478 (204)   (304)   (190)   (340)   (10,004)   (972)   (12,014)  

Recoveries

   349   319   54   157   3,161   381   4,421   201    143    39    56    4,321    366    5,126   

Provision

   110   1,396   293   319   6,479   482   9,079   1,351    540    45    402    4,836    615    7,789   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Ending balance

  $4,273   $7,743   $676   $1,367   $12,230   $447   $26,736    $5,621     $8,122     $570     $1,485     $11,383     $456     $27,637   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Evaluated for impairment:

               

Individually

  $201   $1,057   $—     $—     $—     $—     $1,258    $1,556     $911     $    $    $    $    $2,467   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Collectively

  $4,072   $6,686   $676   $1,367   $12,230   $447   $25,478    $4,065     $7,211     $570     $1,485     $11,383     $456     $25,170   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Loans:

               

Ending balance

  $265,751   $470,312   $113,101   $320,658   $609,390   $22,893   $1,802,105    $267,377     $476,407     $100,241     $379,774     $636,357     $20,915     $1,881,071   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Evaluated for impairment:

               

Individually

  $3,474   $9,663   $—     $—     $—     $—     $13,137    $4,288     $3,020     $    $    $    $    $7,308   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Collectively

  $262,277   $460,649   $113,101   $320,658   $609,390   $22,893   $1,788,968    $263,089     $473,387     $100,241     $    379,774     $636,357     $20,915     $  1,873,763   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

2012

        

Allowance for loan losses:

        

Beginning balance

  $4,036   $6,418   $858   $1,242   $10,189   $517   $23,260  

Charge-offs

   (729  (745  (326  (305  (6,589  (874  (9,568

Recoveries

   336    261    130    44    2,769    354    3,894  

Provision

   1,241    647    78    301    4,346    515    7,128  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Ending balance

  $4,884   $6,581   $740   $1,282   $10,715   $512   $24,714  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Evaluated for impairment:

        

Individually

  $664   $310   $—     $—     $—     $—     $974  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Collectively

  $4,220   $6,271   $740   $1,282   $10,715   $512   $23,740  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Loans:

        

Ending balance

  $258,706   $414,282   $133,341   $282,503   $559,964   $26,657   $1,675,453  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Evaluated for impairment:

        

Individually

  $3,413   $1,799   $—     $—     $—     $—     $5,212  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Collectively

  $255,293   $412,483   $133,341   $282,503   $559,964   $26,657   $1,670,241  
  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

 

- 8788 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(5.)LOANS (Continued)

 

  Commercial
Business
 Commercial
Mortgage
 Residential
Mortgage
 Home
Equity
 Consumer
Indirect
 Other
Consumer
 Total  Commercial
Business
 Commercial
Mortgage
 Residential
Mortgage
 Home
Equity
 Consumer
Indirect
 Other
Consumer
 Total 

2011

        

2013

       

 

Allowance for loan losses:

               

Beginning balance

  $3,712   $6,431   $1,013   $972   $7,754   $584   $20,466     $4,884      $6,581      $740      $1,282     $10,715      $512      $24,714   

Charge-offs

   (1,346 (751 (152 (449 (4,713 (877 (8,288 (1,070)   (553)   (411)   (391)   (8,125)   (928)   (11,478)  

Recoveries

   401   245   90   44   2,066   456   3,302   349    319    54    157    3,161    381    4,421   

Provision (credit)

   1,269   493   (93 675   5,082   354   7,780  

Provision

 110    1,396    293    319    6,479    482    9,079   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Ending balance

  $4,036   $6,418   $858   $1,242   $10,189   $517   $23,260     $4,273      $7,743      $676      $1,367     $12,230      $447      $26,736   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Evaluated for impairment:

    ��          

Individually

  $436   $644   $—     $—     $—     $—     $1,080     $201      $1,057      $     $    $     $     $1,258   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Collectively

  $3,600   $5,774   $858   $1,242   $10,189   $517   $22,180     $4,072      $6,686      $676      $1,367     $12,230      $447      $25,478   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Loans:

               

Ending balance

  $233,727   $394,034   $113,865   $227,853   $465,807   $24,138   $1,459,424     $265,751      $470,312      $113,101      $320,658     $609,390      $22,893      $1,802,105   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Evaluated for impairment:

               

Individually

  $1,259   $2,928   $—     $—     $—     $—     $4,187     $3,474      $9,663      $     $    $     $     $13,137   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Collectively

  $232,468   $391,106   $113,865   $227,853   $465,807   $24,138   $1,455,237     $    262,277      $    460,649      $      113,101      $    320,658     $    609,390      $      22,893      $  1,788,968   
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Risk Characteristics

Commercial business loans primarily consist of loans to small to mid-sized businesses in our market area in a diverse range of industries. These loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. The credit risk related to commercial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations or on the value of underlying collateral, if any.

Commercial mortgage loans generally have larger balances and involve a greater degree of risk than residential mortgage loans, inferring higher potential losses on an individual customer basis. Loan repayment is often dependent on the successful operation and management of the properties, as well as on the collateral securing the loan. Economic events or conditions in the real estate market could have an adverse impact on the cash flows generated by properties securing the Company’s commercial real estate loans and on the value of such properties.

Residential mortgage loans and home equities (comprised of home equity loans and home equity lines) are generally made on the basis of the borrower’s ability to make repayment from his or her employment and other income, but are secured by real property whose value tends to be more easily ascertainable. Credit risk for these types of loans is generally influenced by general economic conditions, the characteristics of individual borrowers, and the nature of the loan collateral.

Consumer indirect and other consumer loans may entail greater credit risk than residential mortgage loans and home equities, particularly in the case of other consumer loans which are unsecured or, in the case of indirect consumer loans, secured by depreciable assets, such as automobiles or boats. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances such as job loss, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

- 8889 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(6.)PREMISES AND EQUIPMENT, NET

Major classes of premises and equipment at December 31 are summarized as follows (in thousands):

 

  2013 2012           2015                   2014         

Land and land improvements

  $4,883   $4,883     $5,917       $4,797    

Buildings and leasehold improvements

   44,830   43,402     46,402       42,826    

Furniture, fixtures, equipment and vehicles

   25,464   24,440     31,868       29,853    
  

 

  

 

   

 

   

 

 

Premises and equipment

   75,177    72,725     84,187       77,476    

Accumulated depreciation and amortization

   (39,168  (36,107   (44,742)      (41,082)   
  

 

  

 

   

 

   

 

 

Premises and equipment, net

  $36,009   $36,618     $39,445       $36,394    
  

 

  

 

   

 

   

 

 

Depreciation and amortization expense relating to premises and equipment, included in occupancy and equipment expense in the consolidated statements of income, amounted to $3.8$4.4 million, $3.6$4.0 million and $3.5$3.8 million for the years ended December 31, 2013, 20122015, 2014 and 2011,2013, respectively.

 

(7.)GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill

Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis, and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The change inCompany performs its annual impairment test of goodwill as of September 30 of each year. See Note 1 for the balanceCompany’s accounting policy for goodwill during the years ended December 31, 2013 and 2012 was as follows (in thousands):other intangible assets.

   2013   2012 

Goodwill, beginning of year

  $48,536    $37,369  

Branch acquisitions

   —       11,167  

Impairment

   —       —    
  

 

 

   

 

 

 

Goodwill, end of year

  $48,536    $48,536  
  

 

 

   

 

 

 

Pursuant to the adoption of ASU 2011-08 in 2012, theThe Company first performed a qualitative assessment of goodwill at the reporting unit level, the Bank, to determine if it was more likely than not that the fair value of theany of its reporting unit isunits was less than its carrying value. In performing a qualitative analysis, factors considered include, but are not limited to, business strategy, financial performance and market and regulatory dynamics. Based on its assessment, the Company concluded it was more likely than not that the fair value of its Insurance reporting unit was less than its carrying value. Accordingly, the Company performed a Step 1 review for possible goodwill impairment.

Under Step 1 of the goodwill impairment review, the fair value of the Insurance reporting unit was calculated using income and market-based approaches. Under Step 1, it was determined that the carrying value of our Insurance reporting unit exceeded its fair value. For Step 2, the implied fair value of the Insurance reporting unit’s goodwill was compared with the carrying amount of the goodwill for the Insurance reporting unit. Based on this assessment, the Company recorded a goodwill impairment charge related to the Insurance reporting unit of $751 thousand during the quarter ended December 31, 2015.

The results of the qualitative assessment for 20132014 indicated that it was not more likely than not that the fair value of any of the Company’s reporting unit isunits was less than its carrying value. Consequently, no additional quantitative two-step impairment test was required, and no impairment was recorded in 2013. In 2012 and 2011 (prior to the adoption of ASU 2011-08) the Company performed a quantitative impairment test that did not result in any impairment.2014.

Declines in the market value of the Company’s publicly traded stock price or declines in the Company’s ability to generate future cash flows may increase the potential that goodwill recorded on the Company’s consolidated statement of financial condition be designated as impaired and that the Company may incur a goodwill write-down in the future.

The Company’s other intangible assets consisted entirely of a core deposit intangible asset. Changeschange in the accumulated amortization and net book value werebalance for goodwill during the years ended December 31 was as follows (in thousands):

 

   2013  2012 

Gross carrying amount

  $2,042   $2,042  

Accumulated amortization

   (576  (189
  

 

 

  

 

 

 

Net book value

  $1,466   $1,853  
  

 

 

  

 

 

 

Amortization during the year

  $387   $189  

There were no core deposit intangible assets or amortization expense for the year ended December 31, 2011.

Estimated core deposit intangible amortization expense for each of the next five years is as follows:

2014

  $341  

2015

   296  

2016

   251  

2017

   205  

2018

   160  
         Banking             Insurance               Total         

Balance, January 1, 2014

   $48,536        $-       $48,536    

Acquisition

   -       12,617       12,617    
  

 

 

   

 

 

   

 

 

 

Balance, December 31, 2014

   48,536       12,617       61,153    

Impairment

   -       (751)      (751)   
  

 

 

   

 

 

   

 

 

 

Balance, December 31, 2015

    $48,536       $11,866       $60,402    
  

 

 

   

 

 

   

 

 

 

 

- 8990 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

(7.)GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)

Other Intangible Assets

The Company has other intangible assets that are amortized, consisting of core deposit intangibles and other intangibles. Changes in the gross carrying amount, accumulated amortization and net book value for the years ended December 31 were as follows (in thousands):

           2015                   2014         

Core deposit intangibles:

    

Gross carrying amount

   $2,042       $2,042    

Accumulated amortization

   (1,213)      (917)   
  

 

 

   

 

 

 

Net book value

   $829       $1,125    
  

 

 

   

 

 

 

Amortization during the year

   $296       $341    
    

Other intangibles:

    

Gross carrying amount

   $6,640       $6,640    

Accumulated amortization

   (925)      (279)    
  

 

 

   

 

 

 

Net book value

   $5,715       $6,361    
  

 

 

   

 

 

 

Amortization during the year

   $646       $279    

Core deposit intangible amortization expense was $387 thousand for the year ended December 31, 2013. Estimated amortization expense of other intangible assets for each of the next five years is as follows:

2016

  $            864  

2017

   778  

2018

   689  

2019

   611  

2020

   533  

 

(8.)DEPOSITS

A summary of deposits as of December 31 are as follows (in thousands):

 

  2013   2012           2015                   2014         

Noninterest-bearing demand

  $535,472    $501,514     $641,972       $571,260    

Interest-bearing demand

   470,733     449,744     523,366       490,190    

Savings and money market

   717,928     655,598     928,175       795,835    

Certificates of deposit, due:

    

Time deposits, due:

    

Within one year

   448,997     495,423     450,885       395,956    

One to two years

   77,219     91,052     97,059       122,819    

Two to three years

   23,642     35,993     46,545       11,448    

Three to five years

   46,045     31,721     42,482       62,991    

Thereafter

   20     749     47       28    
  

 

   

 

   

 

   

 

 

Total certificates of deposit

   595,923     654,938  

Total time deposits

   637,018       593,242    
  

 

   

 

   

 

   

 

 

Total deposits

  $2,320,056    $2,261,794     $ 2,730,531       $ 2,450,527    
  

 

   

 

   

 

   

 

 

Certificates of depositTime deposits in denominations of $100,000$250,000 or more at December 31, 20132015 and 20122014 amounted to $226.0$92.0 million and $222.4$66.5 million, respectively.

Interest expense by deposit type for the years ended December 31 is summarized as follows (in thousands):

 

  2013   2012   2011           2015                   2014                   2013         

Interest-bearing demand

  $729    $598    $614     $754       $607       $729    

Savings and money market

   978     998     1,056     1,166       913       978    

Certificates of deposit

   4,893     6,866     9,764  

Time deposits

   5,386       4,846       4,893    
  

 

   

 

   

 

   

 

   

 

   

 

 

Total interest expense on deposits

  $6,600    $8,462    $11,434     $7,306       $6,366       $6,600    
  

 

   

 

   

 

   

 

   

 

   

 

 

- 91 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

(9.)BORROWINGS

There were no long-term borrowings outstanding as of December 31, 2013 and 2012. Outstanding short-term borrowings are summarized as follows as of December 31 (in thousands):

   2013   2012 

Short-term borrowings:

    

Repurchase agreements

  $39,042    $40,806  

Short-term FHLB borrowings

   298,000     139,000  
  

 

 

   

 

 

 

Total short-term borrowings

  $337,042    $179,806  
  

 

 

   

 

 

 

The Company classifies borrowings as short-term or long-term in accordance with the original terms of the agreement. AtOutstanding borrowings are summarized as follows as of December 31 2013 and 2012, the Company’s short-term borrowings had a weighted average rate of 0.38% and 0.54%, respectively.(in thousands):

           2015                   2014         

Short-term borrowings:

    

Short-term FHLB borrowings

   $293,100       $295,300    

Repurchase agreements

   -       39,504    
  

 

 

   

 

 

 

Total short-term borrowings

   293,100       334,804    

Long-term borrowings:

    

Subordinated notes, net

   38,990       -    
  

 

 

   

 

 

 

Total borrowings

   $332,090       $334,804    
  

 

 

   

 

 

 

Short-term Borrowingsborrowings

Federal funds purchased are short-term borrowings that typically mature within one to ninety days. Short-term repurchaseRepurchase agreements are secured overnight borrowings with customers. Short-term FHLB borrowings have original maturities of less than one year and include overnight borrowings which the Companythat we typically utilizesutilize to address short term funding needs as they arise. Short-term FHLB borrowings at December 31, 20132015 consisted of $198.0$116.8 million in overnight borrowings and $100.0$176.3 million in short-term advances. Short-term FHLB borrowings at December 31, 20122014 consisted of $99.0$129.0 million in overnight borrowings and $40.0$166.3 million in short-term advances.

- 90 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(9.)BORROWINGS (Continued)

Long-term Borrowings

The Company has credit capacity with the FHLB and can borrow through facilities that include an overnight line of credit, amortizing and term advances, and repurchase agreements. The FHLB credit capacity isborrowings are collateralized by securities from the Company’s investment portfolio and certain qualifying loans. The Company may be required to provide additional collateral based on the fair value of the underlying securities. There were no FHLB long-term borrowings outstanding as ofAt December 31, 20132015 and 2012.2014, the Company’s borrowings had a weighted average rate of 0.53% and 0.35%, respectively.

In February 2001,Long-term borrowings

On April 15, 2015, the Company formed Financial Institutions Statutory Trust Iissued $40.0 million of 6.0% fixed to floating rate subordinated notes due April 15, 2030 (the “Trust”“Subordinated Notes”) in a registered public offering. The Subordinated Notes bear interest at a fixed rate of 6.0% per year, payable semi-annually, for the sole purpose of issuing trust preferred securities.first 10 years. From April 15, 2025 to the April 15, 2030 maturity date, the interest rate will reset quarterly to an annual interest rate equal to the then current three-month London Interbank Offered Rate (LIBOR) plus 3.944%, payable quarterly. The Company’s $502 thousand investment in the common equity of the Trust was classified in the consolidated statements of financial condition as other assets and $16.7 million of related 10.20% junior subordinated debentures were classified as long-term borrowings. In 2001,Subordinated Notes are redeemable by the Company incurred costs relatingat any quarterly interest payment date beginning on April 15, 2025 to the issuance of the debentures totaling $487 thousand. These costs, which were included in other assets on the consolidated statements of financial condition, were deferred and were being amortized to interest expense using the straight-line method over a twenty year period.

In August 2011, the Company redeemed all of the 10.20% junior subordinated debenturesmaturity at a redemption price equaling 105.1% of the principal amount redeemed,par, plus all accrued and unpaid interest. As a resultProceeds, net of the redemption, the Company recognized a loss on extinguishment of debt issuance costs of $1.1 million, consistingwere $38.9 million. The net proceeds from this offering were used for general corporate purposes, including but not limited to, contribution of capital to the Bank to support both organic growth and opportunistic acquisitions. The Subordinated Notes qualify as Tier 2 capital for regulatory purposes.

The Company adopted ASU 2015-03 that requires debt issuance costs to be reported as a direct deduction from the face value of the redemption premium of $852 thousandSubordinated Notes and the write-off of the remaining unamortizednot as a deferred charge. Refer to Note 1 for additional information. The debt issuance costs of $231 thousand.will be amortized as an adjustment to interest expense over 15 years.

 

(10.)COMMITMENTS AND CONTINGENCIES

Financial Instruments with Off-Balance Sheet Risk

The Company has financial instruments with off-balance sheet risk established in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk extending beyond amounts recognized in the financial statements.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is essentially the same as that involved with extending loans to customers. The Company uses the same credit underwriting policies in making commitments and conditional obligations as for on-balance sheet instruments.

Off-balance sheet commitments as of December 31 consist of the following (in thousands):

 

   2013   2012 

Commitments to extend credit

  $431,236    $435,948  

Standby letters of credit

   8,618     9,223  
                             2015                  2014         
  

Commitments to extend credit

   $514,818      $450,343    
  

Standby letters of credit

   11,746      8,578    

- 92 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(10.)COMMITMENTS AND CONTINGENCIES (Continued)

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Commitments may expire without being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Standby letters of credit are conditional lending commitments issued by the Company to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support private borrowing arrangements. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers.

The Company also extends rate lock agreements to borrowers related to the origination of residential mortgage loans. To mitigate the interest rate risk inherent in these rate lock agreements when the Company intends to sell the related loan, once originated, as well as closed residential mortgage loans held for sale, the Company enters into forward commitments to sell individual residential mortgages. Rate lock agreements and forward commitments are considered derivatives and are recorded at fair value. There were no forwardForward sales commitments outstanding as oftotaled $1.3 million and $1.2 million at December 31, 20132015 and $1.8 million outstanding as of December 31, 2012. In addition, the2014, respectively. The net change in the fair values of these derivatives was recognized as other noninterest income or other noninterest expense in the consolidated statements of income.

- 91 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(10.)COMMITMENTS AND CONTINGENCIES (Continued)

Lease Obligations

The Company is obligated under a number of noncancellable operating lease agreements 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 payments by year and in the aggregate, under the noncancellable leases with initial or remaining terms of one year or more, are as follows at December 31, 20132015 (in thousands):

 

2014

  $1,440  

2015

   1,381  

2016

   1,273     $1,644    

2017

   878     1,271    

2018

   626     1,020    

2019

   942    

2020

   810    

Thereafter

   3,796     3,160    
  

 

   

 

 
  $9,394     $            8,847    
  

 

   

 

 

Rent expense relating to these operating leases, included in occupancy and equipment expense in the statements of income, was $2.0 million, $1.8 million and $1.7 million $1.6 millionin 2015, 2014 and $1.5 million in 2013, 2012 and 2011, respectively.

Contingent Liabilities

In the ordinary course of business there are various threatened and pending legal proceedings against the Company. Based on consultation with outside legal counsel, management believes that the aggregate liability, if any, arising from such litigation would not have a material adverse effect on the Company’s consolidated financial statements.

- 93 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

(11.)REGULATORY MATTERS

General

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 financial holding companies and banks, including the power to impose substantial fines, operational restrictions and other penalties for violations of laws and regulations and for safety and soundness considerations.

Capital

Banks and financialbank holding companies are subject to various regulatory capital requirements administered by state and 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 consolidated financial statements. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheetoff-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.

The Basel III Capital Rules, a new comprehensive capital framework for U.S. banking organizations, became effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). Quantitative measures established by regulationthe Basel III Capital Rules to ensure capital adequacy require the Company and the Bank to maintainmaintenance of minimum amounts and ratios (set forth in the table that follows) of Total andCommon Equity Tier 1 capital (“CET1”), Tier 1 capital and Total capital (as defined in the regulations) torisk-weighted assets (as defined), and of Tier 1 capital to adjusted quarterly average assets (all as defined(as defined).

The Company’s and the Bank’s Common Equity Tier 1 capital includes common stock and related paid-in capital, net of treasury stock, and retained earnings. In connection with the adoption of the Basel III Capital Rules, we elected to opt-out of the requirement to include most components of accumulated other comprehensive income in Common Equity Tier 1. Common Equity Tier 1 for both the regulations). These minimum amountsCompany and ratios arethe Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities, and subject to transition provisions.

Tier 1 capital includes Common Equity Tier 1 capital and additional Tier 1 capital. For the Company, additional Tier 1 capital at December 31, 2015 includes, subject to limitation, $17.3 million of preferred stock.

Total capital includes Tier 1 capital and Tier 2 capital. Tier 2 capital for both the Company and the Bank includes a permissible portion of the allowance for loan losses. Tier 2 capital for the Company also includes qualified subordinated debt. At December 31, 2015, the Company’s Tier 2 capital included $39.0 million of Subordinated Notes.

Prior to January 1, 2015, under the capital rules then in effect, the table below.

The Company’s and the Bank’s Tier 1 capital consists ofincluded total shareholders’ equity excluding unrealized gainsaccumulated other comprehensive income and losses on securities available for sale (except for unrealized losses which have been determined to be other than temporary and recognized as expense in the consolidated statements of income), goodwill and other intangible assets, and disallowed portionsnet of associated deferred tax assets.liabilities. Tier 1 capital for the Company includes, subject to limitation,also included $17.3 million of preferred stock. The Company and the Bank’s totalTotal capital are comprised ofincluded Tier 1 capital for each entity plus a permissible portion of the allowance for loan losses.

- 92 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(11.)REGULATORY MATTERS (Continued)

The Common Equity Tier 1 (beginning in 2015), Tier 1 and total risk-basedTotal capital ratios are calculated by dividing the respective capital amounts by risk-weighted assets. Risk-weighted assets are calculated based on regulatory requirements and include total assets, excluding goodwill and other intangible assets and disallowed portions of deferred tax assets,with certain exclusions, allocated by risk weight category, and certain off-balance-sheet items, (primarily loan commitments).among other things. The leverage ratio is calculated by dividing Tier 1 capital by adjusted quarterly average total assets, which exclude goodwill and other intangible assets, among other things.

When fully phased in on January 1, 2019, the Basel III Capital Rules will require the Company and disallowed portionsthe Bank to maintain (i) a minimum ratio of deferred taxCommon Equity Tier 1 capital to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% Common Equity Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average quarterly assets.

- 94 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(11.)REGULATORY MATTERS (Continued)

The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level and be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019). The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have any current applicability to the Company or the Bank. The capital conservation buffer is designed to absorb losses during periods of economic stress and, as detailed above, effectively increases the minimum required risk-weighted capital ratios. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets below the effective minimum (4.5% plus the capital conservation buffer and, if applicable, the countercyclical capital buffer) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.

The following table presents actual and required capital ratios as of December 31, 2015 for the Company and the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of December 31, 2015 based on the phase-in provisions of the Basel III Capital Rules and the minimum required capital levels as of January 1, 2019 when the Basel III Capital Rules have been fully phased-in. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules (in thousands):

   Actual  Minimum Capital
Required – Basel III
Phase-in Schedule
  Minimum Capital
Required – Basel III
Fully Phased-in
  Required to be
Considered Well
Capitalized
       Amount           Ratio           Amount          Ratio          Amount          Ratio          Amount          Ratio    

2015

                                                

Tier 1 leverage:

                        

Company

   $    243,452     7.41  %   $    131,506     4.00  %   $    131,506     4.00  %   $     164,382     5.00  %

Bank

    265,487     8.09       131,188     4.00       131,188     4.00       163,985     5.00   

CET1 capital:

                        

Company

    226,413     9.77       104,334     4.50       162,297     7.00       150,705     6.50   

Bank

    265,487     11.49       103,971     4.50       161,733     7.00       150,180     6.50   

Tier 1 capital:

                        

Company

    243,452     10.50       139,112     6.00       197,076     8.50       185,483     8.00   

Bank

    265,487     11.49       138,628     6.00       196,389     8.50       184,837     8.00   

Total capital:

                        

Company

    309,527     13.35       185,483     8.00       243,446     10.50       231,854     10.00   

Bank

    292,572     12.66       184,837     8.00       242,599     10.50       231,046     10.00   

The Company’s and the Bank’s actual and required regulatory capital ratios of December 31, 2014 under the regulatory capital rules then in effect were as follows as of December 31 (in thousands):

 

   Actual For Capital
Adequacy Purposes
 Well Capitalized      Actual Minimum Required
for Capital
Adequacy Purposes
 Required to be
Considered Well
Capitalized
   Amount   Ratio Amount   Ratio Amount   Ratio          Amount          Ratio         Amount          Ratio         Amount          Ratio    

2013

           

2014

               

Tier 1 leverage:

 Company  $215,024     7.63 $112,660     4.00 $140,825     5.00  Company   $     219,904    7.35  % $     119,722    4.00  % $     149,653    5.00  %
 Bank   204,336     7.27   112,498     4.00   140,622     5.00    Bank   215,672    7.21    119,671    4.00    149,588    5.00   

Tier 1 capital:

 Company   215,024     10.82   79,459     4.00   119,188     6.00    Company   219,904    10.47    83,985    4.00    125,977    6.00   
 Bank   204,336     10.31   79,291     4.00   118,937     6.00    Bank   215,672    10.28    83,889    4.00    125,834    6.00   

Total risk-based capital:

 Company   239,878     12.08   158,918     8.00   198,647     10.00    Company   246,166    11.72    167,970    8.00    209,962    10.00   
 Bank   229,139     11.56   158,583     8.00   198,228     10.00    Bank   241,905    11.53    167,779    8.00    209,723    10.00   

2012

           

Tier 1 leverage:

 Company  $200,255     7.71 $103,845     4.00 $129,806     5.00
 Bank   192,136     7.41   103,681     4.00   129,601     5.00  

Tier 1 capital:

 Company   200,255     10.73   74,681     4.00   112,022     6.00  
 Bank   192,136     10.31   74,526     4.00   111,789     6.00  

Total risk-based capital:

 Company   223,610     11.98   149,363     8.00   186,703     10.00  
 Bank   215,443     11.56   149,052     8.00   186,315     10.00  

As of December 31, 2013,2015, the Company and Bank were considered “well capitalized” under all regulatory capital guidelines. Such determination has been made based on the Tier 1 leverage, CET1 capital, Tier 1 capital and total risk-based capital ratios.

Federal Reserve Requirements

TheAs of December 31, 2015 and 2014, the Bank iswas not required to maintain a reserve balance at the FRB of New York. The reserve requirement for the Bank totaledwas $1.0 million as of December 31, 20132013.

- 95 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2012.2013

(11.)REGULATORY MATTERS (Continued)

Dividend Restrictions

In the ordinary course of business, the Company is dependent upon dividends from the Bank to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years.

 

- 93 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(12.)SHAREHOLDERS’ EQUITY

The Company’s authorized capital stock consists of 50,210,000 shares of capital stock, 50,000,000 of which are common stock, par value $0.01 per share, and 210,000 of which are preferred stock, par value $100 per share, which is designated into two classes, Class A of which 10,000 shares are authorized, and Class B of which 200,000 shares are authorized. There are two series of Class A preferred stock: Series A 3% preferred stock and the Series A preferred stock. There is one series of Class B preferred stock:Series B-1 8.48% preferred stock. There were 173,423 shares and 174,709173,398 shares of preferred stock issued and outstanding as of December 31, 20132015 and 2012, respectively.2014.

Common Stock

The following table sets forth the changes in the number of shares of common stock for the years ended December 31:

 

  Outstanding Treasury Issued    Outstanding        Treasury             Issued       

2013

    

2015

      

 

Shares outstanding at beginning of year

   13,787,709   373,888   14,161,597     14,118,048       279,461       14,397,509    

Restricted stock awards issued, net of forfeitures

   24,058   (24,058  —    

Restricted stock awards issued

   59,834       (59,834)      -    

Restricted stock awards forfeited

   (3,490)      3,490       -    

Stock options exercised

   23,265   (23,265  —       18,922       (18,922)      -    

Treasury stock purchases

   (11,349 11,349    —       (7,523)      7,523       -    

Directors’ retainer

   5,672   (5,672  —    

Stock awards

   4,401       (4,401)      -    
  

 

  

 

  

 

   

 

   

 

   

 

 

Shares outstanding at end of year

   13,829,355    332,242    14,161,597     14,190,192       207,317       14,397,509    
  

 

  

 

  

 

   

 

   

 

   

 

 
      

2012

    

2014

      

 

Shares outstanding at beginning of year

   13,803,116    358,481    14,161,597     13,829,355       332,242       14,161,597    

Restricted stock awards issued, net of forfeitures

   7,857    (7,857  —    

Shares issued for the SDN acquisition

   235,912       -       235,912    

Restricted stock awards issued

   43,242       (43,242)      -    

Restricted stock awards forfeited

   (15,441)      15,441       -    

Stock options exercised

   4,250    (4,250  —       34,082       (34,082)      -    

Treasury stock purchases

   (33,330  33,330    —       (9,102)      9,102       -    

Directors’ retainer

   5,816    (5,816  —    
  

 

  

 

  

 

   

 

   

 

   

 

 

Shares outstanding at end of year

   13,787,709    373,888    14,161,597         14,118,048               279,461           14,397,509    
  

 

  

 

  

 

   

 

   

 

   

 

 

Preferred Stock

Series A 3% Preferred Stock.  There were 1,496 shares and 1,4991,492 shares of Series A 3% preferred stock issued and outstanding as of December 31, 20132015 and 2012, respectively.2014. Holders of Series A 3% preferred stock are entitled to receive an annual dividend of $3.00 per share, which is cumulative and payable quarterly. Holders of Series A 3% preferred stock have no pre-emptive right in, or right to purchase or subscribe for, any additional shares of the Company’s capital stock and have no voting rights. Dividend or dissolution payments to the Class A shareholders must be declared and paid, or set apart for payment, before any dividends or dissolution payments can be declared and paid, or set apart for payment, to the holders of Class B preferred stock or common stock. The Series A 3% preferred stock is not convertible into any other of the Company’s securities.

- 96 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(12.)SHAREHOLDERS’ EQUITY (Continued)

Series B-1 8.48% Preferred Stock.   There were 171,927 shares and 173,210171,906 shares of Series B-1 8.48% preferred stock issued and outstanding as of December 31, 20132015 and 2012, respectively.2014. Holders of Series B-1 8.48% preferred stock are entitled to receive an annual dividend of $8.48 per share, which is cumulative and payable quarterly. Holders of Series B-1 8.48% preferred stock have no pre-emptive right in, or right to purchase or subscribe for, any additional shares of the Company’s common stock and have no voting rights. Accumulated dividends on the Series B-1 8.48% preferred stock do not bear interest, and the Series B-1 8.48% preferred stock is not subject to redemption. Dividend or dissolution payments to the Class B shareholders must be declared and paid, or set apart for payment, before any dividends or dissolution payments are declared and paid, or set apart for payment, to the holders of common stock. TheSeries B-1 8.48% preferred stock is not convertible into any other of the Company’s securities.

- 94 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(12.)SHAREHOLDERS’ EQUITY (Continued)

Redemption of Series A Preferred Stock and Warrant

In December 2008, under the Treasury’s TARP Capital Purchase Program, the Company entered into a Securities Purchase Agreement - Standard Terms with the Treasury pursuant to which, among other things, the Company sold to the Treasury for an aggregate purchase price of $37.5 million, 7,503 shares of fixed rate cumulative perpetual preferred stock, Series A (“Series A” preferred stock) and a warrant to purchase up to 378,175 shares of the Company’s common stock, par value $0.01 per share, at an exercise price of $14.88 per share (the “Warrant”), of the Company.

Pursuant to the terms of the Purchase Agreement, the Company’s ability to declare or pay dividends on any of its shares was limited. Specifically, the Company was prohibited from paying any dividend with respect to shares of common stock, other junior securities or preferred stock rankingpari passu with the Series A preferred stock or repurchasing or redeeming any shares of the Company’s common stock, other junior securities or preferred stock rankingpari passu with the Series A preferred stock in any quarter unless all accrued and unpaid dividends were paid on the Series A preferred stock for all past dividend periods (including the latest completed dividend period), subject to certain limited exceptions.

The $37.5 million in proceeds was allocated to the Series A preferred stock and the Warrant based on their relative fair values at issuance ($35.5 million was allocated to the Series A preferred stock and $2.0 million to the Warrant). The resulting discount for the Series A preferred stock was to be accreted over five years through retained earnings as a preferred stock dividend. The Warrant was to remain in additional paid-in-capital at its initial book value until it was exercised or expired.

In February 2011, the Company redeemed one-third, or $12.5 million, of the Series A preferred stock. In March 2011, the remaining $25.0 million of the Series A preferred stock was redeemed. The unamortized discount related to the Series A preferred stock was charged to retained earnings upon redemption. The complete redemption of the Series A preferred stock removed the TARP restrictions pertaining to the Company’s ability to declare and pay dividends and repurchase its common stock, as well as certain restrictions associated with executive compensation.

In May 2011, the Company repurchased the Warrant issued to the Treasury. The repurchase price of $2.1 million was recorded as a reduction of additional paid-in capital.

- 95 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

 

(13.)ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table presents the components of other comprehensive income (loss) for the years ended December 31 (in thousands):

 

   Pre-tax
Amount
  Tax Effect  Net-of-tax
Amount
 

2013

    

Securities available for sale and transferred securities:

    

Change in unrealized gain/loss during the period

  $(34,135 $(13,522 $(20,613

Change in net unrealized gain on securities transferred to held to maturity

   (72  (29  (43

Reclassification adjustment for net gains included in net income

   (1,226  (485  (741
  

 

 

  

 

 

  

Total securities available for sale and transferred securities

   (35,433  (14,036  (21,397

Pension and post-retirement obligations:

    

Net actuarial gain (loss), net of amortization

   13,223    5,238    7,985  

Prior service cost, net of amortization

   (47  (19  (28
  

 

 

  

 

 

  

 

 

 

Total pension and post-retirement obligations

   13,176    5,219    7,957  
  

 

 

  

 

 

  

Other comprehensive loss

  $(22,257 $(8,817 $(13,440
  

 

 

  

 

 

  

 

 

 

2012

    

Securities available for sale:

    

Change in unrealized gain/loss during the period

  $6,682   $2,646   $4,036  

Reclassification adjustment for gains included in income

   (2,651  (1,050  (1,601

Reclassification adjustment for impairment charges included in income

   91    36    55  
  

 

 

  

 

 

  

 

 

 

Total securities available for sale

   4,122    1,632    2,490  

Pension and post-retirement obligations:

    

Net actuarial gain (loss), net of amortization

   (253  (99  (154

Prior service cost, net of amortization

   (47  (19  (28
  

 

 

  

 

 

  

 

 

 

Total pension and post-retirement obligations

   (300  (118  (182
  

 

 

  

 

 

  

 

 

 

Other comprehensive income

  $3,822   $1,514   $2,308  
  

 

 

  

 

 

  

 

 

 

2011

    

Securities available for sale:

    

Change in unrealized gain/loss during the period

  $22,350   $8,855   $13,495  

Reclassification adjustment for gains included in income

   (3,003  (1,190  (1,813

Reclassification adjustment for impairment charges included in income

   18    7    11  
  

 

 

  

 

 

  

 

 

 

Total securities available for sale

   19,365    7,672    11,693  

Pension and post-retirement obligations:

    

Net actuarial gain (loss), net of amortization

   (9,930  (3,934  (5,996

Prior service cost, net of amortization

   (49  (19  (30
  

 

 

  

 

 

  

 

 

 

Total pension and post-retirement obligations

   (9,979  (3,953  (6,026
  

 

 

  

 

 

  

 

 

 

Other comprehensive income

  $9,386   $3,719   $5,667  
  

 

 

  

 

 

  

 

 

 
   

Pre-tax

Amount

  Tax Effect  

Net-of-tax

Amount

 

2015

    

 

 

Securities available for sale and transferred securities:

    

Change in unrealized gain/loss during the period

   $(1,529)     $(591)     $(938)   

Reclassification adjustment for net gains included in net income(1)

   (2,251)     (868)     (1,383)   
  

 

 

  

 

 

  

 

 

 

Total securities available for sale and transferred securities

   (3,780)     (1,459)     (2,321)   

Pension and post-retirement obligations:

    

Net actuarial gains (losses) arising during the year

   (887)     (342)     (545)   

Amortization of net actuarial loss and prior service cost included in income

   895      345      550    
  

 

 

  

 

 

  

 

 

 

Total pension and post-retirement obligations

   8      3      5    
  

 

 

  

 

 

  

 

 

 

Other comprehensive loss

   $(3,772)     $(1,456)     $(2,316)   
  

 

 

  

 

 

  

 

 

 
    

2014

    

 

 

Securities available for sale and transferred securities:

    

Change in unrealized gain/loss during the period

   $        14,008      $        5,549      $        8,459    

Reclassification adjustment for net gains included in net income(1)

   (2,478)     (981)     (1,497)   
  

 

 

  

 

 

  

 

 

 

Total securities available for sale and transferred securities

   11,530      4,568      6,962    

Pension and post-retirement obligations:

    

Net actuarial gains (losses) arising during the year

   (9,709)     (3,846)     (5,863)   

Amortization of net actuarial loss and prior service cost included in income

   128      51      77    
  

 

 

  

 

 

  

 

 

 

Total pension and post-retirement obligations

   (9,581)     (3,795)     (5,786)   
  

 

 

  

 

 

  

 

 

 

Other comprehensive income

   $1,949      $773      $1,176    
  

 

 

  

 

 

  

 

 

 
    

2013

    

 

 

Securities available for sale and transferred securities:

    

Change in unrealized gain/loss during the period

   $(34,135)     $(13,522)     $(20,613)   

Reclassification adjustment for net gains included in net income(1)

   (1,298)     (514)     (784)   
  

 

 

  

 

 

  

 

 

 

Total securities available for sale and transferred securities

   (35,433)     (14,036)     (21,397)   

Pension and post-retirement obligations:

    

Net actuarial gains (losses) arising during the year

   11,860      4,698      7,162    

Amortization of net actuarial loss and prior service cost included in income

   1,316      521      795    
  

 

 

  

 

 

  

 

 

 

Total pension and post-retirement obligations

   13,176      5,219      7,957    
  

 

 

  

 

 

  

 

 

 

Other comprehensive loss

   $(22,257)     $(8,817)     $(13,440)   
  

 

 

  

 

 

  

 

 

 

(1)

Includes amounts related to the amortization/accretion of unrealized net gains and losses related to the Company’s reclassification of available for sale investment securities to the held to maturity category. The unrealized net gains/losses will be amortized/accreted over the remaining life of the investment securities as an adjustment of yield.

 

- 9697 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(13.)ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (Continued)

 

Activity in accumulated other comprehensive income (loss), net of tax, was as follows (in thousands):

 

  Securities
Available
for Sale and
Transferred
Securities
 Pension
and Post-
retirement
Obligations
 Accumulated
Other
Comprehensive
Income (Loss)
  Securities
    Available for    
Sale and
Transferred
Securities
     Pension and    
Post-
retirement
Obligations
     Accumulated    
Other
Comprehensive
Income (Loss)
 

Balance at January 1, 2013

�� $16,060   $(12,807 $3,253  

Other comprehensive (loss) income before reclassifications

   (20,656 7,173   (13,483

Balance at January 1, 2015

  $1,625       $(10,636)     $(9,011)   

Other comprehensive income (loss) before reclassifications

 (938)    (545)   (1,483)   

Amounts reclassified from accumulated other comprehensive income

   (741 784   43   (1,383)    550     (833)   
  

 

  

 

  

 

  

 

  

 

  

 

 

Net current period other comprehensive (loss) income

   (21,397  7,957    (13,440 (2,321)    5     (2,316)   
  

 

  

 

  

 

  

 

  

 

  

 

 

Balance at December 31, 2013

  $(5,337 $(4,850 $(10,187

Balance at December 31, 2015

  $(696)     $(10,631)     $(11,327)   
  

 

  

 

  

 

  

 

  

 

  

 

 

Balance at January 1, 2012

  $13,570   $(12,625 $945  
   

Balance at January 1, 2014

  $(5,337)     $(4,850)      $(10,187)   

Other comprehensive income (loss) before reclassifications

 8,459     (5,863)    2,596    

Amounts reclassified from accumulated other comprehensive income

 (1,497)    77     (1,420)   
 

 

  

 

  

 

 

Net current period other comprehensive (loss) income

 6,962     (5,786)    1,176    
 

 

  

 

  

 

 

Balance at December 31, 2014

  $1,625      $(10,636)     $(9,011)   
 

 

  

 

  

 

 
   

Balance at January 1, 2013

  $16,060      $(12,807)     $3,253    

Other comprehensive income (loss) before reclassifications

   4,036    (981  3,055   (20,613)    7,162     (13,451)   

Amounts reclassified from accumulated other comprehensive income

   (1,546  799    (747 (784)    795     11    
  

 

  

 

  

 

  

 

  

 

  

 

 

Net current period other comprehensive income (loss)

   2,490    (182  2,308   (21,397)    7,957     (13,440)   
  

 

  

 

  

 

  

 

  

 

  

 

 

Balance at December 31, 2012

  $16,060   $(12,807 $3,253  

Balance at December 31, 2013

   $(5,337)     $(4,850)     $(10,187)   
  

 

  

 

  

 

  

 

  

 

  

 

 

Balance at January 1, 2011

  $1,877   $(6,599 $(4,722

Other comprehensive income (loss) before reclassifications

   13,495    (6,363  7,132  

Amounts reclassified from accumulated other comprehensive loss

   (1,802  337    (1,465
  

 

  

 

  

 

 

Net current period other comprehensive income (loss)

   11,693    (6,026  5,667  
  

 

  

 

  

 

 

Balance at December 31, 2011

  $13,570   $(12,625 $945  
  

 

  

 

  

 

 

The following table presents the amounts reclassified out of each component of accumulated other comprehensive income (loss) for the years ended December 31 (in thousands):

Details About Accumulated Other

Comprehensive Income Components

  Amount Reclassified from
Accumulated Other
Comprehensive Income
   

Affected Line Item in the

Consolidated Statement of Income

   2015  2014    

Realized gain on sale of investment securities

   $    1,988      $    2,041      Net gain on disposal of investment securities

Amortization of unrealized holding gains (losses) on investment securities transferred from available for sale to held to maturity

   263      437      Interest income
  

 

 

  

 

 

   
   2,251      2,478      Total before tax
   (868)     (981)     Income tax expense
  

 

 

  

 

 

   
   1,383      1,497      Net of tax

Amortization of pension and post-retirement items:

     

Prior service credit(1)

   48      48      Salaries and employee benefits

Net actuarial losses (1)

   (943)     (176)     Salaries and employee benefits
  

 

 

  

 

 

   
   (895)     (128)     Total before tax
   345      51      Income tax benefit
  

 

 

  

 

 

   
   (550)     (77)     Net of tax
  

 

 

  

 

 

   

Total reclassified for the period

   $833      $1,420      
  

 

 

  

 

 

   

(1)

These items are included in the computation of net periodic pension expense. See Note 17 – Employee Benefit Plans for additional information.

- 98 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

(14.)SHARE-BASED COMPENSATION

The Company maintains certain stock-based compensation plans, approved by the Company’s shareholders that are administered by the Board, or the Management Development and Compensation Committee (the “Compensation Committee”) of the Board. In May 2009,2015, the Company’s shareholders ofapproved the Company approved two share-based compensation plans,2015 Long-Term Incentive Plan (the “2015 Plan”) to replace the 2009 Management Stock Incentive Plan (“Management Plan”) and the 2009 Directors’ Stock Incentive Plan (“Director’s Plan”), and collectively with(collectively, the Management Plan, “the“2009 Plans”). An aggregateA total of 690,000438,076 shares oftransferred from the Company’s common stock have been reserved2009 Plans were available for issuance by the Company under the terms of the Management Plangrant pursuant to the grant2015 Plan as of incentive stock options (not to exceed 500,000 shares), non-qualified stock options and restricted stock grants, allMay 6, 2015, the date of which are defined in the plan. An aggregate of 250,000 sharesapproval of the Company’s common stock have been reserved for issuance by the Company2015 Plan. In addition, any shares subject to outstanding awards under the terms of the Director’s Plan pursuant to the grant of non-qualified stock options and restricted stock grants, all of which2009 Plans that are definedcanceled, expired, forfeited or otherwise not issued or are settled in the plan. Under both plans, for purposes of calculating the number of shares of common stockcash on or after May 6, 2015, will become available for issuance, each share of common stock granted pursuant to a restricted stock grant shall count as 1.64 shares of common stock.future award grants under the 2015 Plan. As of December 31, 2013,2015, there were approximately 185,000 and 425,000424,000 shares available for grant under the Director’s Plan and Management Plan, respectively, of which 61% were available for issuance as restricted stock grants.2015 Plan.

Under the Plans, the Board, in the case of the Director’s Plan, or the Compensation Committee in the case of the Management Plan, may establish and prescribe grant guidelines including various terms and conditions for the granting of stock-based compensation. For stock options, the exercise price of each option equals the market price of the Company’s stock on the date of the grant. All options expire after a period of ten years from the date of grant and generally become fully exercisable over a period of 3 to 5 years from the grant date. When an option recipient exercises their options, the Company issues shares from treasury stock and records the proceeds as additions to capital. Shares of restricted stock granted to employees generally vest over 2 to 3 years from the grant date. Fifty percent of the shares of restricted stock granted to non-employee directors generally vests on the date of grant and the remaining fifty percent generally vests one year from the grant date. Vesting of the shares may be based on years of service, established performance measures or both. If restricted stock grants are forfeited before they vest, the shares are reacquired into treasury stock.

- 97 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(14.)SHARE-BASED COMPENSATION (Continued)

The share-based compensation plans were established to allow for the granting of compensation awards to attract, motivate and retain employees, executive officers and non-employee directors who contribute to the successlong-term growth and profitability of the Company and to give such persons a proprietary interest in the Company, thereby enhancing their personal interest in the Company’s success.

The Company awarded grants of 33,03536,384 shares of restricted common stock to certain members of management during the year ended December 31, 2013. Fifty2015. Thirty percent of the shares subject to each grant will be earned based upon achievement of an EPS performance requirement for the Company’s fiscal year ended December 31, 2013.2015. The remaining fiftyseventy percent of the shares will be earned based on the Company’s achievement of a relative total shareholder return (“TSR”) performance requirement, on a percentile basis, compared to a defined group of peer companiesthe SNL Small Cap Bank & Thrifts Index over a three-year performance period ended December 31, 2015.2017. The shares earned based on the achievement of the EPS and TSR performance requirements, if any, will vest based on February 25, 2018 assuming the recipient’s continuous service to the Company on December 31, 2015.Company.

The grant-date fair value of the TSR portion of the award granted during the year ended December 31, 20132015 was determined using the Monte Carlo simulation model on the date of grant, assuming the following (i) expected term of 2.882.85 years, (ii) risk free interest rate of 0.42%0.92%, (iii) expected dividend yield of 3.59%3.53% and (iv) expected stock price volatility over the expected term of the TSR award of 37.2%26.8%. The grant-date fair value of all other restricted stock awards is equal to the closing market price of ourthe Company’s common stock on the date of grant.

In addition, theThe Company granted 1,00012,700 additional shares of restricted common stock to management during the year ended December 31, 2013. The2015. These shares will vest after completion of a three-year service requirement. The average market price of the restricted stock awards on the date of grant was $20.70.$22.79.

During the year ended December 31, 2013,2015, the Company granted 9,000a total of 10,750 restricted shares of restricted common stock to non-employee directors, of which 4,5005,380 shares vested immediately and 4,5005,370 shares will vest after completion of a one-year service requirement. The market price of the restricted stock on the date of grant was $19.81.$23.25. In addition, the Company issued a total of 4,401 shares of common stock in-lieu of cash for the annual retainer of three non-employee directors during the year ended December 31, 2015. The weighted average market price of the stock on the date of grant was $24.96.

The restricted stock awards granted to management and directors in 20132015 do not have rights to dividends or dividend equivalents.

- 99 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(14.)SHARE-BASED COMPENSATION (Continued)

The Company uses the Black-Scholes valuation method to estimate the fair value of its stock option awards. There were no stock options awarded during 2013, 20122015, 2014 or 2011.2013. There was no unrecognized compensation expense related to unvested stock options as of December 31, 2013.2015. The following is a summary of stock option activity for the year ended December 31, 20132015 (dollars in thousands, except per share amounts):

 

  Number of
Options
 Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Term
   Aggregate
Intrinsic
Value
     Number of  
Options
   Weighted  
Average
Exercise
Price
   Weighted  
Average
Remaining
Contractual
Term
   Aggregate  
Intrinsic
Value
 

Outstanding at beginning of year

   319,275   $20.22         135,416      $19.25      

Granted

   —      —           -      -      

Exercised

   (23,265 19.31         (18,922)    18.99      

Forfeited

   —            -      -      

Expired

   (103,076 21.15         (14,245)    19.87      
  

 

        

 

    

Outstanding and exercisable at end of period

   192,934   $19.83     2.6 years    $940     102,249      $19.21     1.3 years      $    899    

The aggregate intrinsic value (the amount by which the market price of the stock on the date of exercise exceeded the market price of the stock on the date of grant) of option exercises for the years ended December 31, 2013, 20122015, 2014 and 20112013 was $106 thousand, $10$161 thousand, and $31$106 thousand, respectively. The total cash received as a result of option exercises under stock compensation plans for the years ended December 31, 2015, 2014 and 2013 2012 and 2011 was $448$359 thousand, $69$667 thousand, and $91$448 thousand, respectively. The tax benefits realized in connection with these stock option exercises were not significant.

- 98 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(14.)SHARE-BASED COMPENSATION (Continued)

The following is a summary of restricted stock award activity for the year ended December 31, 2013:2015:

 

  Number of
Shares
 Weighted Average
Market Price at
Grant Date
     Number of  
Shares
 Weighted
Average
Market
Price at
  Grant Date  
 

Outstanding at beginning of year

   79,580   $16.89     59,113      $17.24    

Granted

   43,035   16.94     59,834     17.66    

Vested

   (38,598 17.04     (32,549)    17.80    

Forfeited

   (18,977 16.60     (3,490)    19.32    
  

 

    

 

  

Outstanding at end of period

   65,040   $16.92     82,908      $17.23    
  

 

    

 

  

As of December 31, 2013,2015, there was $325$737 thousand of unrecognized compensation expense related to unvested restricted stock awards that is expected to be recognized over a weighted average period of 1.61.8 years.

The Company amortizes the expense related to restricted stock awards over the vesting period. Share-based compensation expense is recorded as a component of salaries and employee benefits in the consolidated statements of income for awards granted to management and as a component of other noninterest expense for awards granted to directors. The share-based compensation expense for the years ended December 31 was as follows (in thousands):

 

  2013   2012   2011            2015                     2014                     2013           

Salaries and employee benefits

  $236    $394    $972    $    431      $    270      $    236    

Other noninterest expense

   171     132     133   243     201     171    
  

 

   

 

   

 

  

 

  

 

  

 

 

Total share-based compensation expense

  $407    $526    $1,105    $    674      $    471      $    407    
  

 

   

 

   

 

  

 

  

 

  

 

 

- 100 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

(15.)INCOME TAXES

The income tax expense for the years ended December 31 consisted of the following (in thousands):

 

   2013   2012   2011 

Current tax expense:

      

Federal

  $8,917    $4,021    $3,747  

State

   1,913     955     1,158  
  

 

 

   

 

 

   

 

 

 

Total current tax expense

   10,830     4,976     4,905  
  

 

 

   

 

 

   

 

 

 

Deferred tax expense:

      

Federal

   1,251     5,262     5,584  

State

   296     1,081     926  
  

 

 

   

 

 

   

 

 

 

Total deferred tax expense

   1,547     6,343     6,510  
  

 

 

   

 

 

   

 

 

 

Total income tax expense

  $12,377    $11,319    $11,415  
  

 

 

   

 

 

   

 

 

 

Income tax expense differed from the statutory federal income tax rate for the years ended December 31 as follows:

   2013  2012  2011 

Statutory federal tax rate

   35.0  35.0  35.0

Increase (decrease) resulting from:

    

Tax exempt interest income

   (4.8  (4.6  (4.3

Non-taxable earnings on company owned life insurance

   (1.6  (1.8  (1.5

State taxes, net of federal tax benefit

   3.8    3.8    4.0  

Nondeductible expenses

   0.2    0.3    0.4  

Other, net

   0.1    (0.1  (0.2
  

 

 

  

 

 

  

 

 

 

Effective tax rate

   32.7  32.6  33.4
  

 

 

  

 

 

  

 

 

 

- 99 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(15.)INCOME TAXES (Continued)

Total income tax expense (benefit) was allocated as follows for the years ended December 31 (in thousands):

   2013  2012   2011 

Income tax expense

  $12,377   $11,319    $11,415  

Shareholder’s equity

   (8,817  1,514     3,718  

The Company’s net deferred tax asset is included in other assets in the consolidated statements of condition. The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31 (in thousands):

   2013   2012 

Deferred tax assets:

    

Allowance for loan losses

  $10,591    $9,791  

Net unrealized loss on securities available for sale

   3,501     —    

Other than temporary impairment of investment securities

   2,728     5,283  

Deferred compensation

   873     868  

Share-based compensation

   753     1,111  

SERP agreements

   709     734  

Interest on nonaccrual loans

   662     732  

Other

   814     1,060  
  

 

 

   

 

 

 

Gross deferred tax assets

   20,631     19,579  

Deferred tax liabilities:

    

Prepaid pension costs

   6,185     1,648  

Depreciation and amortization

   1,606     1,827  

Loan servicing assets

   620     681  

Net unrealized gain on securities available for sale

   —       10,536  

Other

   63     —    
  

 

 

   

 

 

 

Gross deferred tax liabilities

   8,474     14,692  
  

 

 

   

 

 

 

Net deferred tax asset

  $12,157    $4,887  
  

 

 

   

 

 

 
          2015                  2014                  2013         

Current tax expense (benefit):

   

Federal

  $8,720      $7,546      $8,917    

State

  21      (75)     1,913    
 

 

 

  

 

 

  

 

 

 

Total current tax expense

  8,741      7,471      10,830    
 

 

 

  

 

 

  

 

 

 

Deferred tax expense (benefit):

   

Federal

  1,440      2,538      1,251    

State

  358      (384)     296    
 

 

 

  

 

 

  

 

 

 

Total deferred tax expense

  1,798      2,154      1,547    
 

 

 

  

 

 

  

 

 

 

Total income tax expense

  $10,539      $9,625      $12,377    
 

 

 

  

 

 

  

 

 

 

 

Income tax expense differed from the statutory federal income tax rate for the years ended December 31 as follows:

 

  

          2015                  2014                  2013         

Statutory federal tax rate

  35.0%    35.0%    35.0%  

Increase (decrease) resulting from:

   

Tax exempt interest income

  (6.1)      (5.1)      (4.8)    

Tax credits and adjustments

  (0.7)      (3.5)      -      

Non-taxable earnings on company owned life insurance

  (1.8)      (1.6)      (1.6)    

State taxes, net of federal tax benefit

  0.7       (0.8)      3.8     

Nondeductible expenses

  0.3       0.5       0.2     

Goodwill and contingent consideration adjustments

  (0.3)      -        -      

Other, net

  -        0.2        0.1      
 

 

 

  

 

 

  

 

 

 

Effective tax rate

  27.1%    24.7%    32.7%  
 

 

 

  

 

 

  

 

 

 

 

Total income tax expense (benefit) was allocated as follows for the years ended December 31 (in thousands):

 

  

          2015                  2014                  2013         

Income tax expense

  $10,539      $9,625      $12,377    

Shareholder’s equity

  (1,456)     925      (8,817)   

The Company recognizes deferred income taxes for the estimated future tax effects of differences between the tax and financial statement bases of assets and liabilities considering enacted tax laws. These differences result in deferred tax assets and liabilities, which are included in other assets in the Company’s consolidated statements of condition. The Company also assesses the likelihood that deferred tax assets will be realizable based on, among other considerations, future taxable income and establishes, if necessary, a valuation allowance for those deferred tax assets determined to not likely be realizable. A deferred tax asset valuation allowance is recognized if, based on the weight of available evidence (both positive and negative), it is more likely than not that some portion or all of the deferred tax assets will not be realized. The future realization of deferred tax benefits depends upon the existence of sufficient taxable income within the carry-back and carry-forward periods. Management’s judgment is required in determining the appropriate recognition of deferred tax assets and liabilities, including projections of future taxable income.

- 101 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(15.)INCOME TAXES (Continued)

The Company’s net deferred tax asset is included in other assets in the consolidated statements of condition. The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31 (in thousands):

          2015                  2014         

Deferred tax assets:

  

Allowance for loan losses

  $    10,452      $    10,666    

Deferred compensation

  972      938    

Investment in limited partnerships

  954      953    

SERP agreements

  767      704    

Interest on nonaccrual loans

  615      664    

Benefit of tax credit carryforwards

  502      569    

Share-based compensation

  538      565    

Net unrealized loss on securities available for sale

  420      -    

Other than temporary impairment of investment securities

  -      1,917    

Other

  328      520    
 

 

 

  

 

 

 

Gross deferred tax assets

  15,548      17,496    

Deferred tax liabilities:

  

Prepaid pension costs

  5,065      5,346    

Intangible assets

  2,667      2,662    

Depreciation and amortization

  1,004      1,249    

Net unrealized gain on securities available for sale

  -      1,039    

Loan servicing assets

  479      525    
 

 

 

  

 

 

 

Gross deferred tax liabilities

  9,215      10,821    
 

 

 

  

 

 

 

Net deferred tax asset

  $6,333      $6,675    
 

 

 

  

 

 

 

In March 2014, the New York legislature approved changes in the state tax law that will be phased-in over two years, beginning in 2015. The primary changes that impact us include the repeal of the Article 32 franchise tax on banking corporations (“Article 32A”) for 2015, expanded nexus standards for 2015 and a reduction in the corporate tax rate for 2016. The repeal of Article 32A and the expanded nexus standards lowered our taxable income apportioned to New York in 2015 compared to 2014. In addition, the New York state income tax rate will be reduced from 7.1% to 6.5% in 2016.

Based upon the Company’s historical and projected future levels of pre-tax and taxable income, the scheduled reversals of taxable temporary differences to offset future deductible amounts, and prudent and feasible tax planning strategies, management believes it is more likely than not that the deferred tax assets will be realized. As such, no valuation allowance has been recorded as of December 31, 20132015 or 2012.2014.

The Company and its subsidiaries are primarily subject to federal and New York State (“NYS”) income taxes. The federal and NYS income tax years currently open for auditsaudit are 20102013 through 2013.2015. The New York income tax years currently open for audit are 2012 through 2015.

At December 31, 2013,2015, the Company had no federal or NYSNew York net operating loss orcarryforwards. The Company has New York tax credit carryforwards.credits of approximately $800 thousand which have an unlimited carryforward period.

The Company’s unrecognized tax benefits and changes in unrecognized tax benefits were not significant as of or for the years ended December 31, 20132015, 2014 and 2012.2013. There were no material interest or penalties recorded in the income statement in income tax expense for the yearyears ended December 31, 2015, 2014 and 2013. As of December 31, 2013,2015 and 2014, there were no amounts accrued for interest or penalties related to uncertain tax positions.

 

- 100102 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(16.)EARNINGS PER COMMON SHARE

The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted EPS for each of the years ended December 31 (in thousands, except per share amounts). All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities.

 

  2013 2012 2011 

Net income available to common shareholders

  $24,064   $21,975   $19,617  

Less: Earnings allocated to participating securities

   —     2   38  
  

 

  

 

  

 

           2015                   2014                   2013         

Net income available to common shareholders for EPS

  $24,064   $21,973   $19,579     $26,875       $27,893       $24,064    
  

 

  

 

  

 

   

 

   

 

   

 

 

Weighted average common shares outstanding:

          

Total shares issued

   14,162    14,162    13,599     14,398       14,261       14,162    

Unvested restricted stock awards

   (69  (107  (166   (93)      (64)      (69)   

Treasury shares

   (354  (359  (366   (224)      (304)      (354)   
  

 

  

 

  

 

   

 

   

 

   

 

 

Total basic weighted average common shares outstanding

   13,739    13,696    13,067     14,081       13,893       13,739    

Incremental shares from assumed:

          

Exercise of stock options

   13    4    3     24       26       13    

Vesting of restricted stock awards

   32    51    65     30       27       32    

Exercise of warrant

   —      —      22  
  

 

  

 

  

 

   

 

   

 

   

 

 

Total diluted weighted average common shares outstanding

   13,784    13,751    13,157     14,135       13,946       13,784    
      

Basic earnings per common share

  $1.75   $1.60   $1.50     $1.91       $2.01       $1.75    
  

 

  

 

  

 

   

 

   

 

   

 

 

Diluted earnings per common share

  $1.75   $1.60   $1.49     $1.90       $2.00       $1.75    
  

 

  

 

  

 

   

 

   

 

   

 

 

For each of the periods presented, average shares subject to the following instruments were excluded from the computation of diluted EPS because the effect would be antidilutive:

For each of the periods presented, average shares subject to the following instruments were excluded from the computation of diluted EPS because the effect would be antidilutive:

   

For each of the periods presented, average shares subject to the following instruments were excluded from the computation of diluted EPS because the effect would be antidilutive:

   

Stock options

   122    303    339     -       3       122    

Restricted stock awards

   2    1    —       1       1       2    
  

 

  

 

  

 

   

 

   

 

   

 

 

Total

   1       4       124    
   124    304    339    

 

   

 

   

 

 
  

 

  

 

  

 

 

- 101 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

There were no participating securities outstanding for the years ended December 31, 2013, 20122015, 2014 and 2011

2013; therefore, the two-class method of calculating basic and diluted EPS was not applicable for the years presented.

 

(17.)EMPLOYEE BENEFIT PLANS

Defined Contribution Plan

Employees that meet specified eligibility conditions are eligible to participate in the Company sponsored 401(k) plan. Under the plan, participants may make contributions, in the form of salary deferrals, up to the maximum Internal Revenue Code limit. Until December 31, 2015, the Company matched a participant’s contributions up to 4.5% of compensation, calculated at 100% of the first 3% of compensation and 50% of the next 3% of compensation deferred by the participant. The Company was also permitted to make additional discretionary matching contributions, although no such additional discretionary contributions were made in 2015, 2014 or 2013. The expense included in salaries and employee benefits in the consolidated statements of income for this plan amounted to $1.3 million in 2015 and $1.1 million in 2014 and 2013. Effective January 1, 2016, the 401(k) Plan was amended to discontinue the Company’s matching contribution.

Defined Benefit Pension Plan

The Company participates in The New York State Bankers Retirement System (the “Plan”), a defined benefit pension plan covering substantially all employees, subject to the limitations related to the plan closure effective December 31, 2006. ThePrior to January 1, 2016, the benefits arewere generally based on years of service and the employee’s highest average compensation during five consecutive years of employment. The defined benefit plan was closed to new participants effective December 31, 2006. Only employees hired on or before December 31, 2006 and who met participation requirements on or before January 1, 2008 arewere eligible to receive benefits.

Effective January 1, 2016, the Plan was amended to open the Plan up to eligible employees who were hired on and after January 1, 2007, discontinue the Plan’s prior formula and provide all eligible participants with a cash balance benefit formula.

- 103 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(17.)EMPLOYEE BENEFIT PLANS (Continued)

The following table provides a reconciliation of the Company’s changes in the plan’sPlan’s benefit obligations, fair value of assets and a statement of the funded status as of and for the year ended December 31 (in thousands):

 

  2013 2012           2015                   2014         

Change in projected benefit obligation:

       

Projected benefit obligation at beginning of period

  $53,625   $48,303     $61,732       $48,991    

Service cost

   2,063   2,037     2,324       1,918    

Interest cost

   2,017   2,017     2,328       2,291    

Actuarial (gain) loss

   (6,393 3,291     (4,406)      10,938    

Benefits paid and plan expenses

   (2,321 (2,023   (2,746)      (2,406)   
  

 

  

 

   

 

   

 

 

Projected benefit obligation at end of period

   48,991    53,625     59,232       61,732    
  

 

  

 

   

 

   

 

 

Change in plan assets:

       

Fair value of plan assets at beginning of period

   57,785    46,943     75,584       64,603    

Actual return on plan assets

   9,139    4,865     (480)      5,387    

Employer contributions

   —      8,000     -       8,000    

Benefits paid and plan expenses

   (2,321  (2,023   (2,746)  ��   (2,406)   
  

 

  

 

   

 

   

 

 

Fair value of plan assets at end of period

   64,603    57,785     72,358       75,584    
  

 

  

 

   

 

   

 

 

Funded status at end of period

  $15,612   $4,160     $13,126       $13,852    
  

 

  

 

   

 

   

 

 

The accumulated benefit obligation was $44.0$53.5 million and $48.0$54.9 million at December 31, 20132015 and 2012,2014, respectively.

The Company’s funding policy is to contribute, at a minimum, an actuarially determined amount that will satisfy the minimum funding requirements determined under the appropriate sections of Internal Revenue Code. The Company hashad no minimum required contribution for the 20142016 fiscal year.

Estimated benefit payments under the pension planPlan over the next ten years at December 31, 20132015 are as follows (in thousands):

 

2014

  $1,709  

2015

   1,868  

2016

   2,094    $2,127  

2017

   2,277     2,288  

2018

   2,339     2,346  

2019 - 2023

   14,044  

2019

   2,472  

2020

   2,666  

2021 - 2025

           15,627  

Net periodic pension cost consists of the following components for the years ended December 31 (in thousands):

 

  2013 2012 2011           2015                   2014                   2013         

Service cost

  $2,063   $2,037   $1,756     $2,324       $1,918       $2,063    

Interest cost on projected benefit obligation

   2,017   2,017   2,027     2,328       2,291       2,017    

Expected return on plan assets

   (3,684 (3,211 (2,653   (4,820)      (4,117)      (3,684)   

Amortization of unrecognized loss

   1,344   1,370   608     926       159       1,344    

Amortization of unrecognized prior service cost

   20   20   19     20       20       20    
  

 

  

 

  

 

   

 

   

 

   

 

 

Net periodic pension cost

  $1,760   $2,233   $1,757     $778       $271       $1,760    
  

 

  

 

  

 

   

 

   

 

   

 

 

 

- 102104 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(17.) EMPLOYEE BENEFIT PLANS (Continued)

(17.)EMPLOYEE BENEFIT PLANS (Continued)

 

The actuarial assumptions used to determine the net periodic pension cost were as follows:

 

  2013 2012 2011           2015                   2014                   2013         

Weighted average discount rate

   3.84 4.27 5.38   3.86%          4.80%          3.84%       

Rate of compensation increase

   3.00 3.00 3.00   3.00%          3.00%          3.00%       

Expected long-term rate of return

   6.50 7.00 7.00   6.50%          6.50%          6.50%       

The actuarial assumptions used to determine the projected benefit obligation were as follows:

 

  2013 2012 2011           2015                   2014                   2013         

Weighted average discount rate

   4.80 3.84 4.27   4.21%          3.86%          4.80%       

Rate of compensation increase

   3.00 3.00 3.00   3.00%          3.00%          3.00%       

The weighted average discount rate was based upon the projected benefit cash flows and the market yields of high grade corporate bonds that are available to pay such cash flows.

The weighted average expected long-term rate of return is estimated based on current trends in the Plan’s assets as well as projected future rates of return on those assets and reasonable actuarial assumptions based on the guidance provided by Actuarial Standard of Practice No. 27, “Selection of Economic Assumptions for Measuring Pension Obligations” for long term inflation, and the real and nominal rate of investment return for a specific mix of asset classes. The following assumptions were used in determining the long-term rate of return:

 

Equity securities

  Dividend discount model, the smoothed earnings yield model and the equity risk premium model
Fixed income securities  Current yield-to-maturity and forecasts of future yields
Other financial instruments  Comparison of the specific investment’s risk to that of fixed income and equity instruments and using judgment

The long term rate of return considers historical returns. Adjustments were made to historical returns in order to reflect expectations of future returns. These adjustments were due to factor forecasts by economists and long-term U.S. Treasury yields to forecast long-term inflation. In addition, forecasts by economists and others for long-term GDP growth were factored into the development of assumptions for earnings growth and per capita income.

The Plan’s overall investment strategy is to achieve a mix of approximately 97% of investments for long-term growth and 3% for near-term benefit payments with a wide diversification of asset types, fund strategies, and fund managers. The target allocations for Plan assets are shown in the table below. Cash equivalents consist primarily of government issues (maturing in less than three months) and short term investment funds. Equity securities primarily include investments in common stock, depository receipts, preferred stock, commingled pension trust funds, exchange traded funds and real estate investment trusts. Fixed income securities include corporate bonds, government issues, credit card receivables, mortgage backed securities, municipals, commingled pension trust funds and other asset backed securities. Other investments are real estate interests and related investments held within a commingled pension trust fund.

 

- 103105 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(17.)EMPLOYEE BENEFIT PLANS (Continued)

 

Effective February 2012, the Plan revised its investment guidelines. The Plan currently prohibits its investment managers from purchasing any security greater than 5% of the portfolio at the time of purchase or greater than 8% at market value in any one issuer. Effective June 2013, the issuer of any security purchased must be located in a country in the Morgan Stanley Capital International World Index. In addition, the following are prohibited:

 

Equity securities

  

Short sales

 

Unregistered securitiesstocks

 

Margin purchases

Fixed income securities

  

Mortgage backed derivatives that have an inverse floating rate coupon or that are interest only securities

 

Any ABS that is not issued by the U.S. Government or its agencies or its instrumentalities

 

Generally securities of less than Baa2/BBB quality may not be purchased

 

Securities of less than A-quality may not in the aggregate exceed 13% of the investment manager’s portfolio. Prior to February 2012, these investments could not exceed 10% of the manager’s portfolio.

 

Effective February 2012, anAn investment manager’s portfolio of commercial MBS and ABS shall not exceed 10% of the portfolio at the time of purchase.

Other financial instruments

  

Unhedged currency exposure in countries not defined as “high income economies” by the World Bank

All other investments not prohibited by the Plan are permitted. At December 31, 20132015 and 2012,2014, the Plan held certain investments which are no longer deemed acceptable to acquire. These positions will be liquidated when the investment managers deem that such liquidation is in the best interest of the Plan.

The target allocation range below is both historic and prospective in that it has not changed since prior to 2012.2013. It is the asset allocation range that the investment managers have been advised to adhere to and within which they may make tactical asset allocation decisions.

 

  

2015

Target

  

 Percentage of Plan Assets 

at December 31,

   

Weighted  

Average  

Expected  

Long-term  

    

 

 

   
  2014
Target
Allocation
  Percentage of
Plan Assets at
December 31,
 Weighted
Average
Expected
Long-term
Rate of Return
        Allocation       2015   2014   Rate of Return  
   2013 2012   

 

  

 

   

 

 

Asset category:

             

Cash equivalents

   0 – 20 5.5 12.8 0.17       0 – 20%   5.2%         8.7%        0.16%

Equity securities

   40 – 60   50.6   45.5   4.26    40 – 60   47.2       48.2      3.97   

Fixed income securities

   40 – 60   43.9   41.7   2.06    40 – 60   43.9       43.1      2.01   

Other financial instruments

   0 – 5    —      —      —      0 – 5   3.7        -    0.28   

Assets are segregated by the level of the valuation inputs within the fair value hierarchy established by ASC Topic 820 utilized to measure fair value (see Note 18 - Fair Value Measurements). There were no assets classified as Level 3 assets during the years ended December 31, 2013 and 2012.

In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Investments valued using the NAV (Net Asset Value) are classified as level 2 if the Plan can redeem its investment with the investee at the NAV at the measurement date. If the Plan can never redeem the investment with the investee at the NAV, it is considered a level 3. If the Plan can redeem the investment at the NAV at a future date, the Plan’s assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset.

 

- 104106 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(17.)EMPLOYEE BENEFIT PLANS (Continued)

 

The Plan uses the Thomson Reuters Pricing Service to determine the fair value of equities andexcluding commingled pension trust funds, the pricing service of IDC Corporate USA to determine the fair value of fixed income securities. securities excluding commingled pension trust funds and JP Morgan Chase Bank, N.A. (“JPMorgan”) to determine the fair value of commingled pension trust funds.

The following is a table of the pricing methodology and unobservable inputs used by JPMorgan in pricing commingled pension trust funds (“CPTF”):

Principal Valuation

Technique(s) Used

Unobservable Inputs
CPTF - Fixed Income:

CPTF (Corporate High Yield) of JPMorgan

Market

None

CPTF (High Yield) of JPMorganMarket Comparables CompaniesEBITDA multiple and discounts for lack of marketability
CPTF (Extended Duration) of JPMorganMarket and Income

Constant prepayment rate, Constant

default rate and Yield

CPTF (Long Duration Investment Grade) of JPMorganMarketNone
CPTF (Emerging Markets Currency Debt) of JPMorganMarketNone
CPTF (Emerging Markets - Fixed Income) of JPMorganMarketNone
CPTF – Other:

CPTF (Strategic Property) of JPMorganMarket, Income, Debt Service and Sales ComparisonCredit Spreads, Discount Rate, Loan to Value Ratio, Terminal Capitalization Rate and Value per Square Foot

When valuing Commingled Pension Trust Funds (Equity) JPMorgan uses a market methodology and does not rely on unobservable inputs in those valuations.

The following table sets forth a summary of the changes in the Plan’s level 3 assets for the year ended December 31, 2015:

Level 3 assets, beginning of year

 $-  

Purchases

2,334  

Unrealized gains

336  

Level 3 assets, end of year

 $            2,670  

- 107 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(17.)EMPLOYEE BENEFIT PLANS (Continued)

The major categories of Plan assets measured at fair value on a recurring basis as of December 31 are presented in the following tabletables (in thousands).

 

   Level 1
Inputs
   Level 2
Inputs
   Level 3
Inputs
   Total
Fair Value
 

2013

        

Cash equivalents:

        

Foreign currencies

   92     —       —       92  

Government issues

   —       937     —       937  

Short term investment funds

   —       2,498     —       2,498  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cash equivalents

   92     3,435     —       3,527  

Equity securities:

        

Common stock

   32,072     —       —       32,072  

Depository receipts

   309     96     —       405  

Preferred stock

   151     —       —       151  

Real estate investment fund

   94     —       —       94  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total equity securities

   32,626     96     —       32,722  

Fixed income securities:

        

Auto loan receivable

   —       232     —       232  

Collateralized mortgage obligations

   —       7,079     —       7,079  

Corporate Bonds

   —       7,609     —       7,609  

FHLMC

   —       883     —       883  

FNMA

   —       3,044     —       3,044  

GNMA I

   —       215     —       215  

GNMA II

   —       96     —       96  

Government Issues

   —       8,984     —       8,984  

Municipals

   —       212     —       212  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed income securities

   —       28,354     —       28,354  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Plan investments

  $32,718     31,885     —       64,603  
  

 

 

   

 

 

   

 

 

   

 

 

 

- 105 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

(17.) EMPLOYEE BENEFIT PLANS (Continued)

  Level 1
Inputs
   Level 2
Inputs
   Level 3
Inputs
   Total
Fair Value
            Level 1                     Level 2                     Level 3            Total 

2012

        
  Inputs   Inputs   Inputs        Fair Value      

2015

        

 

Cash equivalents:

                

Foreign currencies

   60     —       —       60     $35       $-       $-       $35    

Government issues

   —       314     —       314  

Short term investment funds

   —       7,083     —       7,083     -       3,745       -       3,745    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total cash equivalents

   60     7,397     —       7,457     35       3,745       -       3,780    

Equity securities:

                

Common stock

   25,447     —       —       25,447     13,083       -       -       13,083    

Depository receipts

   569     —       —       569     336       -       -       336    

Preferred stock

   113     —       —       113  

Real estate investment fund

   113     —       —       113  

Commingled pension trust funds

   -       10,557       -       10,557    

Exchange traded funds

   10,190       -       -       10,190    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total equity securities

   26,242     —       —       26,242     23,609       10,557       -       34,166    

Fixed income securities:

                

Auto loan receivable

   —       313     —       313  

Collateralized mortgage obligations

   —       6,262     —       6,262     -       608       -       608    

Corporate Bonds

   —       5,456     —       5,456  

Commingled pension trust funds

   -       17,889       -       17,889    

Corporate bonds

   -       3,439       -       3,439    

FHLMC

   —       717     —       717     -       276       -       276    

FNMA

   —       2,867     —       2,867     -       1,966       -       1,966    

GNMA I

   —       31     —       31  

GNMA II

   —       133     —       133     -       384       -       384    

Government Issues

   —       8,231     —       8,231  

Municipals

   —       63     —       63  

Other Asset Backed

   —       13     —       13  

Government issues

   -       7,180       -       7,180    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total fixed income securities

   —       24,086     —       24,086     -       31,742       -       31,742    

Other investments:

        

Commingled pension trust funds – Realty

   -       -       2,670       2,670    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total Plan investments

  $26,302     31,483     —       57,785     $23,644       $46,044       $2,670       $72,358    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

At December 31, 20132015, the portfolio was managed by two investment firms, with control of the portfolio split approximately 58% and 41%38% under the control of the investment managers with the remaining 1%4% under the direct control of the Plan. A portfolio concentration in two of the State Street Bank & Trust Co. Short Term Investment Fundcommingled pension trust funds, an exchange traded fund and a short term investment fund of 5%11%, 7%, 7% and 12%5%, respectively, existed at December 31, 20132015.

- 108 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2012, respectively.2013

(17.)EMPLOYEE BENEFIT PLANS (Continued)

            Level 1                     Level 2                     Level 3            Total 
   Inputs   Inputs   Inputs        Fair Value      

2014

        

 

 

Cash equivalents:

        

Foreign currencies

   $31       $-       $-       $31    

Government issues

   -       249       -       249    

Short term investment funds

   -       6,327       -       6,327    
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cash equivalents

   31       6,576       -       6,607    

Equity securities:

        

Common stock

   14,732       -       -       14,732    

Depository receipts

   185       -       -       185    

Commingled pension trust funds

   -       10,802       -       10,802    

Exchange traded funds

   10,573       -       -       10,573    

Preferred stock

   140       -       -       140    
  

 

 

   

 

 

   

 

 

   

 

 

 

Total equity securities

   25,630       10,802       -       36,432    

Fixed income securities:

        

Auto loan receivable

   -       330       -       330    

Collateralized mortgage obligations

   -       682       -       682    

Commingled pension trust funds

   -       21,083       -       21,083    

Corporate bonds

   -       2,971       -       2,971    

FHLMC

   -       73       -       73    

FNMA

   -       1,951       -       1,951    

GNMA II

   -       123       -       123    

Government issues

   -       5,139       -       5,139    

Other asset backed securities

   -       160       -       160    

Other securities

   -       33       -       33    
  

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed income securities

   -       32,545       -       32,545    
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Plan investments

   $25,661       $49,923       $-       $75,584    
  

 

 

   

 

 

   

 

 

   

 

 

 

At December 31, 2014, the portfolio was managed by two investment firms, with control of the portfolio split approximately 57% and 39% under the control of the investment managers with the remaining 4% under the direct control of the Plan. A portfolio concentration in two of the commingled pension trust funds and a short term investment fund of 13%, 9% and 8%, respectively, existed at December 31, 2014.

Postretirement Benefit Plan

An entity acquired by the Company 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 the acquired entity and the retirees 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 employees who had already met the then-applicable age and service requirements 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. Retirees ages 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 included in other liabilities in the consolidated statements of financial condition related to this plan amounted to $93$107 thousand and $118$124 thousand as of December 31, 20132015 and 2012,2014, respectively. The postretirement expense for the plan that was included in salaries and employee benefits in the consolidated statements of income was not significant for the years ended December 31, 2013, 20122015, 2014 and 2011.2013. The plan is not funded.

 

- 106109 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(17.)EMPLOYEE BENEFIT PLANS (Continued)

 

The components of accumulated other comprehensive loss related to the defined benefit plan and postretirement benefit plan as of December 31 are summarized below (in thousands):

 

   2013  2012 

Defined benefit plan:

   

Net actuarial loss

  $(8,237 $(21,428

Prior service cost

   (72  (93
  

 

 

  

 

 

 
   (8,309  (21,521
  

 

 

  

 

 

 

Postretirement benefit plan:

   

Net actuarial loss

   (163  (195

Prior service credit

   440    508  
  

 

 

  

 

 

 
   277    313  
  

 

 

  

 

 

 
   (8,032  (21,208

Deferred tax benefit

   3,182    8,401  
  

 

 

  

 

 

 

Amounts included in accumulated other comprehensive loss

  $(4,850 $(12,807
  

 

 

  

 

 

 

Changes in plan assets and benefit obligations recognized in other comprehensive loss on a pre-tax basis during the years ended December 31 are as follows (in thousands):

  2013 2012            2015                     2014          

Defined benefit plan:

       

Net actuarial gain (loss)

  $11,847   $(1,638

Net actuarial loss

   $(17,715)      $(17,747)   

Prior service cost

   (32)      (52)   
  

 

   

 

 
   (17,747)      (17,799)   
  

 

   

 

 

Postretirement benefit plan:

    

Net actuarial loss

   (162)      (186)   

Prior service credit

   304       372    
  

 

   

 

 
   142       186    
  

 

   

 

 
   (17,605)      (17,613)   

Deferred tax benefit

   6,974       6,977    
  

 

   

 

 

Amounts included in accumulated other comprehensive loss

   $(10,631)      $(10,636)   
  

 

   

 

 

Changes in plan assets and benefit obligations recognized in other comprehensive income on a pre-tax basis during the years ended December 31 are as follows (in thousands):

Changes in plan assets and benefit obligations recognized in other comprehensive income on a pre-tax basis during the years ended December 31 are as follows (in thousands):

   
  2015   2014 

Defined benefit plan:

    

Net actuarial (loss) gain

   $(894)      $(9,669)   

Amortization of net loss

   1,344   1,370     926       159    

Amortization of prior service cost

   21   20     20       20    
  

 

  

 

   

 

   

 

 
   13,212    (248   52       (9,490)   
  

 

  

 

   

 

   

 

 

Postretirement benefit plan:

       

Net actuarial gain

   32    15  

Net actuarial (loss) gain

   7       (40)   

Amortization of net loss

   17       17    

Amortization of prior service credit

   (68  (67   (68)      (68)   
  

 

  

 

   

 

   

 

 
   (36  (52   (44)      (91)   
  

 

  

 

   

 

   

 

 

Total recognized in other comprehensive loss

  $13,176   $(300

Total recognized in other comprehensive income

   $8       $(9,581)   
  

 

  

 

   

 

   

 

 

For the year ending December 31, 2014,2016, the estimated net loss and prior service costcredit for the plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost is $159$955 thousand and $20$47 thousand, respectively.

Defined Contribution Plan

Employees that meet specified eligibility conditions are eligible to participate in the Company sponsored 401(k) plan. Under the plan, participants may make contributions, in the form of salary deferrals, up to the maximum Internal Revenue Code limit. The Company matches a participant’s contributions up to 4.5% of compensation, calculated at 100% of the first 3% of compensation and 50% of the next 3% of compensation deferred by the participant. The Company may also make additional discretionary matching contributions, although no such additional discretionary contributions were made in 2013, 2012 or 2011. The expense included in salaries and employee benefits in the consolidated statements of income for this plan amounted to $1.1 million in 2013 and $1.0 million in 2012 and 2011.

Supplemental Executive Retirement PlansAgreements

The Company has non-qualified Supplemental Executive Retirement PlansAgreements (“SERPs”) covering one current and four former executives. The unfunded pension liability related to the SERPs was $2.1$2.3 million and $2.2 million at December 31, 20132015 and 2012,2014, respectively. SERP expense was $408 thousand, $295 thousand, and $95 thousand $1.3 million,for 2015, 2014 and $67 thousand for 2013, 2012 and 2011, respectively.

 

- 107110 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(18.)FAIR VALUE MEASUREMENTS

Determination of Fair Value – Assets Measured at Fair Value on a Recurring and Nonrecurring Basis

Valuation Hierarchy

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. ASC Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

Level 2 - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

Level 3 - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Securities available for sale:Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Loans held for sale:    The fair value of loans held for sale is determined using quoted secondary market prices and investor commitments. Loans held for sale are classified as Level 2 in the fair value hierarchy.

Collateral dependent impaired loans:  Fair value of impaired loans with specific allocations of the allowance for loan losses is measured based on the value of the collateral securing these loans and is classified as Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable and collateral value is determined based on appraisals performed by qualified licensed appraisers hired by the Company. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business. Such discounts are typically significant and result in a Level 3 classification of the inputs for determining fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.

 

- 108111 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(18.)FAIR VALUE MEASUREMENTS (Continued)

 

Loan servicing rights:Loan servicing rights do not trade in an active market with readily observable market data. As a result, the Company estimates the fair value of loan servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income. The assumptions used in the discounted cash flow model are those that we believe market participants would use in estimating future net servicing income, including estimates of loan prepayment rates, servicing costs, ancillary income, impound account balances, and discount rates. The significant unobservable inputs used in the fair value measurement of the Company’s loan servicing rights are the constant prepayment rates and weighted average discount rate. Significant increases (decreases) in any of those inputs in isolation could result in a significantly lower (higher) fair value measurement. Although the constant prepayment rate and the discount rate are not directly interrelated, they will generally move in opposite directions. Loan servicing rights are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation.

Other real estate owned (Foreclosed assets):  Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. The appraisals are sometimes further discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Such discounts are typically significant and result in a Level 3 classification of the inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

Commitments to extend credit and letters of credit:Commitments to extend credit and fund letters of credit are principally at current interest rates, and, therefore, the carrying amount approximates fair value. The fair value of commitments to is not material.

 

- 109112 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(18.)FAIR VALUE MEASUREMENTS (Continued)

 

Assets Measured at Fair Value

The following table presents for each of the fair-value hierarchy levels the Company’s assets that are measured at fair value on a recurring and non-recurring basis as of December 31 (in thousands).:

 

  Quoted Prices in
Active Markets
for Identical
Assets or
Liabilities
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total   

  Quoted Prices  

in Active

Markets for

Identical

Assets or

Liabilities

   

Significant

Other

   Observable   

Inputs

   

Significant

 Unobservable 

Inputs

     

2013

        
  (Level 1)   (Level 2)   (Level 3)          Total        

2015

        

 

Measured on a recurring basis:

                

Securities available for sale:

                

U.S. Government agencies and government sponsored enterprises

  $—      $134,452    $—      $134,452     $-       $260,863       $-       $260,863    

Mortgage-backed securities

   —       474,549     —       474,549     -       283,314       -       283,314    

Asset-backed securities

   —       399     —       399     -       218       -       218    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
  $—      $609,400    $—      $609,400     $-       $544,395       $-       $544,395    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Measured on a nonrecurring basis:

                

Loans:

                

Loans held for sale

  $—      $3,381    $—      $3,381     $-       $1,430       $-       $1,430    

Collateral dependent impaired loans

   —       —       9,227     9,227     -       -       1,485       1,485    

Other assets:

                

Loan servicing rights

   —       —       1,565     1,565     -       -       1,241       1,241    

Other real estate owned

   —       —       333     333     -       -       163       163    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
  $—      $3,381    $11,125    $14,506     $-       $1,430       $2,889       $4,319    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

2012

        
        

2014

        

 

Measured on a recurring basis:

                

Securities available for sale:

                

U.S. Government agencies and government sponsored enterprises

  $—      $131,695    $—      $131,695     $-       $160,475       $-       $160,475    

State and political subdivisions

   —       195,210     —       195,210  

Mortgage-backed securities

   —       495,868     —       495,868     -       461,788       -       461,788    

Asset-backed securities

     1,023       1,023     -       231       -       231    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
  $—      $823,796    $—      $823,796     $-       $622,494       $-       $622,494    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Measured on a nonrecurring basis:

                

Loans:

                

Loans held for sale

  $—      $1,518    $—      $1,518     $-       $755       $-       $755    

Collateral dependent impaired loans

   —       —       2,364     2,364     -       -       2,652       2,652    

Other assets:

                

Loan servicing rights

   —       —       1,719     1,719     -       -       1,359       1,359    

Other real estate owned

   —       —       184     184     -       -       194       194    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
  $—      $1,518    $4,267    $5,785     $-       $755       $4,205       $4,960    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

There were no transfers between levelLevels 1 and 2 during the years ended December 31, 20132015 and 2012.2014. There were no liabilities measured at fair value on a recurring or nonrecurring basis during the years ended December 31, 20132015 and 2012.2014.

 

- 110113 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(18.)FAIR VALUE MEASUREMENTS (Continued)

 

The following table presents additional quantitative information about assets measured at fair value on a recurring and nonrecurring basis for which the Company has utilized Level 3 inputs to determine fair value (dollars in thousands).

 

Asset

  Fair
Value
   

Valuation Technique

  

Unobservable Input

  Unobservable Input
Value or Range

Collateral dependent impaired loans

  $9,227    Appraisal of collateral (1)  Appraisal adjustments (2)  18% - 100% discount
    Discounted cash flow  Discount rate  4.6%(3)
      Risk premium rate  12.0%(3)

Loan servicing rights

  $1,565    Discounted cash flow  Discount rate  5.2%(3)
      Constant prepayment rate  12.4%(3)

Other real estate owned

  $333    Appraisal of collateral (1)  Appraisal adjustments(2)  28% - 44% discount

Asset

Fair
    Value    
Valuation
Technique
Unobservable Input    Unobservable Input    
Value or Range

Collateral dependent impaired loans

 $  1,485  Appraisal of collateral (1) Appraisal adjustments (2)0% - 100% discount

Loan servicing rights

 $1,241  Discounted cash flow Discount rate  5.0% (3)
 Constant prepayment rate12.4% (3)

Other real estate owned

 $163  Appraisal of collateral (1) Appraisal adjustments (2)9% - 58% discount

 

(1)

Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable.

(2)

Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.

(3)

Weighted averages.

Changes in Level 3 Fair Value Measurements

There were no assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of December 31, 2013. The reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) foror during the yearyears ended December 31, 2012 is as follows (in thousands):

Securities available for sale, beginning of period

  $1,636  

Sales

   (360

Total gains (losses) realized/unrealized:

  

Included in earnings

   331  

Included in other comprehensive income

   (102

Transfers from Level 3 to Level 2

   (1,505
  

 

 

 

Securities available for sale, end of period

  $—    
  

 

 

 

The Company transferred all of the assets classified as Level 3 assets at December 31, 2011 to Level 2 during the three months ended March 31, 2012. The transfers of the $1.5 million of pooled trust preferred securities out of Level 3 was primarily the result of using observable pricing information or a third party pricing quote that appropriately reflects the fair value of those securities, without the need for adjustment based on our own assumptions regarding the characteristics of a specific security or the current liquidity in the market.

- 111 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015 and 2011

(18.)FAIR VALUE MEASUREMENTS (Continued)

2014.

Disclosures about Fair Value of Financial Instruments

The assumptions used below are expected to approximate those that market participants would use in valuing these financial instruments.

Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument, including estimates of timing, amount of expected future cash flows and the credit standing of the issuer. Such estimates do not consider the tax impact of the realization of unrealized gains or losses. In some cases, the fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial instrument. Care should be exercised in deriving conclusions about our business, its value or financial position based on the fair value information of financial instruments presented below.

The estimated fair value approximates carrying value for cash and cash equivalents, FHLB andFRB stock, accrued interest receivable, non-maturity deposits, short-term borrowings and accrued interest payable. Fair value estimates for other financial instruments not included elsewhere in this disclosure are discussed below.

Securities held to maturity:The fair value of the Company’s investment securities held to maturity is primarily measured using information from a third-party pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Loans:The fair value of the Company’s loans was estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made for the same remaining maturities. Loans were first segregated by type such as commercial, residential mortgage, and consumer, and were then further segmented into fixed and variable rate and loan quality categories. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

Time deposits:The fair value of time deposits was estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments. The fair values of the Company’s time deposit liabilities do not take into consideration the value of the Company’s long-term relationships with depositors, which may have significant value.

Long-term borrowings:Long-term borrowings consist of $40 million of subordinated notes issued during the second quarter of 2015. The subordinated notes are publicly traded and are valued based on market prices, which are characterized as Level 2 liabilities in the fair value hierarchy.

- 114 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

(18.)FAIR VALUE MEASUREMENTS (Continued)

The following presents the carrying amount, estimated fair value, and placement in the fair value measurement hierarchy of the Company’s financial instruments as of December 31 (in thousands):

 

  Level in  2015   2014 
  Fair Value          Estimated               Estimated     
  Level in
Fair Value
Measurement
Hierarchy
   2013   2012         Measurement             Carrying        Fair        Carrying        Fair 
  Carrying
Amount
   Estimated
Fair Value
   Carrying
Amount
   Estimated
Fair Value
   Hierarchy  Amount   Value   Amount   Value 

Financial assets:

                    

Cash and cash equivalents

   Level 1    $59,692    $59,692    $60,436    $60,436    Level 1   $60,121       $60,121       $58,151       $58,151    

Securities available for sale

   Level 2     609,400     609,400     823,796     823,796    Level 2   544,395       544,395       622,494       622,494    

Securities held to maturity

   Level 2     249,785     250,657     17,905     18,478    Level 2   485,717       490,064       294,438       298,695    

Loans held for sale

   Level 2     3,381     3,381     1,518     1,547    Level 2   1,430       1,430       755       755    

Loans

   Level 2     1,797,656     1,802,407     1,678,648     1,701,419    Level 2     2,055,192         2,046,235         1,881,713         1,887,959    

Loans (1)

   Level 3     9,227     9,227     2,364     2,364    Level 3   1,485       1,485       2,652       2,652    

Accrued interest receivable

   Level 1     8,150     8,150     7,843     7,843    Level 1   8,609       8,609       8,104       8,104    

FHLB and FRB stock

   Level 2     19,663     19,663     12,321     12,321    Level 2   19,991       19,991       19,014       19,014    

Financial liabilities:

                    

Non-maturity deposits

   Level 1     1,724,133     1,724,133     1,606,856     1,606,856    Level 1   2,093,513       2,093,513       1,857,285       1,857,285    

Time deposits

   Level 2     595,923     596,928     654,938     658,342    Level 2   637,018       636,159       593,242       593,793    

Short-term borrowings

   Level 1     337,042     337,042     179,806     179,806    Level 1   293,100       293,100       334,804       334,804    

Long-term borrowings

  Level 2   38,990       40,313       -       -    

Accrued interest payable

   Level 1     3,407     3,407     3,819     3,819    Level 1   4,676       4,676       3,862       3,862    

 

(1)

Comprised of collateral dependent impaired loans.

- 112 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December) 31, 2013, 2012 and 2011

 

(19.)PARENT COMPANY FINANCIAL INFORMATION

Condensed financial statements pertaining only to the Parent are presented below (in thousands).

 

Condensed Statements of Condition  December 31, 
   2013   2012 

Assets:

    

Cash and due from subsidiary

  $9,510    $6,602  

Investment in and receivables due from subsidiary

   245,071     246,535  

Other assets

   3,463     3,563  
  

 

 

   

 

 

 

Total assets

  $258,044    $256,700  
  

 

 

   

 

 

 

Liabilities and shareholders’ equity:

    

Other liabilities

  $3,205    $2,803  

Shareholders’ equity

   254,839     253,897  
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

  $258,044    $256,700  
  

 

 

   

 

 

 

Condensed Statements of Income  Years ended December 31, 
   2013   2012   2011 

Dividends from subsidiary and associated companies

  $15,000    $4,000    $9,233  

Management and service fees from subsidiary

   368     517     1,161  

Other income

   71     24     78  
  

 

 

   

 

 

   

 

 

 

Total income

   15,439     4,541     10,472  
  

 

 

   

 

 

   

 

 

 

Operating expenses

   2,906     2,732     3,787  

Loss on extinguishment of debt

   —       —       1,083  
  

 

 

   

 

 

   

 

 

 

Total expenses

   2,906     2,732     4,870  
  

 

 

   

 

 

   

 

 

 

Income before income tax benefit and equity in undistributed earnings of subsidiary

   12,533     1,809     5,602  

Income tax benefit

   1,020     991     1,539  
  

 

 

   

 

 

   

 

 

 

Income before equity in undistributed earnings of subsidiary

   13,553     2,800     7,141  

Equity in undistributed earnings of subsidiary

   11,977     20,649     15,658  
  

 

 

   

 

 

   

 

 

 

Net income

  $25,530    $23,449    $22,799  
  

 

 

   

 

 

   

 

 

 
Condensed Statements of Condition  December 31, 
           2015                   2014         

Assets:

    

Cash and due from subsidiary

   $15,787      $9,559   

Investment in and receivables due from subsidiary

   318,928      273,237   

Other assets

   4,451      3,433   
  

 

 

   

 

 

 

Total assets

   $339,166      $286,229   
  

 

 

   

 

 

 

Liabilities and shareholders’ equity:

    

Long-term borrowings, net of issuance costs of $1,010

   $38,990      $  

Other liabilities

   6,332      6,697   

Shareholders’ equity

   293,844      279,532   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $     339,166      $     286,229   
  

 

 

   

 

 

 

 

- 113115 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 20122015, 2014 and 20112013

 

(19.)PARENT COMPANY FINANCIAL INFORMATION (Continued)

 

Condensed Statements of Income              Years ended December 31,             
  2015 2014 2013

Dividends from subsidiary and associated companies

   $16,000    $20,920    $15,000  

Management and service fees from subsidiary

   599   417   368  

Other income

   1,175   74   71  
  

 

 

 

 

 

Total income

   17,774   21,411   15,439  

Interest expense

   1,750   -   -  

Operating expenses

   3,509   3,437   2,906  
  

 

 

 

 

 

Total expense

   5,259   3,437   2,906  

Income before income tax benefit and equity in undistributed
earnings of subsidiary

   12,515   17,974   12,533  

Income tax benefit

   1,814   1,120   1,020  
  

 

 

 

 

 

Income before equity in undistributed earnings of subsidiary

   14,329   19,094   13,553  

Equity in undistributed earnings of subsidiary

   14,008   10,261   11,977  
  

 

 

 

 

 

Net income

   $28,337    $29,355    $25,530  
  

 

 

 

 

 

Condensed Statements of Cash Flows  Years ended December 31,   Years ended December 31,
  2013 2012 2011   2015 2014 2013

Cash flows from operating activities:

        

Net income

  $25,530   $23,449   $22,799     $28,337    $29,355    $25,530  

Adjustments to reconcile net income to net cash provided by operating activities:

        

Equity in undistributed earnings of subsidiary

   (11,977 (20,649 (15,658   (14,008 (10,261 (11,977

Depreciation and amortization

   47   65   116     97   48   47  

Share-based compensation

   407   526   1,105     674   471   407  

Decrease in other assets

   166   805   771  

(Decrease) increase in other liabilities

   (17 44   (534

(Increase) decrease in other assets

   (1,069 5,661   166  

Decrease in other liabilities

   (258 (5,717 (17
  

 

  

 

  

 

   

 

 

 

 

 

Net cash provided by operating activities

   14,156    4,240    8,599     13,773   19,557   14,156  

Cash flows from investing activities:

    

Capital investment in Five Star Bank

   (34,000  -    -  

Net cash paid for acquisition

   -   (7,995  -  
  

 

 

 

 

 

Net cash used in investing activities

   (34,000 (7,995  -  

Cash flows from financing activities:

        

Redemption of junior subordinated debentures

   —      —      (16,702

Proceeds from issuance of preferred and common shares, net of issuance costs

   —      —      43,127  

Issuance of long-term debt, net of issuance costs

   38,940    -    -  

Purchase of preferred and common shares

   (360  (559  (37,764   (202 (196 (360

Repurchase of warrant issued to U.S. Treasury

   —      —      (2,080

Proceeds from stock options exercised

   448    69    91     359   667   448  

Dividends paid

   (11,218  (8,866  (7,564   (12,721 (11,984 (11,218

Other

   (118  97    20     79    -   (118
  

 

  

 

  

 

   

 

 

 

 

 

Net cash used in financing activities

   (11,248  (9,259  (20,872

Net cash provided by (used in) financing activities

   26,455   (11,513 (11,248
  

 

  

 

  

 

   

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

   2,908    (5,019  (12,273

Net increase in cash and cash equivalents

   6,228   49   2,908  

Cash and cash equivalents as of beginning of year

   6,602    11,621    23,894     9,559   9,510   6,602  
  

 

  

 

  

 

   

 

 

 

 

 

Cash and cash equivalents as of end of the year

  $9,510   $6,602   $11,621     $15,787    $9,559    $9,510  
  

 

  

 

  

 

   

 

 

 

 

 

 

- 114116 -


ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

ITEM 9A.(20.)CONTROLS AND PROCEDURESSEGMENT REPORTING

The Company has two reportable operating segments, banking and insurance, which are delineated by the consolidated subsidiaries of Financial Institutions, Inc. The banking segment includes all of the Company’s retail and commercial banking operations. The insurance segment includes the activities of SDN, a full service insurance agency that provides a broad range of insurance services to both personal and business clients. The Company operated as one business segment until the acquisition of SDN on August 1, 2014, at which time the new “Insurance” segment was created for financial reporting purposes. Holding company amounts are the primary differences between segment amounts and consolidated totals, and are reflected in the Holding Company and Other column below, along with amounts to eliminate balances and transactions between segments.

The following tables present information regarding the Company’s business segments as of and for the periods indicated (in thousands).

         Banking            Insurance      Holding
 Company and 
Other
   Consolidated  
Totals

December 31, 2015

                 

Goodwill

    $48,536     $11,866     $-     $60,402  

Other intangible assets, net

   829    5,715    -    6,544  

Total assets

   3,356,987    20,315    3,722    3,381,024  
     

December 31, 2014

                 

Goodwill

    $48,536     $12,617     $-     $61,153  

Other intangible assets, net

   1,125    6,361    -    7,486  

Total assets

   3,065,109    20,368    4,044    3,089,521  
   Banking Insurance(1) Holding
Company and
Other
 Consolidated
Totals

Year ended December 31, 2015

                 

Net interest income (expense)

    $97,063    $-    $(1,750  $95,313  

Provision for loan losses

   (7,381  -    -    (7,381

Noninterest income

   24,734    4,969    634    30,337  

Noninterest expense(2)

   (71,599  (5,426  (2,368  (79,393
  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

   42,817    (457  (3,484  38,876  

Income tax (expense) benefit

   (12,230  (121  1,812    (10,539
  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

    $30,587    $(578  $(1,672  $28,337  
  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     

Year ended December 31, 2014

                 

Net interest income

    $93,774    $-    $-    $93,774  

Provision for loan losses

   (7,789  -    -    (7,789

Noninterest income

   23,602    2,073    (325  25,350  

Noninterest expense

   (67,857  (1,877  (2,621  (72,355
  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

   41,730    196    (2,946  38,980  

Income tax (expense) benefit

   (10,735  (9  1,119    (9,625
  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

    $30,995    $187    $(1,827  $29,355  
  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

Reflects activity from SDN since August 1, 2014, the date of acquisition.

(2)

Insurance segment includes goodwill impairment of $751 thousand.

- 117 -


ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.   CONTROLS AND PROCEDURES

Effectiveness of Controls and Procedures

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Accounting Officer), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b), as adopted by the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (“Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this Annual Report on Form 10-K.

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Management Report on Internal Control over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Management assessed the Company’s internal control over financial reporting based on criteria established in theInternal Control—Integrated Framework (1992)(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has concluded that, as of December 31, 2013,2015, the Company maintained effective internal control over financial reporting. Management’s Report on Internal Control over Financial Reporting is included under Item 8 “Financial Statements and Supplementary Data” in Part II of this Form 10-K.

KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K, and has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting. The Report of Independent Registered Public Accounting Firm that attests the effectiveness of internal control over financial reporting is included under Item 8 “Financial Statements and Supplementary Data” in Part II of this Form 10-K.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended December 31, 20132015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

ITEM 9B.OTHER INFORMATION

During February 2014, Five Star Bank (the “Bank”) formed a wholly-owned subsidiary, Five Star REIT, Inc. (the “REIT”), to acquire a portion of the Bank’s assets, which will primarily be qualifying mortgage related loans. The Bank made an initial contribution of mortgage related loans to the REIT in return for common stock of the REIT. The REIT expects to purchase mortgage related loans from the Bank on a periodic basis going forward. The REIT entered into service agreements with the Bank for administrative and investment services. The Company expects the formation of the REIT to result in a lower effective tax rate for 2014 subject to New York State tax reform and future tax legislation.

The foregoing disclosure is being made on a voluntary basis and was not required to be disclosed on a Form 8-K.Not applicable.

 

- 115118 -


PART III

 

ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

In response to this Item, the information set forth in the Company’s Proxy Statement for its 20142016 Annual Meeting of Shareholders (the “2014“2016 Proxy Statement”) to be filed within 120 days following the end of the Company’s fiscal year, under the headings “Proposal 1 - Election of Directors,” “Business Experience and Qualification of Directors,” “Our Executive Officers,” and “Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by reference.

The information under the heading “Executive Officers” in Part I, Item 1 of this Form 10-K is also incorporated herein by reference.

Information concerning the Company’s Audit Committee and the Audit Committee’s financial expert is set forth under the caption “Corporate Governance Overview”“Board Meetings and Committees” in the 20142016 Proxy Statement and is incorporated herein by reference.

The Company has adopted a Code of Business Conduct and Ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. TheInformation concerning the Company’s Code of Business Conduct and Ethics is posted on the Company’s internet website atwww.fiiwarsaw.comset forth under the Corporate Overview/Governance Documents tabscaption “Code of Ethics” in the Investor Relations drop down menu. In addition, the Company will provide a copy of the Code of Business Conduct2016 Proxy Statement and 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 Business Conduct and 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 Business Conduct and Ethics,is incorporated herein by posting such information on the Company’s website.reference.

 

ITEM 11.EXECUTIVE COMPENSATION

ITEM 11.   EXECUTIVE COMPENSATION

In response to this Item, the information set forth in the 20142016 Proxy Statement under the headings “Compensation Discussion and Analysis” andAnalysis,” “Executive Compensation Tables”Tables,” “Management Development and Compensation Committee Interlocks and Insider Participation,” “Director Compensation,” and “Management Development and Compensation Committee Report” is incorporated herein by reference.

 

ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

In response to this Item, the information set forth in the 20142016 Proxy Statement under the heading “Security Ownership of Certain Beneficial Owners and Management” is incorporated herein by reference.

Equity Compensation Plan Information

The following table sets forth, as of December 31, 2013,2015, information about our equity compensation plans that have been approved by our shareholders, including the number of shares of our common stock exercisable under all outstanding options, warrants and rights, the weighted average exercise price of all outstanding options, warrants and rights and the number of shares available for future issuance under our equity compensation plans. We have no equity compensation plans that have not been approved by our shareholders.

 

     Number of securities to  
be issued upon exercise
of outstanding options,
warrants and rights
     Weighted average  
exercise price
of outstanding
options, warrants
and rights
      Number of securities   
   remaining for future   
   issuance under equity   
   compensation plans   
   (excluding securities   
   reflected in column (a))   

Plan Category

  Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights

(a)
   Weighted average
exercise price
of outstanding
options, warrants
and rights

(b)
   Number of securities
remaining for future
issuance under equity
compensation plans
(excluding securities
reflected in column (a))

(c)
    (a)   (b)    (c)

Equity compensation plans approved by shareholders

   192,934    $19.83     560,436     102,249   $19.21              424,144

Equity compensation plans not approved by shareholders

   —      $—       —       -   $-                  -

 

- 116 -ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE


ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

In response to this Item, the information set forth in the 20142016 Proxy Statement under the headings “Certain Relationships and Related Party Transactions” and “Corporate Governance Overview”“Board Independence” is incorporated herein by reference.

 

ITEM 14.PRINCIPAL ACCOUNTING FEES AND SERVICES

ITEM 14.   PRINCIPAL ACCOUNTING FEES AND SERVICES

In response to this Item, the information set forth in the 20142016 Proxy Statement under the headings “Audit Committee Report” andheading “Independent Registered Public Accounting Firm” is incorporated herein by reference.

 

- 117119 -


PART IV

 

ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

 (a)

FINANCIAL STATEMENTS

Reference is made to the Index to Consolidated Financial Statements of Financial Institutions, Inc. and subsidiaries under Item 8 “Financial Statements and Supplementary Data” in Part II of this Annual Report on Form 10-K.

 

 (b)

EXHIBITS

The following is a list of all exhibits filed or incorporated by reference as part of this Report.

 

Exhibit

Number

  

Description

  

Location

 3.1  Amended and Restated Certificate of Incorporation of the Company  

Incorporated by reference to Exhibits 3.1, 3.2 and 3.3 of the Form 10-K for the year ended December 31, 2008, dated March 12, 2009

 3.2  Amended and Restated Bylaws of the Company  

Incorporated by reference to Exhibit 3.4 of the Form 10-K for the year ended December 31, 2008, dated March 12, 2009

 4.1

Subordinated Indenture, dated as of April 15, 2015, between Financial Institutions, Inc. and Wilmington Trust, National Association, as Trustee

Incorporated by reference to Exhibit 4.1 of the Form 8-K, dated April 15, 2015
 4.2

First Supplemental Indenture, dated as of April 15, 2015, between Financial Institutions, Inc. and Wilmington Trust, National Association, as Trustee

Incorporated by reference to Exhibit 4.2 of the Form 8-K, dated April 15, 2015
 4.3

Form of Global Note to represent the 6.00% Fixed-to-Floating Rate Subordinated Notes due April 15, 2030

Incorporated by reference to Exhibit A of Exhibit 4.2 of the Form 8-K, dated April 15, 2015
10.1  1999 Management Stock Incentive Plan  

Incorporated by reference to Exhibit 10.1 of theS-1 Registration Statement

10.2  Amendment Number One to the 1999 Management Stock Incentive Plan  

Incorporated by reference to Exhibit 10.1 of the Form 8-K, dated July 28, 2006

10.3  

Form of Non-Qualified Stock Option Agreement Pursuant to the 1999 Management Stock Incentive Plan

  

Incorporated by reference to Exhibit 10.2 of the Form 8-K, dated July 28, 2006

10.4Form of Restricted Stock Award Agreement Pursuant to the 1999 Management Stock Incentive PlanIncorporated by reference to Exhibit 10.3 of the Form 8-K, dated July 28, 2006
10.5Form of Restricted Stock Award Agreement Pursuant to the 1999 Management Stock Incentive PlanIncorporated by reference to Exhibit 10.1 of the Form 8-K, dated January 23, 2008
10.6  1999 Directors Stock Incentive Plan  

Incorporated by reference to Exhibit 10.2 of theS-1 Registration Statement

10.7 10.5  Amendment to the 1999 Director Stock Incentive Plan  

Incorporated by reference to Exhibit 10.7 of the Form 10-K for the year ended December 31, 2008, dated March 12, 2009

10.8 10.6  2009 Management Stock Incentive Plan  

Incorporated by reference to Exhibit 10.8 of the Form 10-Q for the quarterly period ended June 30, 2009, dated August 5, 2009

10.9 10.7  2009 Directors’ Stock Incentive Plan  

Incorporated by reference to Exhibit 10.9 of the Form 10-Q for the quarterly period ended June 30, 2009, dated August 5, 2009

10.10 10.8  Form of Restricted Stock Award Agreement Pursuant to the 2009 Directors’ Stock Incentive PlanIncorporated by reference to Exhibit 10.10 of theForm 10-K for the year ended December 31, 2012, dated March 18, 2013
10.11Form of Restricted Stock Award Agreement Pursuant to the 2009 Management Stock Incentive Plan (Special, one-time Award)Incorporated by reference to Exhibit 10.1 of theForm 8-K, dated January 19, 2010
10.12

Form of Restricted Stock Award Agreement Pursuant to the 2009 Management Stock Incentive Plan (LTIP Award)

  

Incorporated by reference to Exhibit 10.2 of theForm 8-K, dated March 1, 2010

 

- 118 -


Exhibit
Number

Description

Location

  10.13 10.9  Form of “Service Based” Restricted Stock Award Agreement Pursuant to the 2009 Management Stock Incentive Plan  

Incorporated by reference to Exhibit 10.12 of the Form 10-K for the year ended December 31, 2011, dated March 9, 2012

- 120 -


  10.14

Exhibit

Number

  Form of 2012 Performance Program Master Agreement

Description

  Incorporated by reference to Exhibit 10.13 of the Form 10-K for the year ended December 31, 2011, dated March 9, 2012

Location

 10.15Form of 2012 Performance Program Award CertificateIncorporated by reference to Exhibit 10.14 of the Form 10-K for the year ended December 31, 2011, dated March 9, 2012
  10.1610.10  Form of 2013 Performance Program Master Agreement  

Incorporated by reference to Exhibit 10.16 of theForm 10-K for the year ended December 31, 2012, dated March 18, 2013

 10.1710.11  Form of 2013 Performance Program Award Certificate  

Incorporated by reference to Exhibit 10.17 of theForm 10-K for the year ended December 31, 2012, dated March 18, 2013

 10.1810.12  Amended and Restated Executive Agreement between Financial Institutions, Inc. and Peter G. HumphreyIncorporated by reference to Exhibit 10.1 of theForm 8-K, dated July 5, 2012
  10.19

Amended and Restated Executive Agreement between Financial Institutions, Inc. and Martin K. Birmingham

  Incorporated by reference to Exhibit 10.1 of theForm 8-K, dated May 23, 2013
  10.20 10.13  Executive Agreement between Financial Institutions, Inc. and Kevin B. Klotzbach  

Incorporated by reference to Exhibit 10.2 of theForm 8-K, dated May 23, 2013

 10.2110.14  Executive Agreement between Financial Institutions, Inc. and Richard J. Harrison  

Incorporated by reference to Exhibit 10.3 of theForm 8-K, dated May 23, 2013

 10.2210.15  Executive Agreement between Financial Institutions, Inc. and Ronald Mitchell McLaughlin  

Incorporated by reference to Exhibit 10.4 of the Form 8-K, dated July 5, 2012

 10.2310.16  Executive Agreement between Financial Institutions, Inc. and Kenneth V. Winn  

Incorporated by reference to Exhibit 10.5 of theForm 8-K, dated July 5, 2012

 10.24Separation and release agreement between Five Star Bank and George D. HagiIncorporated by reference to Exhibit 10.6 of theForm 8-K, dated July 5, 2012
  10.2510.17  Voluntary Retirement Agreement with Ronald A. Miller  

Incorporated by reference to Exhibit 10.2 of theForm 8-K, dated September 26, 2008

 10.2610.18  Amendment to Voluntary Retirement Agreement with Ronald A. Miller  

Incorporated by reference to Exhibit 10.1 of theForm 8-K, dated March 3, 2010

 10.27Separation and release agreement between Financial Institutions, Inc. and Peter G. HumphreyIncorporated by reference to Exhibit 10.2 of theForm 10-Q for the quarterly period ended September 30, 2012, dated November 6, 2012
  10.2810.19  Supplemental Executive Retirement Agreement between Financial Institutions, Inc. and Peter G. Humphrey  

Incorporated by reference to Exhibit 10.3 of theForm 10-Q for the quarterly period ended September 30, 2012, dated November 6, 2012

*10.29 10.20  Assignment, PurchaseSupplemental Executive Retirement Agreement between Financial Institutions, Inc. and AssumptionRichard J. Harrison

Incorporated by reference to Exhibit 10.1 of the Form 10-Q for the quarterly period ended June 30, 2014, dated August 5, 2014

 10.21Separation and release agreement between Financial Institutions, Inc. and Kenneth V. Winn

Incorporated by reference to Exhibit 10.1 of the Form 10-Q for the quarterly period ended September 30, 2014, dated November 4, 2014

 10.22Financial Institutions, Inc. 2015 Long-Term Incentive Plan

Incorporated by reference to Exhibit 10.1 of the Form 10-Q for the quarterly period ended June 30, 2015, dated August 5, 2015

 10.23Form of Director Annual Restricted Stock Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan

Incorporated by reference to Exhibit 10.2 of the Form 10-Q for the quarterly period ended June 30, 2015, dated January 19, 2012 between First Niagara Bank, National Association and Five Star BankAugust 5, 2015

 10.24Form of Director “In Lieu of Cash Fees” Stock Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan

Incorporated by reference to Exhibit 10.3 of the Form 10-Q for the quarterly period ended June 30, 2015, dated August 5, 2015

 10.25Form of Restricted Stock Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan

Incorporated by reference to Exhibit 10.4 of the Form 10-Q for the quarterly period ended June 30, 2015, dated August 5, 2015

 10.26Form of Performance Stock Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan

Incorporated by reference to Exhibit 10.5 of the Form 10-Q for the quarterly period ended June 30, 2015, dated August 5, 2015

 10.27Form of Restricted Stock Unit Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan  Incorporated by reference to Exhibit 10.2410.6 of theForm 10-K for the year ended December 31, 2011, dated March 9, 2012
*10.30Amendment No. 1 to Assignment, Purchase and Assumption Agreement, effective as of August 16, 2012, by and between Five Star Bank and First Niagara Bank, National AssociationIncorporated by reference to Exhibit 10.1 of theForm 10-Q for the quarterly period ended SeptemberJune 30, 2012,2015, dated November 6, 2012August 5, 2015

 

- 119121 -


Exhibit

Number

  

Description

  

Location

*10.31 10.28  Purchase and AssumptionForm of Performance Stock Unit Award Agreement dated January 19, 2012 between First Niagara Bank, National Association and Five Star BankPursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan  

Incorporated by reference to Exhibit 10.2510.7 of theForm 10-K for the year ended December 31, 2011, dated March 9, 2012

*10.32Amendment No. 1 to Purchase and Assumption Agreement, effective as of June 21, 2012, by and between Five Star Bank and First Niagara Bank, National Association.Incorporated by reference to Exhibit 10.1 of theForm 8-K, dated June 28, 2012
  10.33Executive Agreement between Financial Institutions, Inc. and Karl F. KrebsIncorporated by reference to Exhibit 10.3 of theForm 8-K, dated July 5, 2012
  10.34Separation and release agreement between Financial Institutions, Inc. and Karl F. KrebsIncorporated by reference to Exhibit 10.1 of theForm 10-Q for the quarterly period ended SeptemberJune 30, 2013,2015, dated NovemberAugust 5, 2013
2015

 21  Subsidiaries of Financial Institutions, Inc.  

Filed Herewith

 23  Consent of Independent Registered Public Accounting Firm  

Filed Herewith

 31.1  

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Principal Executive Officer

  Filed Herewith
 31.2  

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Principal Financial Officer

  Filed Herewith
 32  

Certification pursuant to 18to18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

  Filed Herewith
101.INS  

XBRL Instance Document

  
101.SCH  

XBRL Taxonomy Extension Schema Document

  
101.CAL  

XBRL Taxonomy Extension Calculation Linkbase Document

  
101.LAB  

XBRL Taxonomy Extension Label Linkbase Document

  
101.PRE  

XBRL Taxonomy Extension Presentation Linkbase Document

  
101.DEF  XBRL Taxonomy Extension Definition Linkbase Document  

 All material agreements consist of management contracts, compensatory plans or arrangements.

*Except for these agreements, all of our other material agreements consist of Management contracts, Compensatory plans or arrangements.

 

- 120122 -


SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    FINANCIAL INSTITUTIONS, INC.
March 12, 20148, 2016  By:  

/s/ Martin K. Birmingham

    

 

Martin K. Birmingham

  Martin K. Birmingham
    President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signatures

  

Title

 

Date

/s/ Martin K. Birmingham

  

Director, President and Chief Executive Officer

(Principal Executive Officer)

 March 12, 20148, 2016
Martin K. Birmingham  (Principal Executive Officer)

/s/ Kevin B. Klotzbach

  

Executive Vice President and Chief Financial Officer

(Principal Financial Officer)

 March 12, 20148, 2016
Kevin B. Klotzbach  (Principal Financial Officer)

/s/ Michael D. Grover

  

Senior Vice President and Chief Accounting Officer

(Principal Accounting Officer)

 March 12, 20148, 2016
Michael D. Grover  (Principal Accounting Officer)

/s/ Karl V. Anderson, Jr.

  Director  March 12, 20148, 2016
Karl V. Anderson, Jr.  

/s/ John E. Benjamin

  Director Chairman March 12, 20148, 2016
John E. Benjamin  

/s/ Barton P. DambraAndrew W. Dorn, Jr.

  Director  March 12, 2014
Barton P. Dambra March 8, 2016
Andrew W. Dorn, Jr.

/s/ Robert M. Glaser

DirectorMarch 8, 2016
Robert M. Glaser

/s/ Samuel M. Gullo

  Director  March 12, 20148, 2016
Samuel M. Gullo  

/s/ Susan R. Holliday

  Director  March 12, 20148, 2016
Susan R. Holliday  
/s/ Peter G. HumphreyDirectorMarch 12, 2014
Peter G. Humphrey

/s/ Erland E. Kailbourne

  Director  March 12, 20148, 2016
Erland E. Kailbourne  

/s/ Robert N. Latella

  Director, Vice Chairman March 12, 20148, 2016
Robert N. Latella  

/s/ James L. Robinson

  Director  March 12, 20148, 2016
James L. Robinson  

/s/ James H. Wyckoff

  Director  March 12, 20148, 2016
James H. Wyckoff  

 

- 121123 -