The provision for loan and lease losses represents management’s estimate of the expense necessary to maintain the allowance for loan and lease losses at an adequate level. The provision for loan and lease losses was $1.5 million and $3.3 million for the three and nine months ended September 30, 2008, compared to $387,000 and $1.1 million, for the same periods in 2007. The increase in the provision for the three and nine months ended September 30, 2008 reflects the growth in loans and leases, an increase in net charge-offs and nonperforming loans, and the impacts of a slowing economy. The allowance for loan and lease losses, as a percentage of period end loans was 1.01% at September 30, 2008, compared to 1.04% at September 30, 2007. The section captioned “Allowance for Loan and Lease Losses and Nonperforming Assets” contained elsewhere in this report has further details on the allowance for loan and lease losses.
Noninterest income is a significant source of income for the Company, representing 35.2% of total revenues for the first nine months of 2008, compared to 37.6% for the same period in 2007. Noninterest income for the three months ended September 30, 2008 was $11.4 million, a decrease of 1.2% from the same period in 2007. The economic climate has played a role in this trend as investment services fees, service charges on deposit accounts and card services income were all down slightly from the third quarter of 2007. Year-to-date 2008, noninterest income was $35.7 million, up 8.7% over the same period in 2007. Year-to-date 2008 noninterest income included $1.6 million of pre-tax other income related to proceeds received from the Company’s allocation of the Visa, Inc. initial public offering (the “Visa IPO”), consisting of a $1.2 million gain on the partial redemption of Visa stock and a $0.4 million partial reversal of a fourth quarter 2007 accrual for indemnification charges. Visa withheld a portion of the shares allocated to its member banks to create an escrow account to cover the costs and liabilities associated with certain litigation for which its member banks are obligated to indemnify Visa. Visa’s funding of this escrow account allowed member banks to reverse litigation related accruals made in the fourth quarter of 2007, up to each bank’s proportionate membership interest of the $3.0 billion used to fund the escrow account.
Investment services income was $3.5 million in the third quarter of 2008, down 3.6% from the same period in 2007. For the first nine months of 2008, investment services income was $10.7 million, an increase of 0.9% over the same period in 2007. Investment services income reflects income from Tompkins Investment Services (“TIS”), a division within Tompkins Trust Company, and AM&M. Investment services income includes: trust services, financial planning, wealth management services, and brokerage related services. TIS generates fee income through managing trust and investment relationships, managing estates, providing custody services, and managing investments in employee benefits plans. TIS also oversees retail brokerage activities in the Company’s banking offices. TIS revenues for the three and nine months ended September 30, 2008, decreased by $232,000 or 12.3%, and $233,000 or 4.3%, respectively, compared to the same periods in 2007. With fees largely based on the market value and the mix of assets managed, the general direction of the stock market has a considerable impact on fee income. TIS has been successful with business development initiatives and customer retention despite the challenging equities market in 2008 and the recent turmoil in the financial markets. The market value of assets managed by, or in custody of, TIS was $1.76 billion at September 30, 2008, down 3.8% from $1.83 billion at September 30, 2007. These figures include $503.4 million and $484.1 million, respectively, of Company-owned securities of which TIS is custodian.
AM&M provides fee-based financial planning services, wealth management services, and brokerage services to independent financial planners and investment advisors. AM&M revenues increased by $79,000 or 4.3% and by $437,000 or 7.9% for the three and nine months ended September 30, 2008, compared to the same periods in 2007. Growth in financial planning and wealth management fees and insurance commissions were partially offset by lower broker-dealer fees, which were unfavorably impacted by weak equities markets. The market value of assets under management by AM&M was $507.3 million at September 30, 2008, down 4.7% from $532.2 million at September 30, 2007.
Insurance commissions and fees for the three and nine months ended September 30, 2008 increased by $138,000 or 4.7%, and $334,000 or 4.0%, respectively, as compared to the same periods in 2007. The growth in insurance commissions and fees was mainly in personal line revenues, and was partly due to an acquisition in the third quarter of 2007.
Service charges on deposit accounts for the three months ended September 30, 2008, decreased by $118,000 or 4.2% as compared to the same period in 2007. For the first nine months of 2008, service charges on deposit accounts increased by $146,000 or 1.9%. The largest component of this category is overdraft fees, which is largely driven by customer activity. Customer activity has been changing over the past several years, with electronic transactions such as debit cards and Internet banking reducing the volume of checks. The Company reviewed and revised the way that it processes these transactions during the second quarter of 2007 to process electronic transactions substantially the same as paper transactions, which has had a favorable impact on overdraft income.
Card services income for the three and nine months ended September 30, 2008, was down $154,000 or 17.4%, and $76,000 or 2.9%, respectively, over the comparable prior year periods. Debit card income is down compared to the prior year mainly due to a new rewards program implemented in the second quarter of 2008, and the associated accrual to reflect the Company’s liability under the new rewards program.
Net mark-to-market gains on securities and borrowings held at fair value totaled $1,000 for the three months ended September 30, 2008, compared to net mark-to-market losses on securities and borrowings held at fair value of $298,000 for the three months ended September 30, 2007. Year-to-date 2008, net mark-to-market losses were $334,000, compared to losses of $446,000 for the same period in 2007. Mark-to-market losses or gains relate to the change in the fair value of securities and borrowings where the Company has elected the fair value option.
Noninterest income for the third quarter of 2008 includes $398,000 of income relating to increases in the cash surrender value of corporate owned life insurance (COLI). This compares to $302,000 for the same period in 2007. For the year-to-date period income from this source was up $229,000 or 26.7% over the same period last year. The COLI relates to life insurance policies covering certain executive officers of the Company. The Company’s average investment in COLI was $32.2 million for the nine month period ended September 30, 2008, compared to $26.1 million for the same period in 2007. The Company purchased $3.0 million of additional insurance in the fourth quarter of 2007 and acquired $3.5 million in the acquisition of Sleepy Hollow. Although income associated with the insurance policies is not included in interest income, the COLI produced a tax-equivalent return of 7.52% for the first nine months of 2008, compared to 7.33% for the same period in 2007.
Other income for the third quarter of 2008 was $376,000, down $32,000 or 7.8% from the third quarter of 2007. For the nine months ended September 30, 2008, other income was $1.1 million, an increase of $250,000 from the same period prior year. Contributing to the year-to-date increase in other income were the following: increase in earnings related to the Company’s investment in a Small Business Investment Company (up $77,000), and gains on sales of fixed assets (up $42,000).
The net gain on sale of available-for-sale securities of $283,000 for the third quarter of 2007 was primarily on the sale of the Company’s Mastercard stock that it received as a member bank at the time of Mastercard’s initial public offering. The year-to-date 2008 gains of $424,000 reflect sales of available-for-sale securities mainly during the first and second quarters for liquidity purposes and to reinvest proceeds to improve net interest income in light of actions taken by the Federal Reserve that resulted in 200 basis point declines in both the Federal funds rate and prime rate in the first quarter of 2008.
Noninterest Expenses
Total noninterest expenses increased 12.6% to $22.2 million for the three months ended September 30, 2008, compared to $19.7 million for the same period in 2007, and increased 10.0% to $64.3 million for the nine months ended September 30, 2008, from $58.5 million for the same period in 2007. The increase in 2008 over 2007 was primarily in salary and wages and occupancy related expenses, which were all impacted by the Sleepy Hollow acquisition. Changes in the components of noninterest expense are discussed below.
Personnel-related expense, which includes salary, wages, pension and other employee benefits, increased by $1.1 million or 9.7%, and $2.8 million or 8.1%, respectively, for the three and nine-month periods ended September 30, 2008 compared to the same periods in 2007. Salaries and wages for the three months and nine months ended September 30, 2008 were up $1.2 million or 12.9% and $2.7 million or 10.3%, respectively, compared to the same period in 2007. The increases in both periods were primarily related to the staffing requirement for six banking offices added in May 2008, with the acquisition of Sleepy Hollow. Actual full time equivalent employees (FTEs) totaled 698 at September 30, 2008 compared to 644 at September 30, 2007. Pension and other employee benefits for the three months and nine months ended September 30, 2008 were down $37,000 or 1.4%, and up $41,000 or 0.5%, respectively, compared to the same period in 2007. Increases in healthcare and other post-retirement benefits were mainly offset by lower pension related expenses. The third quarter and year-to-date 2007 results included pre-tax severance charges of $740,000 related to reorganization and profit improvement initiatives implemented in 2007.
Expenses related to bank premises and furniture and fixtures increased by $360,000 or 14.8% and by $812,000 or 10.9% for the three and nine month periods ended September 30, 2008 compared to the same periods in 2007. Additions to the company’s branch network as well as increases in depreciation, real estate taxes and utilities contributed to the increased expenses for premises and furniture and fixtures year-over-year. The acquisition of Sleepy Hollow in May of 2008 added six banking offices to the Company’s branch network.
Marketing expense for the three and nine months ended September 30, 2008, were up by $87,000 or 15.3%, and $345,000 or 19.7%, respectively, compared to the same periods in 2007. The primary reason for the period over period increase was the residual expenses for ad campaigns and mailings related to the addition of six new branches in the acquisition of Sleepy Hollow.
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Professional fees for the three and nine months ended September 30, 2008, were down by $346,000 or 33.1%, and $539,000 or 20.7%, respectively, compared to the same periods in 2007. The third quarter and year-to-date periods in 2007 included consulting fees of $447,000 and $827,000, respectively, related to the implementation of certain profit improvement initiatives in 2007.
Software licensing and maintenance expense for the three and nine months ended September 30, 2008 increased by $103,000 or 18.7%, and $489,000 or 31.4% over the same periods in 2007. Contributing to the increase in 2008 was an increase in core operating system expense, and process improvement related initiatives.
Cardholder expense of $407,000 increased by $166,000 for three months ended September 30, 2008, compared to $241,000 for the same period in 2007, and increased $188,000 or 25.7% for the nine months ended September 30, 2008. The increases are primarily due to some one-time expenses related to the conversion to a new card processing system in the second quarter of 2008.
Other operating expenses increased by $911,000 or 29.8%, and $1.7 million or 17.6% for the three and nine month periods ended September 30, 2008, compared to the same periods in 2007. Contributing to the year-to-date increase in other operating expenses were the following: telephone (up $92,000), printing and supplies (up $205,000); regulatory agency expense (up $394,000), and merger related expenses (up $73,000). The increase in regulatory expense resulted as available FDIC assessment credits awarded for prior contributions were mostly utilized for assessments through June 30, 2008, and an increase in total deposits. In October 2008, the FDIC announced its intention to increase deposit insurance assessments beginning in 2009 to ensure that the FDIC deposit insurance fund can adequately cover projected losses from future bank failures. The projected increase would effectively double the average insurance premiums paid by banks and thrifts.
Income Tax Expense
The provision for income taxes provides for Federal and New York State income taxes. The provision for the three months ended September 30, 2008, was $3.7 million, compared to $3.2 million for the same period in 2007. For the year-to-date period ended September 30, 2008, the provision was $10.8 million compared to $8.8 million for the same period in 2007. The Company’s effective tax rate for the third quarters of 2008 and 2007 was 31.6%. For the nine months ended September 30, 2008, the effective tax rate was 32.2%, compared to 31.7% for the comparable prior year period. The increase in the effective tax rate for the first nine months of 2008 compared to 2007 was primarily the result of nontaxable items representing a smaller percentage of the higher pre-tax income for the nine months ended September 30, 2008 as compared to the prior year period.
FINANCIAL CONDITION
Total assets were $2.7 billion at September 30, 2008, up $365.6 million or 15.5% over December 31, 2007, and up 17.6% over September 30, 2007. Asset growth includes $269.1 million of assets acquired in the acquisition of Sleepy Hollow. Asset growth over year-end 2007 included a $51.5 million increase in securities ($46.9 million acquired from Sleepy Hollow), a $278.3 million increase in the total loans and leases ($151.2 million acquired from Sleepy Hollow), and a $5.8 million increase in cash and equivalents.
Loans totaled $1.7 billion or 63.1% of total assets at September 30, 2008, compared to $1.4 billion or 61.0% of total assets at December 31, 2007. The 19.3% growth in total loans from year-end 2007 was mainly in commercial real estate, residential real estate, and commercial loans and included $151.2 million of loans purchased in the acquisition of Sleepy Hollow. Residential real estate loans, including home equity loans, were up $108.1 million or 21.3%, and commercial real estate and commercial loans were up $159.2 million or 18.9%. Consumer loans were up $6.1 million or 7.5% over December 31, 2007.
Nonperforming loans (loans on nonaccrual, loans past due 90 days or more and still accruing interest, and loans restructured where the terms of repayment have been renegotiated, resulting in a reduction and or deferral of interest and principal) were $12.6 million at September 30, 2008, up from $9.3 million at December 31, 2007. Nonperforming loans represented 0.73% of total loans at September 30, 2008, compared to 0.65% of total loans at December 31, 2007. The increase in nonperforming loans was mainly a result of nonperforming loans acquired in the Sleepy Hollow acquisition. For the nine months ended September 30, 2008, net charge-offs were $2.1 million, up from $968,000 in the same period of 2007.
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Over the past year or so, there has been significant attention to subprime consumer real estate lending in the media. The Company has not engaged in the origination or purchase of subprime loans as a line of business and residential loan charge-offs amounted to $98,000 for the nine months ended September 30, 2008, compared to $98,000 for the same period in 2007. In addition, the combined nonperforming loan balances in our construction and home equity lending portfolios represents less than 0.05% of total loans.
As of September 30, 2008, total securities were $800.4 million or 29.4% of total assets, compared to $748.9 million or 31.7% of total assets at year-end 2007. The portfolio is comprised primarily of mortgage-backed securities, obligations U.S. of Government sponsored agencies, and obligations of states and political subdivisions. The Company has no investments in preferred stock of U.S. Government sponsored agencies, no investments in pools of Trust Preferred securities, and no securities where management has deemed impairment to be other than temporary. The after-tax unrealized gain on the available-for-sale securities was $41,348 at September 30, 2008, compared to an after-tax unrealized gain of $1.3 million at December 31, 2007.
As of September 30, 2008, the trading portfolio totaled $38.8 million, down from $60.1 million at December 31, 2007. The decrease reflects maturities during the first nine months of 2008.
Total deposits were $2.1 billion at September 30, 2008, up $373.8 million or 21.7% over December 31, 2007, and up $368.9 million or 21.4% over September 30, 2007. The Company acquired $229.0 million of deposits in the acquisition of Sleepy Hollow. The growth in total deposits from December 31, 2007 was mainly in money market and savings balances, which were up $232.7 million or 31.4% ($93.1 million acquired in Sleepy Hollow acquisition). Noninterest bearing deposit balances were up $25.7 million or 6.5% ($24.5 million acquired in Sleepy Hollow acquisition). Time deposit balances were up $115.4 million or 19.7% ($109.2 million acquired in Sleepy Hollow acquisition). Other borrowings decreased $25.8 million from year-end 2007 to $185.1 million at September 30, 2008, as the Company paid down some overnight FHLB borrowings with the increase in deposit balances. During the second quarter of 2007, the Company elected the fair value option for $25.0 million of FHLB borrowings incurred during the quarter. Since December 31, 2007, the fair value of these borrowings increased by $162,000.
Capital
Total shareholders’ equity totaled $212.6 million at September 30, 2008, an increase of $15.4 million from December 31, 2007. Additional paid-in capital increased by $4.1 million, from $147.7 million at December 31, 2007, to $151.8 million at September 30, 2008, reflecting $3.1 million in proceeds from stock option exercises and $683,000 related to stock-based compensation. Retained earnings increased $12.5 million from $57.3 million at December 31, 2007, to $69.8 million at September 30, 2008, reflecting net income of $22.6 million less dividends paid of $9.4 million and a cumulative-effect adjustment of $582,000 related to the adoption of EITF 06-4,Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. Accumulated other comprehensive loss increased by $989,000 from a net unrealized loss of $6.9 million at December 31, 2007, to a net unrealized loss of $7.9 million at September 30, 2008, reflecting a decrease in unrealized gains on available-for-sale securities due to higher market rates, partially offset by amounts recognized in other comprehensive income related to postretirement benefit plans. Under regulatory requirements, amounts reported as accumulated other comprehensive income/loss related to net unrealized gain or loss on available for sale securities and the funded status of the Corporation’s defined benefit post-retirement benefit plans do not increase or reduce regulatory capital and are not included in the calculation of risk-based capital and leverage ratios.
Cash dividends paid in the first nine months of 2008 totaled approximately $9.4 million, representing 41.8% of year-to-date earnings. Cash dividends of $0.98 per share paid during the first nine months of 2008 were up 6.5% over cash dividends of $0.92 per share paid in the first nine months of 2007.
On July 22, 2008, the Company’s Board of Directors approved a stock repurchase plan (the “2008 Plan”). The 2008 Plan authorizes the repurchase of up to 150,000 shares of the Company’s outstanding common stock over a two-year period. The 2008 Plan replaces a previous repurchase plan that expired in July 2008. The Company did not repurchase any shares of common stock under the previous plan during the first nine months of 2008. Over the life of the plan approved in 2006, the Company repurchased 420,575 shares.
The Company and its banking subsidiaries are subject to various regulatory capital requirements administered by Federal banking agencies. Management believes the Company and its subsidiaries meet all capital adequacy requirements to which they are subject. The table below reflects the Company’s capital position at September 30, 2008, compared to the regulatory capital requirements for “well capitalized” institutions.
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| | | | | | | | | | | | |
REGULATORY CAPITAL ANALYSIS September 30, 2008 | | | | | | | | |
|
| | | | | | | |
| | Actual | | | Well Capitalized
Requirement | |
(Dollar amounts in thousands) | | Amount | | Ratio | | | Amount | | Ratio | |
| | | | | | | | | | | |
Total Capital (to risk weighted assets) | | $ | 202,872 | | 10.9 | % | | $ | 185,463 | | 10.0 | % |
Tier I Capital (to risk weighted assets) | | $ | 185,410 | | 10.0 | % | | $ | 111,278 | | 6.0 | % |
Tier I Capital (to average assets) | | $ | 185,410 | | 7.0 | % | | $ | 133,335 | | 5.0 | % |
| | | | | | | | | | | | | |
As illustrated above, the Company’s capital ratios on September 30, 2008, remain well above the minimum requirements for well capitalized institutions. As of September 30, 2008, the capital ratios for each of the Company’s subsidiary banks also exceeded the minimum levels required to be considered well capitalized. The Company and its affiliates remained well capitalized after the May 9, 2008 acquisition of Sleepy Hollow Bancorp.
Allowance for Loan and Lease Losses and Nonperforming Assets
Management reviews the adequacy of the allowance for loan and lease losses (the “allowance”) on a regular basis. Management considers the accounting policy relating to the allowance to be a critical accounting policy, given the inherent uncertainty in evaluating the levels of the allowance required to cover credit losses in the Company’s portfolio and the material effect that assumption could have on the Company’s results of operations. Factors considered in determining the adequacy of the allowance and the related provision include: management’s approach to granting new credit; the ongoing monitoring of existing credits by the internal and external loan review functions; the growth and composition of the loan and lease portfolio; the level and trend of market interest rates; comments received during the course of regulatory examinations; current local economic conditions; past due and nonperforming loan statistics; estimated collateral values; and an historical review of loan and lease loss experience.
The allowance represented 1.01% of total loans and leases outstanding at September 30, 2008, compared to 1.01% at December 31, 2007 and 1.04% at September 30, 2007. The allowance coverage of nonperforming loans (loans past due 90 days and accruing, nonaccrual loans, and restructured troubled debt) was 1.4 times at September 30, 2008, 1.6 times at December 31, 2007, and 1.7 times at September 30, 2007. Based upon consideration of the above factors, management believes that the allowance is adequate to provide for the risk of loss inherent in the current loan and lease portfolio. Activity in the Company’s allowance for loan and lease losses during the first nine months of 2008 and 2007 and for the 12 months ended December 31, 2007 is illustrated in the table below.
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ANALYSIS OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES(In thousands) | | | | |
|
| | | | | | | | |
| | 09/30/08 | | 12/31/07 | | 09/30/07 | |
| | | | | | | | | | | |
Average loans and leases outstanding during the period | | $ | 1,564,185 | | $ | 1,362,417 | | $ | 1,348,397 | |
| | | | | | | | | | | |
Total loans and leases outstanding at end of period | | $ | 1,718,378 | | $ | 1,440,122 | | $ | 1,383,928 | |
| | | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | | |
ALLOWANCE FOR LOAN AND LEASE LOSSES | | | | | | | | | | |
| | | | | | | | | | | |
Beginning balance | | $ | 14,607 | | $ | 14,328 | | $ | 14,328 | |
| | | | | | | | | | | |
Provision for loan and lease losses | | | 3,323 | | | 1,529 | | | 1,050 | |
Loans charged off | | | (2,452 | ) | | (1,760 | ) | | (1,356 | ) |
Loan recoveries | | | 343 | | | 510 | | | 388 | |
| | | | | | | | | | | |
Net charge-offs | | | (2,109 | ) | | (1,250 | ) | | (968 | ) |
| | | | | | | | | | | |
Allowance acquired in purchase acquisition | | | 1,485 | | | 0 | | | 0 | |
| | | | | | | | | | | |
Ending balance | | $ | 17,306 | | $ | 14,607 | | $ | 14,410 | |
| | | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | | |
Allowance for loan and lease losses to total loans and leases | | | 1.01 | % | | 1.01 | % | | 1.04 | % |
| | | | | | | | | | | |
Annualized net charge-offs to average loans and leases | | | 0.18 | % | | 0.09 | % | | 0.10 | % |
| | | | | | | | | | | |
Net charge-offs for the nine months ended September 30, 2008 totaled $2.1 million compared to $968,000 in the comparable year ago period. Contributing to the increase in net charge-offs in 2008 over 2007 was a $400,000 charge-off taken on one commercial credit in the third quarter of 2008. Annualized net charge-offs for the first nine months of the year represented 0.18% of average loans, up from 0.10% for the first nine months of 2007. The provision for loan and lease losses totaled $3.3 million for the nine months ended September 30, 2008 compared to $1.1 million for the same period in 2007. Higher net charge-offs and nonperforming loans, growth in the loan portfolio, and concern over economic conditions contributed to the increase in the provision for loan and leases losses in 2008 over 2007.
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The level of nonperforming assets at September 30, 2008, and 2007, and December 31, 2007 is illustrated in the table below. Nonperforming assets of $13.1 million as of September 30, 2008, were up $3.7 million from nonperforming assets of $9.4 million at year-end 2007. Nonperforming assets represented 0.48% of total assets at September 30, 2008, compared to 0.40% at December 31, 2007, and 0.37% at September 30, 2007. The increase in nonperforming assets was partially due to the second quarter of 2008 acquisition of Sleepy Hollow, which added about $2.6 million of nonperforming assets. Approximately $3.5 million of nonperforming loans at September 30, 2008, were secured by U.S. government guarantees, while $1.5 million were secured by one-to-four family residential properties.
As of September 30, 2008, the Company’s recorded investment in loans and leases that are considered impaired totaled $8.4 million compared to $7.0 million at September 30, 2007. The $8.4 million of impaired loans at September 30, 2008, had related allowances of $224,000, and the $7.0 million of impaired loans at September 30, 2007, had related allowances of $66,000.
| | | | | | | | | | |
NONPERFORMING ASSETS (In thousands) | | | | | | | |
|
| | | | | | | | |
| | 09/30/08 | | 12/31/07 | | 09/30/07 | |
| | | | | | | | |
Nonaccrual loans and leases | | $ | 12,463 | | $ | 8,890 | | $ | 7,869 | |
Loans past due 90 days and accruing | | | 0 | | | 312 | | | 370 | |
Troubled debt restructuring not included above | | | 132 | | | 145 | | | 0 | |
| | | | | | | | | | | |
Total nonperforming loans | | | 12,595 | | | 9,347 | | | 8,239 | |
| | | | | | | | | | | |
Other real estate, net of allowances | | | 526 | | | 5 | | | 345 | |
| | | | | | | | | | | |
Total nonperforming assets | | $ | 13,121 | | $ | 9,352 | | $ | 8,584 | |
| | | | | | | | | | | |
Total nonperforming loans and leases as a percentage of total loans and leases | | | 0.73 | % | | 0.65 | % | | 0.60 | % |
| | | | | | | | | | | |
Total nonperforming assets as a percentage of total assets | | | 0.48 | % | | 0.40 | % | | 0.37 | % |
| | | | | | | | | | | |
Potential problem loans and leases are loans and leases that are currently performing, but where known information about possible credit problems of the related borrowers causes management to have doubt as to the ability of such borrowers to comply with the present loan payment terms and may result in disclosure of such loans and leases as nonperforming at some time in the future. Management considers loans and leases classified as Substandard that continue to accrue interest to be potential problem loans and leases. At September 30, 2008, the Company’s internal loan review function had identified 36 commercial relationships totaling $10.8 million, which it has classified as Substandard, which continue to accrue interest. As of December 31, 2007, the Company’s internal loan review function had classified 34 commercial relationships as Substandard totaling $13.4 million, which continued to accrue interest. These loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and personal or government guarantees. These factors, when considered in the aggregate, give management reason to believe that the current risk exposure on these loans is not significant. However, these loans do exhibit certain risk factors, which have the potential to cause them to become nonperforming. Accordingly, management’s attention is focused on these credits, which are reviewed at least quarterly.
Deposits and Other Liabilities
Total deposits of $2.1 billion at September 30, 2008, were up $373.8 million or 21.7% from December 31, 2007. Deposit growth included $232.7 million in savings and money market balances, $115.4 million in time deposits and $25.7 million in noninterest bearing deposits. A large portion of the growth was due to the Sleepy Hollow acquisition. Total deposits in Sleepy Hollow Bank’s five Westchester County, New York branches were $229.0 million at the time of the acquisition. Growth in municipal deposits accounted for a majority of the increase in savings and money market balances from year-end 2007. In 2007 and 2008, the Federal Reserve reduced short-term market rates, which led to a decrease in rates paid on deposits. With deposit rates down on time deposits and more in line with money market rates, municipalities are placing tax deposits into money market accounts. Municipal deposit balances are somewhat seasonal, increasing as tax deposits are collected and decreasing as these monies are used by the municipality.
The Company’s primary funding source is core deposits, defined as total deposits less time deposits of $100,000 or more, brokered time deposits, and municipal money market deposits. Core deposits increased 20.3% from year-end 2007 to $1.6 billion at September 30, 2008 and represented 64.9% of total liabilities. The addition of five banking offices acquired in the Sleepy Hollow acquisition contributed to the growth in core deposits.
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The Company also uses non-core funding sources, which include municipal money market deposits, time deposits of $100,000 or more, brokered deposits, term advances and securities sold under agreements to repurchase (“repurchase agreements”) with the Federal Home Loan Bank (“FHLB”), and retail repurchase agreements, to support asset growth. Non-core funding totaled $844.6 million at September 30, 2008, up from $775.7 million at December 31, 2007. The increase in non-core funding between December 31, 2007, and September 30, 2008, was concentrated in municipal money market deposits, which were up $46.3 million to $166.1 million at September 30, 2008 and time deposits of $100,000 or more which were up $46.8 million.
The Company’s liability for repurchase agreements amounted to $190.3 million at September 30, 2008, which is down from $195.4 million at December 31, 2007. Included in repurchase agreements at September 30, 2008, were $152.4 million in FHLB repurchase agreements and $37.9 million in retail repurchase agreements. Retail repurchase agreements are arrangements with local customers of the Company, in which the Company agrees to sell securities to the customer with an agreement to repurchase those securities at a specified later date. Included in the $152.4 million of repurchase agreements with the FHLB are $137.4 million that have call dates between 2007 and 2017 and are callable if certain conditions are met. Also included in the $152.4 million are $15.0 million of repurchase agreements with the FHLB where the Company has elected to adopt the fair value option under SFAS 159. The fair value of these repurchase agreements has increased by $41,000 (net mark-to-market pre-tax loss of $41,000) since December 31, 2007.
At September 30, 2008, other borrowings of $185.1 million included $155.9 million of term advances with the FHLB, and a $21.0 million term borrowing with a money center bank. Included in the $155.9 million of term advances with the FHLB are $144.0 million of advances that have call dates between 2007 and 2017 and are callable if certain conditions are met. The Company elected the fair value option under SFAS 159 for a $10.0 million advance with the FHLB. The fair value of this advance has increased by $121,000 (net mark-to-market pre-tax loss of $121,000) from year-end 2007.
Liquidity
The objective of liquidity management is to ensure the availability of adequate funding sources to satisfy the demand for credit, deposit withdrawals, and business investment opportunities. The Company’s large, stable core deposit base and strong capital position are the foundation for the Company’s liquidity position. The Company uses a variety of resources to meet its liquidity needs, which include deposits, cash and cash equivalents, short-term investments, cash flow from lending and investing activities, repurchase agreements, and borrowings. Asset and liability positions are monitored primarily through Asset/Liability Management Committees of the Company’s subsidiary banks individually and on a combined basis. These Committees review periodic reports on liquidity and interest rate sensitivity positions. Comparisons with industry and peer groups are also monitored. The Company’s strong reputation in the communities it serves, along with its strong financial condition, provides access to numerous sources of liquidity as described below. Management believes these diverse liquidity sources provide sufficient means to meet all demands on the Company’s liquidity that are reasonably likely to occur.
Core deposits are a primary and low cost funding source obtained primarily through the Company’s branch network. Core deposits totaled $1.6 billion at September 30, 2008, up $274.0 million or 20.3% from year-end 2007, and $255.2 million or 18.6% from September 30, 2007. Core deposits represented 77.6% of total deposits and 64.9% of total liabilities at September 30, 2008, compared to 78.5% of total deposits and 62.5% of total liabilities at December 31, 2007.
In addition to core deposits, the Company uses non-core funding sources to support asset growth. These non-core funding sources include time deposits of $100,000 or more, brokered time deposits, municipal money market deposits, securities sold under agreements to repurchase and term advances from the FHLB. Rates and terms are the primary determinants of the mix of these funding sources. Non-core funding sources, as a percentage of total liabilities, were 33.7% at September 30, 2008, down from 35.9% at December 31, 2007.
Cash and cash equivalents totaled $55.6 million as of September 30, 2008, up from $49.9 million at December 31, 2007. Short-term investments, consisting of securities due in one year or less, decreased from $68.0 million at December 31, 2007, to $43.1 million on September 30, 2008. The Company also has $38.8 million of securities designated as trading securities. The Company pledges securities as collateral for certain non-core funding sources. Securities carried at $577.5 million at December 31, 2007, and $664.2 million at September 30, 2008, were pledged as collateral for public deposits or other borrowings, and pledged or sold under agreements to repurchase. Pledged securities represented 83.0% of total securities as of September 30, 2008, compared to 77.1% as of December 31, 2007.
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Cash flow from the loan and investment portfolios provides a significant source of liquidity. These assets may have stated maturities in excess of one year, but have monthly principal reductions. Total mortgage-backed securities, at fair value, were $427.4 million at September 30, 2008, compared with $382.2 million at December 31, 2007. Outstanding principle balances of residential mortgage loans, consumer loans, and leases totaled approximately $716.5 million at September 30, 2008 as compared to $597.4 million at December 31, 2007. Aggregate amortization from monthly payments on these assets provides significant additional cash flow to the Company.
Liquidity is enhanced by ready access to national and regional wholesale funding sources including Federal funds purchased, repurchase agreements, brokered certificates of deposit, and FHLB advances. Through its subsidiary banks, the Company has borrowing relationships with the FHLB and correspondent banks, which provide secured and unsecured borrowing capacity. At September 30, 2008, the unused borrowing capacity on established lines with the FHLB was $443.5 million. As members of the FHLB, the Company’s subsidiary banks can use certain unencumbered mortgage-related assets to secure additional borrowings from the FHLB. At September 30, 2008, total unencumbered residential mortgage loans of the Company were $200.3 million. Additional assets may also qualify as collateral for FHLB advances upon approval of the FHLB.
The Company has not identified any trends or circumstances that are reasonably likely to result in material increases or decreases in liquidity in the near term.
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Item 3. | Quantitative and Qualitative Disclosure About Market Risk |
Interest rate risk is the primary market risk category associated with the Company’s operations. Interest rate risk refers to the volatility of earnings caused by changes in interest rates. The Company manages interest rate risk using income simulation to measure interest rate risk inherent in its on-balance sheet and off-balance sheet financial instruments at a given point in time. The simulation models are used to estimate the potential effect of interest rate shifts on net interest income for future periods. Each quarter, the Asset/Liability Management Committee reviews the simulation results to determine whether the exposure of net interest income to changes in interest rates remains within board-approved levels. The Committee also considers strategies to manage this exposure and incorporates these strategies into the investment and funding decisions of the Company. The Company does not currently use derivatives, such as interest rate swaps, to manage its interest rate risk exposure, but may consider such instruments in the future.
In our most recent simulation, the base case scenario, which assumes interest rates remain unchanged from the date of the simulation, showed an increase in the net interest margin over the next six months as funding costs benefit from the recent reduction in interest rates, followed by a relatively flat net interest margin for the next six months.
The Company’s Board of Directors has set a policy that interest rate risk exposure will remain within a range whereby net interest income will not decline by more than 10% in one year as a result of a 200 basis point parallel change in rate. Given the current level of interest rates, the Company used 100 basis points in the down interest rate scenario in the current model. Based upon the simulation analysis performed as of September 30, 2008, a 200 basis point parallel upward shift in interest rates over a one-year time frame would result in a one-year decline from the base case in net interest income of approximately 2.3%, while a 100 basis point parallel decline in interest rates over a one-year period would result in a decrease from the base case in net interest income of 0.2%. This simulation assumes no balance sheet growth and no management action to address balance sheet mismatches. As of September 30, 2007, the model simulations projected that a 200 basis point parallel upward shift in interest rates over a one-year time frame would result in a one-year decline from the base case in net interest income of approximately 1.4%, while a 200 basis point parallel decline in interest rates over a one-year period would result in a decrease from the base case in net interest income of 3.5%.
The negative exposure in the 200 basis point parallel rising rate environment is mainly driven by the repricing assumptions of the Company’s core deposit base and the lag in the repricing of the Company’s adjustable rate assets. Longer-term, the impact of a rising rate environment is positive as the asset base continues to reset at higher levels, while the repricing of the rate sensitive liabilities moderates. The negative exposure in the 100 basis point parallel declining interest rate scenario results from the Company’s assets repricing downward more rapidly than the rates on the Company’s interest-bearing liabilities, mainly deposits. Rates on savings and money market accounts are at low levels given the recent Federal Reserve cuts in short-term market rates. In addition, the model assumes that prepayments accelerate in the down interest rate environment resulting in additional pressure on asset yields and cash flows are reinvested at lower rates.
Although the simulation model is useful in identifying potential exposure to interest rate movements, actual results may differ from those modeled as the repricing, maturity, and prepayment characteristics of financial instruments may change to a different degree than modeled. In addition, the model does not reflect actions that management may employ to manage its interest rate risk exposure. The Company’s current liquidity profile, capital position, and growth prospects offer management a level of flexibility to take actions that could offset some of the negative effects of unfavorable movements in interest rates. Management believes the current exposure to changes in interest rates is not significant in relation to the earnings and capital strength of the Company.
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In addition to the simulation analysis, management uses an interest rate gap measure. The table below is a Condensed Static Gap Report, which illustrates the anticipated repricing intervals of assets and liabilities as of September 30, 2008. The Company’s one-year interest rate gap was a negative $189,000 or 6.9% of total assets at September 30, 2008, compared to a negative $149,000 or 6.4% of total assets at December 31, 2007. A negative gap position exists when the amount of interest-bearing liabilities maturing or repricing exceeds the amount of interest-earning assets maturing or repricing within a particular time period. This analysis suggests that the Company’s net interest income is more vulnerable to a rising rate environment than it is to sustained low interest rates. An interest rate gap measure could be significantly affected by external factors such as a rise or decline in interest rates, loan or securities prepayments, and deposit withdrawals.
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Condensed Static Gap – September 30, 2008 | Repricing Interval |
| | | | | | | | | | | | | | | | |
(Dollar amounts in thousands) | | Total | | 0-3 months | | 3-6 months | | 6-12 months | | Cumulative
12 months | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Interest-earning assets | | $ | 2,484,746 | | $ | 577,093 | | $ | 160,026 | | $ | 260,898 | | $ | 998,017 | |
Interest-bearing liabilities | | | 2,050,431 | | | 827,956 | | | 182,010 | | | 176,814 | | $ | 1,186,780 | |
| | | | | | | | | | | | | | | | | |
Net gap position | | | | | | (250,863 | ) | | (21,984 | ) | | 84,084 | | | (188,763 | ) |
| | | | | | | | | | | | | | | | | |
Net gap position as a percentage of total assets | | | | | | (9.21 | %) | | (0.81 | %) | | 3.09 | % | | (6.93 | %) |
| | | | | | | | | | | | | | | | | |
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Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
The Company’s management, including its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operations of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of September 30, 2008. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this Report on Form 10-Q the Company’s disclosure controls and procedures were effective in providing reasonable assurance that any information required to be disclosed by the Company in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that material information relating to the Company and its subsidiaries is made known to management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.
Changes in Internal Control Over Financial Reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s third quarter ended September 30, 2008, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
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Item 1. | Legal Proceedings |
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| None |
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Item 1A. | Risk Factors |
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| Material changes to Risk Factors as previously disclosed in Form 10-K: Refer to the discussion on page 18 in this Report under “Recent Market Developments” relating to material changes to the risk factors as presented in the Company’s Annual Report on Form 10-K (for the year ended December 31, 2007) and the Company’s most recent prior Quarterly Report on Form 10-Q (for the quarter ended June 30, 2008). In response to recent events in the financial markets, congress may enact legislation and regulators may promulgate regulations that have an impact on financial institutions, such as protecting certain classes of borrowers from foreclosure actions. |
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Issuer Purchases of Equity Securities
The following table includes all Company repurchases made on a monthly basis during the period covered by this Quarterly Report on Form 10-Q, including those made pursuant to publicly announced plans or programs.
| | | | | | | | | | |
| | | | | | | | | | |
| | Total Number of
Shares Purchased | | Average Price Paid
Per Share | | Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs | | Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs | |
Period | | (a) | | (b) | | (c) | | (d) | |
| | | | | | | | | | |
July 1, 2008 through
July 31, 2008 | | 1,597 | | $ | 46.81 | | 0 | | 150,000 | |
| | | | | | | | | | |
August 1, 2008 through
August 31, 2008 | | 0 | | | 0 | | 0 | | 150,000 | |
| | | | | | | | | | |
September 1, 2008 through
September 30, 2008 | | 0 | | | 0 | | 0 | | 150,000 | |
| | | | | | | | | | |
| | | | | | | | | | | |
Total | | 1,597 | | $ | 46.81 | | 0 | | 150,000 | |
| | | | | | | | | | | |
On July 22, 2008, the Company’s Board of Directors approved a stock repurchase plan (the “2008 Plan”). The 2008 Plan authorizes the repurchase of up to 150,000 shares of the Company’s outstanding common stock over a two-year period. The 2008 Plan replaces a previous repurchase plan that expired in July 2008.
Included above are 1,597 shares purchased in July 2008, at an average cost of $46.81, by the trustee of the rabbi trust established by the Company under the Company’s Stock Retainer Plan For Eligible Directors of Tompkins Financial Corporation and Participating Subsidiaries, and were part of the director deferred compensation under that plan. Shares purchased under the rabbi trust are not part of the Board approved stock repurchase plan.
Recent Sales of Unregistered Securities
None.
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Item 3. | Defaults Upon Senior Securities |
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| None |
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Item 4. | Submission of Matters to a Vote of Security Holders |
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| None |
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Item 5. | Other Information |
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| None |
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| | |
Item 6. | Exhibits | |
| | |
| 31.1 | Certification of Principal Executive Officer and required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended (filed herewith). |
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| 31.2 | Certification of Principal Financial Officer and required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended (filed herewith). |
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| 32.1 | Certification of Principal Executive Officer and required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, 18 U.S.C. Section 1350 (filed herewith) |
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| 32.2 | Certification of Principal Financial Officer and required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, 18 U.S.C. Section 1350 (filed herewith) |
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: November 6, 2008
TOMPKINS FINANCIAL CORPORATION
| | |
By: | /s/ Stephen S. Romaine |
| | |
| Stephen S. Romaine | |
| President and | |
| Chief Executive Officer | |
| (Principal Executive Officer) |
| | |
By: | /s/ Francis M. Fetsko | |
| | |
| Francis M. Fetsko | |
| Executive Vice President and | |
| Chief Financial Officer | |
| (Principal Financial Officer) |
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EXHIBIT INDEX
| | |
Exhibit Number | Description | Pages |
| | | |
| | |
31.1 | Certification of Principal Executive Officer and required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. | 34 |
| | |
31.2 | Certification of Principal Financial Officer and required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. | 35 |
| | |
32.1 | Certification of Principal Executive Officer and required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, 18 U.S.C. Section 1350 | 36 |
| | |
32.2 | Certification of Principal Financial Officer and required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, 18 U.S.C. Section 1350 | 37 |
| | |
| | | |
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