UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED] For the Fiscal Year Ended
December 31, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transaction period from _______ to _______
Commission File Number: 000-23975
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FIRST NIAGARA FINANCIAL GROUP, INC.
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(Exact Name of Registrant as specified in its Charter)
Delaware 42-1556195
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization Identification Number)
6950 South Transit Road, P.O. Box 514, Lockport, NY 14095-0514
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(Address of Principal Executive Officer) (Zip Code)
(716) 625-7500
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(Registrant's Telephone Number Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
None
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Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file reports) and (2) has been subject to such requirements for the
past 90 days.
Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes |X| No |_|
As of March 10, 2004, there were outstanding, 84,046,949 shares of the
Registrant's Common Stock.
The aggregate market value of the 82,180,198 shares of voting stock held by
non-affiliates of the Registrant was $1,171,889,623, as computed by reference to
the last sales price on March 10, 2004, as reported by the NASDAQ National
Market. Solely for purposes of this calculation, all persons who are directors
and executive officers of the Registrant and all persons who are beneficial
owners of more than 10% of its outstanding stock have been deemed to be
affiliates.
DOCUMENTS INCORPORATED
BY REFERENCE
The following documents, in whole or in part, are specifically
incorporated by reference in the indicated Part of the Company's Proxy
Statement:
Document Part
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Proxy Statement for the 2004 Annual Meeting of Part III, Item 10
Stockholders "Directors and Executive Officers of the Registrant"
Part III, Item 11
"Executive Compensation"
Part III, Item 12
"Security Ownership of Certain Beneficial Owners and Management"
Part III, Item 13
"Certain Relationships and Related Transactions"
Part III, Item 14
"Principal Accountant Fees and Services"
2
TABLE OF CONTENTS
ITEM PAGE
NUMBER NUMBER
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PART I
1 Business.......................................................... 4
2 Properties........................................................ 19
3 Legal Proceedings................................................. 19
4 Submission of Matters to a Vote of Security Holders............... 20
PART II
5 Market for Registrant's Common Equity and Related Stockholder
Matters........................................................... 20
6 Selected Financial Data........................................... 21
7 Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 24
7A Quantitative and Qualitative Disclosure about Market Risk......... 40
8 Financial Statements and Supplementary Data....................... 43
9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.............................................. 85
9A Controls and Procedures........................................... 85
PART III
10 Directors and Executive Officers of the Registrant................ 85
11 Executive Compensation............................................ 85
12 Security Ownership of Certain Beneficial Owners and Management.... 85
13 Certain Relationships and Related Transactions.................... 85
14 Principal Accountant Fees and Services............................ 85
PART IV
15 Exhibits, Financial Statement Schedules and Reports on Form 8-K... 86
Signatures........................................................ 87
3
PART I
ITEM 1. BUSINESS
GENERAL
First Niagara Financial Group, Inc.
First Niagara Financial Group, Inc. ("FNFG") is a Delaware corporation, which
holds all of the capital stock of First Niagara Bank ("First Niagara"), a
federally chartered savings bank. FNFG and First Niagara are hereinafter
referred to collectively as "the Company." First Niagara originally was
organized in 1870 as a New York State chartered mutual savings bank. FNFG was
organized in connection with First Niagara's conversion from a New York State
chartered mutual savings bank to a New York State chartered stock savings bank
and the reorganization to a two-tiered mutual holding company in April 1998. As
part of the reorganization, FNFG sold shares of common stock to eligible
depositors of First Niagara and issued approximately 53% of its shares of common
stock to First Niagara Financial Group, MHC (the "MHC"), a mutual holding
company. As a result of share repurchases subsequent to the reorganization, the
MHC's ownership interest grew to 61% of the issued and outstanding shares of
common stock of FNFG.
The Company utilized the proceeds raised in its initial offering to make three
bank and four non-bank acquisitions between 1999 and 2001. In March 2000, FNFG
acquired Albion Banc Corp, Inc., the holding company of Albion Federal Savings
and Loan Association, with assets of $79.3 million and deposits of $61.7
million. The acquisition provided the Company with a contiguous presence between
the Buffalo and Rochester markets. In July 2000, FNFG expanded into Central New
York by acquiring CNY Financial Corporation, the holding company of Cortland
Savings Bank ("Cortland"), with assets of $282.6 million and deposits of $247.3
million. In November 2000, FNFG acquired all of the common stock of Iroquois
Bancorp, Inc., the holding company of Cayuga Bank ("Cayuga") and The Homestead
Savings, FA., with assets of $600.3 million and deposits of $475.7 million. This
acquisition further expanded the Company's presence in Central New York and
significantly increased its commercial loan operations.
In November 2002, FNFG converted First Niagara and the MHC to a federal charter
subject to Office of Thrift Supervision ("OTS") regulation and merged Cortland
and Cayuga into First Niagara. The conversion of FNFG to a federal charter was
approved by stockholders of the Company on January 9, 2003 and was effective
January 17, 2003. The merger of the three banks allows the Company to further
promote the First Niagara brand and gain operational efficiencies, while the
conversion to a federal charter provides the Company with greater corporate
flexibility.
On January 17, 2003, the MHC converted from mutual to stock form (the
"Conversion"). In connection with the Conversion, the 61% of outstanding shares
of FNFG common stock owned by the MHC were sold to depositors of First Niagara
and the public (the "Offering"). Completion of the Conversion and Offering
resulted in the issuance of 67.4 million shares of common stock. A total of 41.0
million shares were sold in subscription, community and syndicated offerings, at
$10.00 per share, and an additional 26.4 million shares were issued to the
former public stockholders of FNFG based upon an exchange ratio of 2.58681 new
shares for each share of FNFG held as of the close of business on January 17,
2003. Following the completion of the Conversion and Offering, FNFG was
succeeded by a new, fully public, Delaware corporation with the same name and
the MHC ceased to exist.
On January 17, 2003, in conjunction with the Conversion and Offering, the
Company acquired Finger Lakes Bancorp, Inc. ("FLBC") the holding company of
Savings Bank of the Finger Lakes ("SBFL"), headquartered in Geneva, New York.
FLBC operated seven branch locations and had assets of $376.2 million and
deposits of $259.5 million. Subsequent to the acquisition, SBFL was merged into
First Niagara. The FLBC acquisition increased the Company's presence in Cayuga
and Tompkins Counties, bridged the Company's Western and Central New York
markets and provided an initial presence in Ontario and Seneca Counties.
The business of FNFG consists of the management of First Niagara and its
Financial Services Group. First Niagara's business is primarily accepting
deposits from customers through its banking centers and investing those
deposits, together with funds generated from operations and borrowings, in
residential mortgage, commercial real estate loans, commercial business loans
and leases, consumer loans, and investment securities. The Company's Financial
Services Group focuses on the delivery of risk and wealth management products
and services, including the sale of consumer and commercial insurance on an
agency basis, as well as investment and trust services. The Company emphasizes
personal service, attention and customer convenience in serving the financial
needs of the individuals, families and businesses residing in its market areas.
At December 31, 2003, FNFG had consolidated assets of $3.6 billion, deposits of
$2.4 billion and stockholders' equity of $728.2 million.
4
First Niagara
First Niagara was organized in 1870 as a New York State chartered mutual savings
bank and operates as a wholly owned subsidiary of FNFG. First Niagara has become
a full-service, multi-market community-oriented savings bank that provides
financial services to individuals, families and businesses through 47 banking
centers, a loan production office and 70 ATM's located in Western and Central
New York. As of December 31, 2003, First Niagara had $3.6 billion of assets,
deposits of $2.4 billion, $525.8 million of stockholders' equity and employed
approximately one thousand people.
At December 31, 2003, the following entities operated as wholly-owned
subsidiaries of First Niagara:
First Niagara Funding, Inc. First Niagara Funding, Inc. is a real estate
investment trust that holds commercial real estate loans, fixed rate residential
mortgages, home equity loans and commercial business loans.
First Niagara Leasing, Inc. First Niagara Leasing, Inc. provides direct
financing to the commercial small ticket lease market.
First Niagara Portfolio Management, Inc. First Niagara Portfolio Management,
Inc. is a New York State Article 9A company, which is primarily involved in the
investment in U.S. government agency and Treasury obligations.
First Niagara Realty, Inc. First Niagara Realty, Inc. invests in and manages the
Company's foreclosed or purchased real estate.
First Niagara Risk Management, Inc. First Niagara Risk Management, Inc. ("FNRM")
is a full service insurance agency engaged in the sale of insurance products
including business and personal insurance, surety bonds, risk management, life,
disability and long-term care coverage. FNRM serves commercial and personal
clients throughout the Company's market areas. FNRM also offers consulting and
risk management services in the areas of alternative risk and self-insurance,
claims investigation and adjusting services and third party administration of
self insured workers' compensation plans. On July 1, 2003, FNRM expanded into
the Rochester, New York market by acquiring Costello, Dreher, Kaiser Insurance
Agency ("Costello") and Loomis & Co., Inc. ("Loomis"). Following completion of
this transaction, Costello and Loomis were merged into FNRM.
First Niagara Securities, Inc. First Niagara Securities, Inc. ("FNS") acts as an
agent for third-party companies to sell and service their insurance products
through First Niagara's banking center network.
In addition to the above subsidiaries, First Niagara has organized all of its
financial services activities, namely insurance, fiduciary and investment
products and services, under one Financial Services Group directed by one
dedicated executive. The Financial Services Group includes the operations of the
Company's FNRM and FNS subsidiaries and the First Niagara Trust and Investment
Services Group. Through the First Niagara Trust and Investment Services Group
the Company offers mutual funds, annuities and other investment products, as
well as a full range of trust and investment advisory services, including living
trusts, executor services, testamentary trusts, employee benefit plan
management, custody services and investment management. This group was
established in order to maximize the Company's cross-marketing capabilities and
integration of its financial services businesses.
Acquisition of Troy Financial Corporation
On January 16, 2004, FNFG acquired 100% of the outstanding common shares of Troy
Financial Corporation ("TFC"), the holding company of The Troy Savings Bank
("TSB") and The Troy Commercial Bank ("TCB"), which had combined assets of
approximately $1.2 billion, deposits of $922.1 million and twenty-one branch
locations. Following completion of the acquisition, TSB was merged with First
Niagara and TCB became a wholly-owned subsidiary of First Niagara as a New York
State chartered commercial bank. This acquisition extended the Company's market
area to the Capital region of New York State, which gives the Company access to
the third largest deposit market in Upstate New York. Giving effect to the
merger of TFC into First Niagara, First Niagara now conducts its business
through 68 banking centers and 92 ATM's and has the following subsidiaries:
First Niagara Commercial Bank (formerly TCB) First Niagara Commercial Bank (the
"Commercial Bank") is a New York State chartered commercial bank whose primary
purpose is to generate municipal deposits, which under New York State law cannot
be accepted by First Niagara, which is a federally chartered savings banks.
First Niagara Capital, Inc. First Niagara Capital, Inc. is licensed by the Small
Business Administration ("SBA") as a Small Business Investment Company and
offers small business loans and makes equity investments in small businesses.
5
32 Second Street Corp. 32 Second Street Corp. holds a 90% percent ownership
interest in Altamont Avenue Associates, which owns a neighborhood shopping
center. The tenant mix includes some national companies as well as many smaller
locally owned businesses.
OTHER INFORMATION
The Company maintains a website at www.fnfg.com. The Company makes available,
free of charge, through this website its annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and all amendments to those
reports as soon as reasonably practicable after such material is electronically
filed with or furnished to the Securities and Exchange Commission ("SEC"). These
forms can be accessed within the Investor Relations portion of the Company's
website by clicking on "SEC Filings." Copies may also be obtained, without
charge, by written request to the Investor Relations Department, 6950 South
Transit Road, P.O. Box 514, Lockport, New York 14095-0514.
The Company has adopted a Code of Ethics that is applicable to the senior
financial officers of the Company, including the Company's principal executive
officer, principal financial officer and corporate controller, among others. The
Code of Ethics is available within the Investor Relations portion of the
Company's website along with any amendments to or waivers from that policy.
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), that involve substantial risks and uncertainties.
These forward-looking statements can be identified by the use of such words as
estimate, project, believe, intend, anticipate, plan, seek, expect and similar
expressions. These forward-looking statements include: statements of the
Company's goals, intentions and expectations; statements regarding the Company's
business plans, prospects, growth and operating strategies; statements regarding
the asset quality of the Company's loan and investment portfolios; and estimates
of the Company's risks and future costs and benefits.
These forward-looking statements are subject to significant risks, assumptions
and uncertainties, including, among other things, the following important
factors that could affect the actual outcome of future events: general economic
conditions, either nationally or in the Company's market areas, that are worse
than expected; significantly increased competition among depository and other
financial institutions; inflation and changes in the interest rate environment
that reduce the Company's margins or reduce the fair value of financial
instruments; changes in laws or government regulations affecting financial
institutions, including changes in regulatory fees and capital requirements; the
Company's ability to enter new markets successfully and capitalize on growth
opportunities; the Company's ability to successfully integrate acquired
entities; changes in consumer spending, borrowing and savings habits; changes in
accounting policies and practices, as may be adopted by the bank regulatory
agencies and the Financial Accounting Standards Board ("FASB"); and changes in
the Company's organization, compensation and benefit plans.
Because of these and other uncertainties, the Company's actual future results
may be materially different from the results indicated by these forward-looking
statements.
MARKET AREAS AND COMPETITION
The Company's primary lending and deposit gathering areas have historically been
concentrated in the same counties as its banking centers. The Company faces
significant competition in both making loans and attracting deposits. The
Upstate New York regions have a high density of financial institutions, some of
which are significantly larger and have greater financial resources than the
Company, and all of which are competitors of the Company to varying degrees. The
Company's competition for loans comes principally from commercial banks, savings
banks, savings and loan associations, mortgage banking companies, credit unions,
insurance companies and other financial services companies. Its most direct
competition for deposits has historically come from savings and loan
associations, savings banks, commercial banks and credit unions. The Company
faces additional competition for deposits from non-depository competitors such
as the mutual fund industry, securities and brokerage firms and insurance
companies.
6
The Company offers a variety of financial services to meet the needs of the
communities it serves and functions under a philosophy that includes a
commitment to customer service and the community. Giving effect to the
acquisition of TFC, the Company presently operates 68 banking centers in 20
counties that span from Buffalo to Albany, New York where the aggregate deposit
market provides significant scale to grow. The four largest cities in the
markets the Company does business are Buffalo, Rochester, Albany and Syracuse.
They have a combined total population of nearly 3.9 million and are the top four
Metropolitan Statistical Areas in New York State outside of New York City.
LENDING ACTIVITIES
General. The Company's principal lending activity has been the origination of
residential mortgages, commercial real estate loans, commercial business loans
and equipment leases to customers located within its primary market areas. The
Company generally sells in the secondary market long-term fixed rate residential
mortgage loans. In line with its long-term customer relationship focus, the
Company generally retains the servicing rights on residential mortgage loans
sold, which results in monthly service fee income. The Company also originates
for retention in its portfolio, home equity and consumer loans with the
exception of education loans, which, as they enter their repayment phase, are
sold to Nelnet.
Residential Real Estate Lending. The Company originates mortgage loans to enable
borrowers to finance residential, owner-occupied properties located in its
primary market areas. The Company offers conforming and non-conforming,
fixed-rate and adjustable-rate, monthly and bi-weekly, residential mortgage
loans with maturities up to 30 years and maximum loan amounts generally up to
$500 thousand. The Company's bi-weekly mortgages feature an accelerated
repayment structure and a linked deposit account.
The Company currently offers both fixed and adjustable rate conventional and
government guaranteed Federal Housing Administration and Veterans Administration
mortgage loans with terms of 10 to 30 years that are fully amortizing with
monthly or bi-weekly loan payments. Residential loans are generally underwritten
according to the Federal National Mortgage Association ("FNMA") and Federal Home
Loan Mortgage Corporation ("FHLMC") uniform guidelines. The Company generally
originates both fixed-rate and adjustable-rate loans in amounts up to the
maximum conforming loan limits as established by FNMA and FHLMC secondary market
standards. Private mortgage insurance ("PMI") and mortgage escrow accounts, from
which disbursements are made for real estate taxes and insurance, are required
for loans with loan-to-value ratios in excess of 80%.
The Company generally sells newly originated conventional, conforming 20 to 30
year monthly fixed, and 25 to 30 year bi-weekly loans in the secondary market to
government sponsored enterprises such as FNMA and FHLMC. The Company intends to
continue to sell into the secondary market its newly originated fixed rate loans
to assist in asset and liability management. In addition to removing a level of
interest rate risk from the balance sheet, the operation of a secondary
marketing function allows the Company the flexibility to continue to make loans
available to customers when deposit flows decline or funds are not otherwise
available for lending purposes.
In an effort to provide financing for low and moderate income buyers, the
Company actively participates in residential mortgage programs and products
sponsored by FNMA, FHLMC, and the State of New York Mortgage Agency ("SONYMA").
The SONYMA mortgage programs provide low and moderate income households with
fixed-rate loans which are generally set below prevailing fixed-rate mortgage
loans and which allow below-market down payments. These loans are sold by the
Company to SONYMA, with the Company retaining the contractual servicing rights.
The Company currently offers adjustable-rate monthly and bi-weekly mortgage loan
("ARM") products secured by residential properties. The residential ARMs are
offered with terms up to 30 years, with rates that adjust every one, five or
seven years. After origination, the interest rate on residential ARMs is reset
based upon a contractual spread or margin above a specified index (i.e. U.S.
Treasury Constant Maturity Index). The appropriate index utilized at each
interest rate change date corresponds to the initial one, five, or seven year
adjustment period of the loan.
ARMs are generally subject to limitations on interest rate increases of up to 2%
per adjustment period and an aggregate adjustment of up to 6% over the life of
the loan. The ARMs require that any payment adjustment resulting from a change
in the interest rate be sufficient to result in full amortization of the loan by
the end of the loan term, and thus, do not permit any of the increased payment
to be added to the principal amount of the loan, commonly referred to as
negative amortization.
7
The retention of ARMs in the Company's portfolio helps to reduce its exposure to
interest rate risk. However, ARMs generally pose credit risks different from the
credit risks inherent in fixed-rate loans primarily because, as interest rates
rise, the underlying debt service payments of the borrowers rise, thereby
increasing the potential for default. In order to minimize this risk, borrowers
of residential one year adjustable-rate loans are qualified at the rate which
would be in effect after the first interest rate adjustment, if that rate is
higher than the initial rate. The Company believes that these risks, which have
not had a material adverse effect on the Company to date, generally are less
onerous than the interest rate risks associated with holding fixed-rate loans.
Certain of the Company's conforming ARMs can be converted at a later date to a
fixed-rate mortgage loan with interest rates based upon the then-current market
rates plus a predetermined margin or spread that was established at the loan
closing. The Company sells ARMs, which are converted to 25 to 30 year fixed-rate
term loans, to either FNMA or FHLMC.
Home Equity Lending. The Company offers fixed-rate, fixed-term, monthly and
bi-weekly home equity loans, and prime rate, variable rate home equity lines of
credit ("HELOCs") in its market areas. Both fixed-rate and floating rate home
equity products are offered in amounts up to 100% of the appraised value of the
property (including the first mortgage) with a maximum loan amount generally up
to $250 thousand. PMI is required for all fixed rate home equity loans and
HELOCs with combined first and second mortgage loan-to-value ratios in excess of
80%. Monthly fixed-rate home equity loans are offered with repayment terms up to
15 years and HELOCs are offered with terms up to 30 years. The line may be drawn
upon for 10 years, during which time principal and interest is paid on the
outstanding balance. Repayment of the remaining principal and interest is then
amortized over the remaining 20 years. Bi-weekly fixed-rate home equity loans
are offered with repayment terms up to 20 years, however, because the loan
amortizes bi-weekly and two additional half payments are made each year, actual
loan terms are significantly less. In July 2003, the Company began offering the
UltraFlex home equity line of credit to complement its more traditional line of
credit products. This line of credit gives consumers flexibility with rates and
terms and offers an interest only payment option for the first five years.
Additionally, this product offers a card option to access funds and allows
customers to convert their variable rate line to a fixed rate loan up to three
times over the term of the line. The minimum line of credit is $10 thousand and
the maximum is $150 thousand (up to $100 thousand if the loan to value exceeds
80%.)
Commercial Real Estate and Multi-family Lending. The Company originates real
estate loans secured predominantly by first liens on apartment houses, office
buildings, shopping centers, retail strip centers, industrial and warehouse
properties and to a lesser extent, by more specialized properties such as
nursing homes, churches, mobile home parks, restaurants, motels/hotels and auto
dealerships. The Company's current policy with regard to such loans is to
emphasize geographic distribution within its market areas, diversification of
property types and minimization of credit risk.
As part of the Company's ongoing strategic initiative to minimize interest rate
risk, commercial and multi-family real estate loans originated for the Company's
portfolio are generally limited to one, three or five year ARM products which
are priced at prevailing market interest rates. The initial interest rates are
subsequently reset after completion of the initial one, three or five year
adjustment period at new market rates that generally range between 200 and 300
basis points over the then, current one, three or five year U.S. Treasury
Constant Maturity Index subject to interest rate floors. The maximum term for
commercial real estate loans is generally not more than 10 years, with a payment
schedule based on not more than a 25-year amortization schedule for multi-family
loans, and 20 years for commercial real estate loans.
The Company also offers commercial real estate and multi-family construction
mortgage loans. Most construction loans are made as "construction/permanent"
loans, which provide for disbursement of loan funds during the construction
period and conversion to a permanent loan upon the completion of construction
and the attainment of either tenant lease-up provisions or prescribed debt
service coverage ratios. The construction phase of the loan is made on a
short-term basis, usually not exceeding 2 years, with floating interest rate
levels generally established at a spread in excess of either the LIBOR or prime
rate. The construction loan application process includes the same criteria which
are required for permanent commercial mortgage loans, as well as a submission to
the Company of completed plans, specifications and cost estimates related to the
proposed construction. These items are used as an additional basis to determine
the appraised value of the subject property. Construction loans involve
additional risks attributable to the fact that loan funds are advanced upon the
security of the project under construction, which is of uncertain value prior to
the completion of construction.
8
The Company has increased its emphasis on commercial real estate and
multi-family lending desiring to invest in assets bearing higher interest rates,
which are more sensitive to interest rate changes but are less susceptible to
prepayment risk. Commercial real estate and multi-family loans, however, entail
significant additional risk as compared with residential mortgage lending, as
they typically involve larger loan balances concentrated with a single borrower
or groups of related borrowers. In addition, the payment experience on loans
secured by income producing properties is typically dependent on the successful
operation of the related real estate project and thus, may be subject to a
greater extent to adverse conditions in the real estate market or to the general
economy. To help mitigate this risk, the Company has put in place concentration
limits based upon loan types and property types and maximum amounts that may be
lent to an individual or group of borrowers.
Consumer Loans. The Company originates a variety of fixed-rate installment and
variable rate lines-of-credit consumer loans, including indirect new and used
automobile loans, mobile home loans, education loans and personal secured and
unsecured loans.
Mobile home loans have shorter terms to maturity and higher yields than
traditional single-family residential mortgage loans. The Company generally
offers mobile home loans in New York, New Jersey and Delaware with fixed-rate,
fully amortizing loan terms of 10 to 20 years. The Company has contracted with
an independent third party to generate all mobile home loan applications.
However, prior to funding, all mobile home loan originations must be
underwritten and approved by designated Company underwriters. As part of a
negotiated servicing contract, the third party originator will, at the request
of the Company, contact borrowers who become delinquent in their payments and
when necessary, will oversee the repossession and sale of mobile homes on the
Company's behalf. For such services the Company pays the originator a fee at
loan funding, of which generally 50% is deposited into a noninterest bearing
escrow account, and is under the sole control of the Company to absorb future
losses which may be incurred on the loans.
The Company participates in indirect automobile lending programs with New York
State auto dealerships that are underwritten in accordance with Company policy.
The Company does not engage in sub-prime lending. The Company also purchases "A"
quality lease paper through third-party finance companies. While the Company
retains the credit risk associated with the auto leases, the residual risk,
repossessions and remarketing remains the contractual responsibility of the
financing companies. Indirect auto loans generally have terms up to 72 months,
while auto leases generally have terms up to 60 months.
The Company originates personal secured and unsecured fixed rate installment
loans and variable rate lines of credit. Terms of the loans range from 6 to 60
months and generally do not exceed $50 thousand. Secured loans are
collateralized by vehicles, savings accounts or certificates of deposit.
Unsecured loans are only approved for more creditworthy customers.
The Company continues to be an active originator of education loans.
Substantially all of the loans are originated under the auspices of the New York
State Higher Education Services Corporation ("NYSHESC") or the American Student
Association ("ASA"). Under the terms of these loans, no repayment is due until
the student graduates, with 98% of the principal guaranteed by NYSHESC or ASA.
The Company's general practice is to sell these education loans to Nelnet as the
loans reach repayment status. The Company generally receives a premium of 0.50%
to 1.50% on the sale of these loans.
Consumer loans generally entail greater risk of loss than residential mortgage
loans, particularly in the case of consumer loans that are unsecured or secured
by assets that tend to depreciate, such as automobiles and mobile homes. In such
cases, repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment for the outstanding loan and the remaining
deficiency often does not warrant further substantial collection efforts against
the borrower. In addition, consumer loan collections are dependent on the
borrower's continued financial stability, which can be adversely affected by job
loss, divorce, illness or personal bankruptcy.
Commercial Business Loans. The Company offers commercial business term loans,
letters of credit, equipment leases and lines-of-credit to small and medium size
companies in its market areas, some of which are secured in part by additional
real estate collateral. Additionally, secured and unsecured commercial loans and
lines-of-credit are made for the purpose of financing equipment acquisition,
inventory, business expansion, working capital and other general business
purposes. The terms of these loans generally range from less than one year to
seven years. The loans are either negotiated on a fixed-rate basis or carry
variable interest rates indexed to the prime rate or LIBOR. Lines of credit
expire after one year and generally carry a variable rate of interest indexed to
the prime rate. The Company has a strategic focus on commercial business and
allocates a greater portion of available funds and personnel resources to both
the commercial middle market and small business lending markets. To facilitate
the Company's expansion of these areas, the Company offers additional commercial
business products such as cash management, merchant services, wire transfer
capabilities, business credit and debit cards, and Internet banking.
9
The Company offers installment direct financing "small ticket" equipment leases,
generally in amounts between $15 thousand to $125 thousand. Terms of these
leases are up to 60 months and are guaranteed by the principals of the lessee,
collateralized by the leased equipment and generally bear interest rates in
excess of 8%. Given the Company's strategy to shift its loan portfolio mix to
higher yielding commercial loans, this product line continues to be an area of
focus.
The Company also dedicates resources to commercial business and real-estate
loans, which are 50% to 85% government guaranteed through the SBA. Terms of
these loans range from one year to twenty-five years and generally carry a
variable rate of interest indexed to the prime rate. This product allows the
Company to better meet the needs of its small business customers in the market
areas it serves, while protecting the Company from undue credit risk.
Commercial business lending is generally considered to involve a higher degree
of credit risk than secured real estate lending. The repayment of unsecured
commercial business loans are wholly dependent upon the success of the
borrower's business, while secured commercial business loans may be secured by
collateral that is not readily marketable.
Classification of Assets. Loans are reviewed on a regular basis and are placed
on nonaccrual status when, in the opinion of management, the collection of
interest is doubtful. Loans are generally placed on nonaccrual status when
payments are 90 days or more past due. At such time, interest accrued and unpaid
is reversed from interest income.
Real estate acquired as a result of foreclosure or by deed in lieu of
foreclosure is classified as Real Estate Owned ("REO") until such time as it is
sold. When real estate is acquired through foreclosure or by deed in lieu of
foreclosure, it is recorded at its fair value, less estimated costs of disposal.
If the value of the property is less than the carrying value of the loan, the
difference is charged against the allowance for credit losses. Any subsequent
write-down of REO is charged against earnings.
Consistent with regulatory guidelines, the Company provides for the
classification of loans considered to be of lesser quality as "substandard,"
"doubtful," or "loss" assets. A loan is considered substandard if it is
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. Substandard loans include those
characterized by the distinct possibility that the Company will sustain some
loss if the deficiencies are not corrected. Loans classified as doubtful have
all of the weaknesses inherent in those classified substandard with the added
characteristic that the weaknesses present make collection or liquidation in
full, on the basis of currently existing facts, conditions, and values, highly
questionable and improbable. Loans classified as loss are those considered
uncollectible and of such little value that their continuance as assets without
the establishment of a specific loss reserve is not warranted. Loans that do not
expose the Company to risk sufficient to warrant classification in one of the
aforementioned categories, but which possess some weaknesses, are designated
"watch" or "special mention."
When the Company classifies problem loans as either substandard or doubtful, it
establishes a specific valuation allowance in an amount deemed prudent by
management. General allowances represent loss allowances that have been
established to recognize the risk associated with outstanding loans, but which,
unlike specific allowances, have not been allocated to particular problem loans.
When the Company classifies problem loans as a loss, it either establishes a
specific allowance for losses equal to 100% of the amount of the loans
classified, or charges-off such amount. The Company's determination as to the
classification of its loans and the amount of its allowance is subject to review
by its regulatory agencies, which can order the establishment of additional
general or specific loss allowances. The Company regularly reviews its loan
portfolio to determine whether any loans require classification in accordance
with Company policy or applicable regulations.
Allowance for Credit Losses. The allowance for credit losses is established
through a provision for credit losses based on management's evaluation of losses
in the loan portfolio. Such evaluation, which includes a review of all loans on
which full collectibility may not be reasonably assured, considers among other
matters, the estimated net realizable value or the fair value of the underlying
collateral, economic conditions, historical loan loss experience and other
factors that warrant recognition in determining the credit loss allowance. The
Company continues to monitor and modify the level of the allowance for credit
losses in order to include all losses at each reporting date that are both
probable and reasonable to estimate. In addition, various regulatory agencies,
as an integral part of their examination process, periodically review the
Company's allowance for credit losses and valuation of REO.
Management's evaluation of the allowance for credit losses is based on a
continuing review of the loan portfolio. The methodology for determining the
amount of the allowance for credit losses consists of several elements. Both
commercial business lines of credit, as well as all individual borrower
commercial loan credit concentrations in excess of $5.0 million have annual
credit reviews. Individual borrower commercial loan credit concentrations
between $1.0 million and $5.0 million have credit reviews every 18 months.
Non-accruing, impaired and delinquent commercial loans are reviewed individually
10
every month and the value of any underlying collateral is considered in
determining estimates of losses on those loans and the need, if any, for a
specific reserve. Another element involves estimating losses in categories of
smaller balance homogeneous loans (residential, home equity, consumer) based
primarily on historical loss experience, industry trends and trends in the real
estate market and the current economic environment in the Company's market
areas. The unallocated portion of the allowance for credit losses is based on
management's evaluation of various conditions, and involves a higher degree of
uncertainty because this component of the allowance for credit losses is not
identified with specific problem credits or portfolio segments. The conditions
evaluated in connection with this element include the following: industry and
regional conditions (primarily Upstate New York where the Company is subject to
a high degree of concentration risk); seasoning of the loan portfolio and
changes in the composition of and growth in the loan portfolio; the strength and
duration of the current business cycle; existing general economic and business
conditions in the lending areas; credit quality trends, including trends in
nonaccruing loans; historical loan charge-off experience; and the results of
regulatory examinations.
INVESTMENT ACTIVITIES
General. The Company's investment policy provides that investment decisions will
be made based on the safety of the investment, liquidity requirements, potential
returns, cash flow targets, and desired risk parameters. In pursuing these
objectives, consideration is given to the ability of an investment to provide
earnings consistent with factors of quality, maturity, marketability and risk
diversification.
The Company limits securities investments to U.S. Government and agency
securities, municipal bonds, corporate debt obligations and corporate equity
securities. In addition, the policy permits investments in mortgage-related
securities, including securities issued and guaranteed by FNMA, FHLMC,
Government National Mortgage Association ("GNMA") and privately-issued
collateralized mortgage obligations ("CMO"). Also permitted are investments in
asset-backed securities ("ABS"), backed by auto loans, credit card receivables,
home equity loans, student loans, and home improvement loans. The investment
strategy generally utilizes a risk management approach of diversified investing
to optimize overall investment yields while managing the global interest rate
risk profile of the Company. To accomplish these objectives, the Company's focus
is on investments in mortgage-related securities, including CMO's, while U.S.
Government and Agency and other non-amortizing securities are utilized for call
protection and liquidity purposes. The Company attempts to maintain a high
degree of liquidity in its investment securities and generally does not invest
in debt securities with expected average lives in excess of 10 years.
SOURCES OF FUNDS
General. Deposits and borrowed funds, primarily Federal Home Loan Bank ("FHLB")
advances and repurchase agreements, are the primary sources of the Company's
funds for use in lending, investing and for other general purposes. In addition,
repayments on loans, proceeds from sales of loans and securities, and cash flows
from operations have historically been additional sources of funds. The Company
has available lines of credit with the FHLB, Federal Reserve Bank ("FRB") and a
commercial bank, which can provide liquidity if the above funding sources are
not sufficient to meet the Company's short-term liquidity needs.
Deposits. The Company offers a variety of deposit account products with a range
of interest rates and terms. The deposit accounts consist of savings accounts,
negotiable order of withdrawal ("NOW") accounts, checking accounts, money market
accounts, and certificates of deposit. The Company offers certificates of
deposit with balances in excess of $100 thousand at preferential rates (jumbo
certificates) and also offers Individual Retirement Accounts ("IRAs") and other
qualified plan accounts. To enhance its deposit product offerings, the Company
also provides commercial business and totally free checking products. With the
acquisition of TFC, the Company now has the ability to accept municipal deposits
through the Commercial Bank.
Borrowed Funds. Borrowings are utilized to lock-in lower cost funding, improve
the maturity and match between certain assets and liabilities and leverage
capital for the purpose of improving return on equity. Such borrowings primarily
consist of advances and repurchase agreements entered into with the FHLB, with
nationally recognized securities brokerage firms and with commercial customers.
11
FINANCIAL SERVICES GROUP
General. To complement its traditional core banking products, the Company offers
a wide-range of insurance and investment products and services to help customers
achieve their financial goals. These products and services are delivered through
the Company's Financial Services Group, a business unit that is organized along
the lines of Risk Management and Wealth Management services. The goal of this
unified financial services team is to help customers identify and achieve long-
and short-range business and financial goals, regardless of their current or
future financial needs.
Risk Management. The Company's Risk Management services consists of the sale of
personal and commercial insurance on an agency basis to consumers, as well as to
small and medium sized companies located in its market areas. The Company offers
life, auto, home, long-term care, disability, key-person life, property
insurance, and general liability business insurance, which includes product
professional and umbrella policies. In addition to its insurance products sold,
the Company provides claims investigation and adjusting services, third party
administration of self insured workers' compensation plans and alternative risk
management and self-insurance consulting services.
The revenue attributable to the Company's Risk Management services consists
primarily of fees paid by clients and commissions, fees and contingent income
paid by insurance companies. These revenues may be affected by premium rate
levels in the insurance markets and available insurance capacity, since
compensation is frequently related to the premiums paid by insureds. Revenue is
also affected by insured values, the development of new products, markets and
services, new and lost business and the underlying economic activity of existing
clients. Contingent income includes payments or allowances by insurance
companies based upon such factors as the overall volume of business placed by
the Company with that insurer and/or the profitability or loss to the insurer on
the risks placed. Revenues vary from quarter to quarter as a result of the
timing of policy renewals, the net effect of new and lost business and
achievement of contingent compensation thresholds, whereas expenses tend to be
more uniform throughout the year. Commission rates vary in amount depending upon
the type of insurance coverage provided, the particular insurer, the capacity in
which the agent acts and negotiations with clients.
Wealth Management. The Company's Wealth Management business consists of the sale
of stocks, bonds, mutual funds, annuities and other investment products
including various IRAs, education savings plans and retirement plans to both
retail and commercial clients. Additionally, the Company offers investment
advisory, trust, pension and custody services.
Revenue from the sale of mutual funds and annuities consists primarily of
commissions paid by clients, investment managers and third-party product
providers. Revenue is affected by the development of new products, markets and
services, new and lost business, the relative attractiveness of investment
products offered under prevailing market conditions, changes in the investment
patterns of clients, the flow of monies to and from accounts and the valuation
of accounts. Products and services of the Wealth Management Group are sold
through First Niagara's retail banking center network and the First Niagara
Trust and Investment Services Group by financial consultants and appropriately
licensed employees.
Investment management services are performed pursuant to advisory contracts,
which provide for fees payable to the Company. The amount of the fees varies
depending on the individual account and is usually based upon a sliding scale in
relation to the level of assets under management. Investment management revenues
depend largely on the total value and composition of assets under management.
Assets under management and revenue levels are particularly affected by
fluctuations in stock and bond market prices, the composition of assets under
management and by the level of investments and withdrawals for current and new
clients. A decline in general market levels will reduce future revenue. Items
affecting revenue also include, but are not limited to, actual and relative
investment performance, service to clients, the relative attractiveness of the
investment style under prevailing market conditions, changes in the investment
patterns of clients and the ability to maintain investment management fees at
appropriate levels. The Company also provides personal trust, employee benefit
trust, and custodial services to clients in its market areas. Similar to
investment management services, trust revenue is derived primarily from
investment management fees, which depend largely on the total value and
composition of assets under management. Assets managed by the Company aggregated
approximately $140.7 million and $132.9 million as of December 31, 2003 and
2002, respectively.
12
SEGMENT INFORMATION
Information about the Company's business segments is included in note 19 of
"Notes to Consolidated Financial Statements" filed herewith in Part II, Item 8,
"Financial Statements and Supplementary Data." The Company has determined it has
two business segments, its banking activities and its financial services
activities. Financial services activities consist of the results of the
Company's FNRM and FNS subsidiaries and the First Niagara Trust and Investment
Services Group, which are organized under one Financial Services Group. Banking
activities consists of the results of First Niagara excluding its financial
services activities.
SUPERVISION AND REGULATION
General. FNFG is a savings and loan holding company examined and supervised by
the OTS, while First Niagara is examined and supervised by the OTS and the
Federal Deposit Insurance Corporation ("FDIC"). This regulation and supervision
establishes a comprehensive framework of activities in which an institution may
engage and is intended primarily for the protection of the FDIC's deposit
insurance funds and depositors. Under this system of federal regulation,
financial institutions are periodically examined to ensure that they satisfy
applicable standards with respect to their capital adequacy, assets, management,
earnings, liquidity and sensitivity to market interest rates. Following
completion of its examination, the federal agency critiques the institution's
operations and assigns its rating (known as an institution's CAMELS rating).
Under federal law, an institution may not disclose its CAMELS rating to the
public. First Niagara also is a member of and owns stock in the FHLB of New
York, which is one of the twelve regional banks in the FHLB System. First
Niagara also is regulated to a lesser extent by the Board of Governors of the
Federal Reserve System, governing reserves to be maintained against deposits and
other matters. The OTS examines First Niagara and prepares reports for the
consideration of its Board of Directors on any operating deficiencies. First
Niagara's relationship with its depositors and borrowers also is regulated to a
great extent by both federal and state laws, especially in matters concerning
the ownership of deposit accounts and the form and content of First Niagara's
loan documents. Any change in these laws or regulations, whether by the FDIC,
OTS or Congress, could have a material adverse impact on the Company and its
operations.
Federal Banking Regulation
Business Activities. A federal savings bank derives its lending and investment
powers from the Home Owners' Loan Act, as amended, and the regulations of the
OTS. Under these laws and regulations, First Niagara may invest in mortgage
loans secured by residential and commercial real estate, commercial business and
consumer loans, certain types of debt securities and certain other assets. First
Niagara also may establish subsidiaries that may engage in activities not
otherwise permissible, including real estate investment and securities and
insurance brokerage.
Capital Requirements. OTS regulations require savings banks to meet three
minimum capital standards: A 1.5% tangible capital ratio, a 4% leverage ratio
(3% for banks receiving the highest rating on the CAMELS rating system) and an
8% risk-based capital ratio. The prompt corrective action standards discussed
below, in effect, establish a minimum 2% tangible capital standard.
The risk-based capital standard for savings banks requires the maintenance of
Tier 1 (core) and total capital (which is defined as core capital and
supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 200%, assigned by the OTS capital regulation based on the risks
believed inherent in the type of asset. Core capital is defined as common
stockholders' equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus and minority interests in equity
accounts of consolidated subsidiaries, less intangibles other than certain
mortgage servicing rights and credit card relationships. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock, the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net
unrealized gains on available-for-sale equity securities with readily
determinable fair market values. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
At December 31, 2003, First Niagara exceeded all minimum regulatory capital
requirements. The current requirements and the actual levels for First Niagara
are detailed in note 12 of "Notes to Consolidated Financial Statements" filed
herewith in Part II, Item 8, "Financial Statements and Supplementary Data."
Liquidity. A federal savings bank is required to maintain a sufficient amount of
liquid assets to ensure its safe and sound operation.
13
Loans-to-One-Borrower. A federal savings bank generally may not make a loan or
extend credit to a single or related group of borrowers in excess of 15% of
unimpaired capital and surplus on an unsecured basis. An additional amount may
be loaned, equal to 10% of unimpaired capital and surplus, if the loan is
secured by readily marketable collateral, but generally does not include real
estate. First Niagara is in compliance with the loans-to-one-borrower
limitations. As a result of the shares issued in connection with the recently
completed acquisition of TFC, the Company's regulatory loans-to-one-borrower
limit has increased from $65.3 million (15% of unimpaired capital and surplus)
as of December 31, 2003 to $84.6 million as of January 31, 2004. However, given
the Company's conservative underwriting standards and risk management
philosophy, management and the Board of Directors has established an internal
loans-to-one-borrower limit of approximately $56.4 million (10% of unimpaired
capital and surplus) as of January 31, 2004.
Qualified Thrift Lender Test. As a federal savings bank, First Niagara is
subject to a qualified thrift lender ("QTL") test. Under the QTL test, First
Niagara must maintain at least 65% of its "portfolio assets" in "qualified
thrift investments" in at least nine months of the most recent 12-month period.
"Portfolio assets" generally means total assets of a savings institution, less
the sum of specified liquid assets up to 20% of total assets, goodwill and other
intangible assets, and the value of property used in the conduct of the savings
bank's business.
"Qualified thrift investments" includes various types of loans made for
residential and housing purposes, investments related to such purposes,
including certain mortgage-backed and related securities, and loans for
personal, family, household and certain other purposes up to a limit of 20% of
portfolio assets. "Qualified thrift investments" also include 100% of an
institution's credit card loans, education loans and small business loans. First
Niagara also may satisfy the QTL test by qualifying as a "domestic building and
loan association" as defined by the Internal Revenue Code of 1986, as amended.
Giving effect to the acquisition of TFC, as of January 31, 2004, First Niagara
had 76% of its portfolio assets in qualified thrift investments.
Capital Distributions. OTS regulations govern capital distributions by a federal
savings bank, which include cash dividends, stock repurchases and other
transactions charged to the capital account. A savings bank must file an
application for approval of a capital distribution if the total capital
distributions for the applicable calendar year exceed the sum of the savings
bank's net income for that year to date plus the savings bank's retained net
income for the preceding two years; the bank would not be at least adequately
capitalized following the distribution; the distribution would violate any
applicable statute, regulation, agreement or OTS-imposed condition; or the
savings bank is not eligible for expedited treatment of its filings.
Even if an application is not otherwise required, every savings bank that is a
subsidiary of a holding company must file a notice with the OTS at least 30 days
before the Board of Directors declares a dividend or approves a capital
distribution. The OTS may disapprove a notice or application if: The savings
bank would be undercapitalized following the distribution; the proposed capital
distribution raises safety and soundness concerns; or the capital distribution
would violate a prohibition contained in any statute, regulation or agreement.
In addition, the Federal Deposit Insurance Act provides that an insured
depository institution shall not make any capital distribution, if after making
such distribution, the institution would be undercapitalized.
Community Reinvestment Act and Fair Lending Laws. All savings banks have a
responsibility under the Community Reinvestment Act ("CRA") and related
regulations of the OTS to help meet the credit needs of their communities,
including low- and moderate-income neighborhoods. In connection with its
examination of a federal savings bank, the OTS is required to assess the savings
bank's record of compliance with the CRA. In addition, the Equal Credit
Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in
their lending practices on the basis of characteristics specified in those
statutes. A bank's failure to comply with the provisions of the CRA could, at a
minimum, result in regulatory restrictions on its activities. The failure to
comply with the Equal Credit Opportunity Act and the Fair Housing Act could
result in enforcement actions by the OTS, as well as other federal regulatory
agencies and the Department of Justice. First Niagara received a "Satisfactory"
CRA rating on its most recent federal examination.
Transactions with Related Parties. A federal savings bank's authority to engage
in transactions with its "affiliates" is limited by OTS regulations and by
Sections 23A and 23B of the Federal Reserve Act (the "FRA"). The term
"affiliates" for these purposes generally means any company that controls or is
under common control with an institution. FNFG is an affiliate of First Niagara.
In general, transactions with affiliates must be on terms that are as favorable
to the savings bank as comparable transactions with non-affiliates. In addition,
certain types of these transactions are restricted to an aggregate percentage of
the savings bank's capital. Collateral in specified amounts must usually be
provided by affiliates in order to receive loans from the savings bank. In
addition, OTS regulations prohibit a savings bank from lending to any of its
affiliates that are engaged in activities that are not permissible for bank
holding companies and from purchasing the securities of any affiliate, other
than a subsidiary.
14
Effective April 1, 2003, the Federal Reserve issued Regulation W, which
comprehensively implements Sections 23A and 23B. The regulation unifies and
updates staff interpretations issued over the years, incorporates several new
interpretative proposals (such as to clarify when transactions with an unrelated
third party will be attributed to an affiliate) and addresses new issues arising
as a result of the expanded scope of non-banking activities engaged in by banks
and bank holding companies in recent years and authorized for financial holding
companies under the Gramm-Leach-Bliley ("GLB") Act.
First Niagara's authority to extend credit to its directors, executive officers
and 10% stockholders, as well as to entities controlled by such persons, is
currently governed by the requirements of Sections 22(g) and 22(h) of the FRA
and Regulation O of the FRB. Among other things, these provisions require that
extensions of credit to insiders (i) be made on terms that are substantially the
same as, and follow credit underwriting procedures that are not less stringent
than, those prevailing for comparable transactions with unaffiliated persons and
that do not involve more than the normal risk of repayment or present other
unfavorable features, and (ii) do not exceed certain limitations on the amount
of credit extended to such persons, individually and in the aggregate, which
limits are based, in part, on the amount of First Niagara's capital. In
addition, extensions of credit in excess of certain limits must be approved by
First Niagara's Board of Directors.
Enforcement. The OTS has primary enforcement responsibility over federal savings
institutions and has the authority to bring enforcement action against all
"institution-affiliated parties," including stockholders, and attorneys,
appraisers and accountants who knowingly or recklessly participate in wrongful
action likely to have an adverse effect on an insured institution. Formal
enforcement action may range from the issuance of a capital directive or a cease
and desist order for the removal of officers and/or directors of the
institution, receivership, conservatorship or the termination of deposit
insurance. Civil penalties cover a wide range of violations and actions, and
range up to $25 thousand per day, unless a finding of reckless disregard is
made, in which case penalties may be as high as $1.1 million per day. The FDIC
also has the authority to recommend to the Director of the OTS that enforcement
action be taken with respect to a particular savings institution. If action is
not taken by the OTS Director, the FDIC has authority to take action under
specified circumstances.
Standards for Safety and Soundness. Federal law requires each federal banking
agency to prescribe certain standards for all insured depository institutions.
These standards relate to, among other things, internal controls, information
and audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, compensation, and other operational and managerial
standards as the agency deems appropriate. The federal banking agencies adopted
Interagency Guidelines Prescribing Standards for Safety and Soundness to
implement the safety and soundness standards required under federal law. The
guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. If the appropriate federal banking agency
determines that an institution fails to meet any standard prescribed by the
guidelines, the agency may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard. If an institution fails
to meet these standards, the appropriate federal banking agency may require the
institution to submit a compliance plan.
Prompt Corrective Action Regulations. Under the prompt corrective action
regulations, the OTS is required and authorized to take supervisory actions
against undercapitalized savings banks. For this purpose, a savings bank is
placed in one of the following five categories based on the bank's capital:
well-capitalized (at least 5% leverage capital, 6% tier 1 risk-based capital and
10% total risk-based capital); adequately capitalized (at least 3% leverage
capital, 4% tier 1 risk-based capital and 8% total risk-based capital);
undercapitalized (less than 8% total risk-based capital, 4% tier 1 risk-based
capital or 3% leverage capital); significantly undercapitalized (less than 6%
total risk-based capital, 3% tier 1 risk-based capital or 3% leverage capital);
and critically undercapitalized (less than 2% tangible capital).
Generally, the banking regulator is required to appoint a receiver or
conservator for a bank that is "critically undercapitalized." The regulation
also provides that a capital restoration plan must be filed with the OTS within
45 days of the date a bank receives notice that it is "undercapitalized,"
"significantly undercapitalized," or "critically undercapitalized." A capital
restoration plan must disclose, among other things, the steps an insured
institution will take to become adequately capitalized without appreciably
increasing the risk to which the institution is exposed. In addition, each
company that controls the institution must guarantee that the institution will
comply with the plan until the institution has been adequately capitalized on
average during each of four consecutive calendar quarters. Such guarantee could
have a material adverse affect on the financial condition of such guarantor. In
addition, numerous mandatory supervisory actions become immediately applicable
to the bank, including, but not limited to, restrictions on growth, investment
activities, capital distributions and affiliate transactions. The OTS may also
take any one of a number of discretionary supervisory actions against
undercapitalized banks, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
15
At December 31, 2003, First Niagara met the criteria for being considered
"well-capitalized." The current requirements and the actual levels for First
Niagara are detailed in note 12 of "Notes to Consolidated Financial Statements"
filed herewith in Part II, Item 8, "Financial Statements and Supplementary
Data."
Insurance of Deposit Accounts. Deposit accounts in First Niagara are insured by
the FDIC, primarily through the Bank Insurance Fund, generally up to a maximum
of $100 thousand per separately insured depositor. Deposits therefore are
subject to FDIC deposit insurance assessments. The FDIC has adopted a risk-based
system for determining deposit insurance assessments. The FDIC is authorized to
raise the assessment rates as necessary to maintain the required ratio of
reserves to insured deposits at 1.25%. In addition, all FDIC-insured
institutions must pay assessments to the FDIC based upon the amount of insured
deposits to fund interest payments on bonds maturing in 2017 issued by a federal
agency to recapitalize the predecessor to the Savings Association Insurance
Fund.
Prohibitions Against Tying Arrangements. Federal savings banks are prohibited,
subject to some exceptions, from extending credit to or offering any other
service, or fixing or varying the consideration for such extension of credit or
service, on the condition that the customer obtain some additional service from
the institution or its affiliates or not obtain services of a competitor of the
institution.
Federal Home Loan Bank System. First Niagara is a member of the FHLB System,
which consists of 12 regional Federal Home Loan Banks. The FHLB System provides
a central credit facility primarily for member institutions. As a member of the
FHLB of New York, First Niagara is required to acquire and hold shares of
capital stock in the FHLB in an amount at least equal to 1% of the aggregate
principal amount of its unpaid residential mortgage loans and similar
obligations at the beginning of each year, or 1/20 of its borrowings from the
FHLB, whichever is greater. First Niagara is in compliance with this
requirement.
Federal Reserve System. The Federal Reserve Board regulations require savings
banks to maintain non-interest-earning reserves against their transaction
accounts, such as NOW and regular checking accounts. First Niagara is in
compliance with these reserve requirements. The balances maintained to meet the
reserve requirements imposed by the Federal Reserve Board may be used to satisfy
liquidity requirements imposed by the OTS.
Holding Company Regulation
FNFG is a savings and loan holding company, subject to regulation and
supervision by the OTS, which has enforcement authority over FNFG. Among other
things, this authority permits the OTS to restrict or prohibit activities that
are determined to be a risk to First Niagara.
Under prior law, a unitary savings and loan holding company generally had no
regulatory restrictions on the types of business activities in which it may
engage, provided that its subsidiary savings bank was a qualified thrift lender.
The GLB Act of 1999, however, restricts unitary savings and loan holding
companies not existing or applied for before May 4, 1999 to those activities
permissible for financial holding companies or for multiple savings and loan
holding companies. FNFG is not a grandfathered unitary savings and loan holding
company and, therefore, is limited to the activities permissible for financial
holding companies or for multiple savings and loan holding companies. A
financial holding company may engage in activities that are financial in nature,
including underwriting equity securities and insurance, incidental to financial
activities or complementary to a financial activity. A multiple savings and loan
holding company is generally limited to activities permissible for bank holding
companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the
prior approval of the OTS, and certain additional activities authorized by OTS
regulations.
Federal law prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring control of
another savings institution or holding company thereof, without prior written
approval of the OTS. It also prohibits the acquisition or retention of, with
specified exceptions, more than 5% of the equity securities of a company engaged
in activities that are not closely related to banking or financial in nature or
acquiring or retaining control of an institution that is not federally insured.
In evaluating applications by holding companies to acquire savings institutions,
the OTS must consider the financial and managerial resources, future prospects
of the savings institution involved, the effect of the acquisition on the risk
to the insurance fund, the convenience and needs of the community and
competitive factors.
16
Commercial Bank Regulation
The Commercial Bank is subject to extensive regulation by the New York State
Banking Department ("NYSBD") as its chartering agency and by the FDIC as its
deposit insurer. The Commercial Bank must file reports with the NYSBD and the
FDIC concerning its activities and financial condition, and it must obtain
regulatory approval prior to entering into certain transactions, such as mergers
with, or acquisitions of, other depository institutions and opening or acquiring
branch offices. The NYSBD and the FDIC conduct periodic examinations to assess
the Commercial Bank's compliance with various regulatory requirements. This
regulation and supervision is intended primarily for the protection of the
deposit insurance funds and depositors. The regulatory authorities have
extensive discretion in connection with the exercise of their supervisory and
enforcement activities, including the setting of policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. This enforcement authority also includes, among other
things, the ability to assess civil money penalties, to issue cease and desist
orders and to remove directors and officers. In general, these enforcement
actions may be initiated in response to violations of laws and regulations and
to unsafe or unsound practices.
The Commercial Bank derives its powers primarily from the applicable provisions
of the New York Banking Law and the regulations adopted thereunder. State banks
are limited in their investments and the activities they may engage in as
principal to those permissible under applicable state law and those permissible
for national banks and their subsidiaries, unless such investments and
activities are specifically permitted by the Federal Deposit Insurance Act or
the FDIC determines that such activity or investment would pose no significant
risk to the deposit insurance funds. The Commercial Bank limits its activities
to accepting municipal deposits and acquiring municipal and other securities.
Under New York Banking Law, the Commercial Bank is not permitted to declare,
credit or pay any dividends if its capital stock is impaired or would be
impaired as a result of the dividend. In addition, the New York Banking Law
provides that the Commercial Bank can not declare nor pay dividends in any
calendar year in excess of its "net profits" for such year combined with its
"retained net profits" of the two preceding years, less any required transfer to
surplus or a fund for the retirement of preferred stock, without prior
regulatory approval.
The Commercial Bank is subject to minimum capital requirements imposed by the
FDIC that are substantially similar to the capital requirements imposed on First
Niagara. The FDIC regulations require that each Bank maintain a minimum ratio of
qualifying total capital to risk-weighted assets of 8.0%, and a minimum ratio of
tier 1 capital to risk-weighted assets of 4.0%. In addition, under the minimum
leverage-based capital requirement adopted by the FDIC, the Commercial Bank must
maintain a ratio of tier 1 capital to average total assets (leverage ratio) of
at least 3% to 5%, depending on the Bank's CAMELS composite examination rating.
Capital requirements higher than the generally applicable minimum requirements
may be established for a particular bank if the FDIC determines that a bank's
capital is, or may become, inadequate in view of the bank's particular
circumstances. Failure to meet capital guidelines could subject a bank to a
variety of enforcement actions, including actions under the FDIC's prompt
corrective action regulations.
Other Legislation
USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 (the
"Patriot Act") was enacted in response to the terrorist attacks, which occurred
on September 11, 2001. The Patriot Act is intended to strengthen U.S. law
enforcement's and the intelligence communities' abilities to work cohesively to
combat terrorism on a variety of fronts. The potential impact of the Patriot Act
on financial institutions of all kinds is significant and wide ranging. The
Patriot Act contains sweeping anti-money laundering and financial transparency
laws and requires various regulations, including standards for verifying
customer identification at account opening, and rules to promote cooperation
among financial institutions, regulators and law enforcement entities in
identifying parties that may be involved in terrorism or money laundering.
Financial Services Modernization Legislation. In November 1999, the GLB Act of
1999 was enacted. The GLB repeals provisions of the Glass-Steagall Act which
restricted the affiliation of Federal Reserve member banks with firms "engaged
principally" in specified securities activities, and which restricted officer,
director, or employee interlocks between a member bank and any company or person
"primarily engaged" in specified securities activities.
17
In addition, the GLB Act contains provisions that expressly preempt any state
law restricting the establishment of financial affiliations, primarily related
to insurance. The general effect of the law is to establish a comprehensive
framework to permit affiliations among commercial banks, insurance companies,
securities firms, and other financial service providers by revising and
expanding the Bank Holding Company Act framework to permit a holding company to
engage in a full range of financial activities through a new entity known as a
"financial holding company." "Financial activities" is broadly defined to
include not only banking, insurance and securities activities, but also merchant
banking and additional activities that the Federal Reserve Board, in
consultation with the Secretary of the Treasury, determines to be financial in
nature, incidental to such financial activities, or complementary activities
that do not pose a substantial risk to the safety and soundness of depository
institutions or the financial system.
The GLB Act provides that no company may acquire control of an insured savings
association unless that company engages, and continues to engage, only in the
financial activities permissible for a financial holding company, unless the
company is grandfathered as a unitary savings and loan holding company on May 4,
1999 or became a unitary savings and loan holding company pursuant to an
application pending on that date.
The GLB Act also permits national banks to engage in expanded activities through
the formation of financial subsidiaries. A national bank may have a subsidiary
engaged in any activity authorized for national banks directly or any financial
activity, except for insurance underwriting, insurance investments, real estate
investment or development, or merchant banking, which may only be conducted
through a subsidiary of a financial holding company. Financial activities
include all activities permitted under new sections of the Bank Holding Company
Act or permitted by regulation.
On December 4, 2003, the Fair and Accurate Credit Transactions ("FACT") Act of
2003 was signed into law. The FACT Act includes many provisions concerning
national credit reporting standards, and permits consumers, including the
customers of the Company, to opt out of information sharing among affiliated
companies for marketing purposes. The FACT Act also requires financial
institutions, including banks, to notify their customers if they report negative
information about them to credit bureaus or if the credit that is granted to
them is on less favorable terms than are generally available. Banks also must
comply with guidelines to be established by their federal banking regulators to
help detect identity theft.
Sarbanes-Oxley Act. On July 30, 2002, the Sarbanes-Oxley Act of 2002 ("SOA") was
signed into law. The stated goals of the SOA are to increase corporate
responsibility, to provide for enhanced penalties for accounting and auditing
improprieties at publicly traded companies and to protect investors by improving
the accuracy and reliability of corporate disclosures pursuant to the securities
laws. The SOA includes very specific additional disclosure requirements and new
corporate governance rules, requires the SEC and securities exchanges to adopt
extensive additional disclosure, corporate governance and other related rules
and mandates further studies of certain issues by the SEC and the Comptroller
General. The SOA represents significant federal involvement in matters
traditionally left to state regulatory systems, such as the regulation of the
accounting profession, and to state corporate law, such as the relationship
between a board of directors and management and between a board of directors and
its committees.
The SOA addresses, among other matters, audit committees; certification of
financial statements by the chief executive officer and chief financial officer;
the forfeiture of bonuses or other incentive-based compensation and profits from
the sale of an issuer's securities by directors and senior officers in the
twelve month period following initial publication of any financial statements
that later require restatement; a prohibition on insider trading during pension
plan black out periods; disclosure of off-balance sheet transactions; a
prohibition on certain loans to directors and officers; expedited filing
requirements for Forms 4; disclosure of a code of ethics and filing a Form 8-K
for a change or waiver of such code; "real time" filing of periodic reports; the
formation of a public accounting oversight board; auditor independence; and
various increased criminal penalties for violations of securities laws. The SEC
has enacted rules to implement various provisions of SOA. The federal banking
regulators have adopted generally similar requirements concerning the
certification of financial statements.
TAXATION
Federal Taxation
General. FNFG and First Niagara are subject to federal income taxation in the
same general manner as other corporations, with some exceptions discussed below.
The following discussion of federal taxation is intended only to summarize
certain pertinent federal income tax matters and is not a comprehensive
description of the tax rules applicable to FNFG and First Niagara.
Method of Accounting. For federal income tax purposes, First Niagara currently
reports its income and expenses on the accrual method of accounting and uses a
tax year ending December 31 for filing its consolidated federal income tax
returns.
18
Taxable Distributions and Recapture. Prior to the Small Business Protection Act
of 1996, bad debt reserves created prior to January 1, 1988 were subject to
recapture into taxable income should First Niagara fail to meet certain thrift
asset and definitional tests. New federal legislation eliminated these thrift
related recapture rules. However, under current law, pre-1988 reserves remain
subject to recapture should First Niagara make certain nondividend distributions
or cease to maintain a bank charter. At December 31, 2003, First Niagara's
federal pre-1988 reserve, which no federal income tax provision has been made,
was approximately $12.8 million.
Minimum Tax. The Internal Revenue Code of 1986 imposes an alternative minimum
tax ("AMT") at a rate of 20% on a base of regular taxable income plus certain
tax preferences ("alternative minimum taxable income" or "AMTI"). The AMT is
payable to the extent such AMTI is in excess of an exemption amount. Net
operating losses can offset no more than 90% of AMTI. Certain payments of
alternative minimum tax may be used as credits against regular tax liabilities
in future years. First Niagara has been subject to the AMT but has no such
amounts available as credits for carryover.
Net Operating Loss Carryovers. A financial institution may carry back net
operating losses to the preceding two taxable years and forward to the
succeeding 20 taxable years, subject to certain limitations. At December 31,
2003, First Niagara had $3.2 million net operating loss carryforwards for
federal income tax purposes and $2.2 million for New York State income tax
purposes.
Corporate Dividends. FNFG may exclude from its income 100% of dividends received
from First Niagara as a member of the same affiliated group of corporations.
Status of Internal Revenue Service Audits. FNFG's federal income tax returns
have not been audited by the Internal Revenue Service during the last five
years.
State Taxation
State of New York. FNFG reports income on a consolidated calendar year basis to
New York State. New York State franchise tax on corporations is imposed in an
amount equal to the greater of (a) 7.5% of "entire net income" allocable to New
York State, (b) 3% of "alternative entire net income" allocable to New York
State, (c) 0.01% of the average value of assets allocable to New York State, or
(d) nominal minimum tax. Entire net income is based on Federal taxable income,
subject to certain modifications. Alternative entire net income is based on
entire net income with certain modifications.
ITEM 2. PROPERTIES
Both FNFG and First Niagara maintain their executive offices at an
administrative center, located at 6950 South Transit Road, Lockport, New York.
The administrative center, built in 1997, has 76 thousand square feet of space
and is owned by First Niagara. As of December 31, 2003, First Niagara conducted
its business through 47 full-service banking centers, a loan production office
and 70 ATM locations. Of the 47 banking centers, 14 are located in Erie County,
5 each in Cayuga, Niagara and Oneida Counties, 4 in Monroe County, 3 each in
Cortland, Ontario and Tompkins Counties, 2 in Orleans County and 1 each in
Genesee, Onondaga and Seneca Counties. Additionally, 23 of the banking centers
are owned and 24 are leased. The loan production office is leased and located in
Monroe County. Taking into consideration the acquisition of TFC, First Niagara
now conducts its business through 68 banking centers and 92 ATM's. The
additional banking centers are located in Albany (6), Greene (5), Rensselaer
(4), Saratoga (1), Schenectady (1), Schoharie (1), Warren (2) and Washington (1)
Counties, of which 14 are owned and 7 are leased.
In addition to its banking center network, First Niagara leases seven offices
and owns eight buildings that it utilizes for its financial services
subsidiaries, back office operations, training, tenant rental and storage. The
total square footage for these facilities is approximately 189 thousand square
feet, which are located in Cayuga, Cortland, Erie, Niagara, Oneida and Seneca
Counties. At December 31, 2003, the Company's premises and equipment had a net
book value of $43.7 million. See note 6 of the "Notes to Consolidated Financial
Statements" filed herewith in Part II, Item 8, "Financial Statements and
Supplementary Data" for further detail on the Company's premises and equipment.
All of these properties are generally in good condition and are appropriate for
their intended use.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any legal proceedings other than proceedings
occurring in the ordinary course of business.
19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 2003.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of FNFG is traded under the symbol of FNFG on the NASDAQ
National Market. At March 10, 2004, FNFG had 84,046,949 shares of common stock
outstanding and had approximately 15,244 shareholders of record. During 2003,
the high and low sales price of the common stock was $16.55 and $10.11,
respectively. FNFG paid dividends of $0.22 per common share during the year
ended December 31, 2003. Share and per share data have been adjusted in this
annual report on Form 10-K to give recognition to the 2.58681 exchange ratio
applied on January 17, 2003. See additional information regarding the market
price and dividends paid filed herewith in Part II, Item 6, "Selected Financial
Data."
The Company does not have any equity compensation program that was not approved
by stockholders, other than its employee stock ownership plan. Set forth below
is certain information as of December 31, 2003 regarding equity compensation to
directors and employees of the Company that has been approved by stockholders.
Number of securities to be issued Number of securities
Equity compensation plans approved by upon exercise of outstanding Weighted average remaining available for
stockholders options and rights exercise price issuance under the plan
- ---------------------------------------- --------------------------------- ---------------- -----------------------
First Niagara Financial Group, Inc. 1999
Stock Option Plan ........................ 3,024,631 $ 4.45 2,804
First Niagara Financial Group, Inc. 1999
Recognition and Retention Plan ........... 358,095 (1) Not Applicable 317,856
First Niagara Financial Group, Inc. 2002
Long-term Incentive Stock Benefit Plan ... 904,620 $13.10 1,251,234
--------------------------------- -----------------------
Total ........................ 4,287,346 $ 6.44 1,571,894
================================= =======================
(1) Represents shares that have been granted but have not yet vested.
FNFG's ability to pay dividends to its shareholders is substantially dependent
upon the ability of First Niagara to pay dividends to FNFG. The payment of
dividends by First Niagara is subject to continued compliance with minimum
regulatory capital requirements. In addition, regulatory approval would be
required prior to First Niagara declaring any dividends in excess of net income
for that year plus net income retained in the two preceding years. First Niagara
must file a notice with the OTS at least 30 days before the Board of Directors
declares a dividend or approves a capital distribution. The OTS may disapprove a
notice or application if: First Niagara would be undercapitalized following the
distribution; the proposed capital distribution raises safety and soundness
concerns; or the capital distribution would violate a prohibition contained in
any statute, regulation or agreement.
20
ITEM 6. SELECTED FINANCIAL DATA
At or for the year ended December 31,
-------------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
(Dollar and share amounts in thousands, except per share amounts)
Selected financial condition data:
Total assets .......................... $ 3,589,507 $ 2,934,795 $ 2,857,946 $ 2,624,686 $ 1,711,712
Loans, net ............................ 2,269,203 1,974,560 1,853,141 1,823,174 985,628
Securities available for sale:
Mortgage-backed ................... 499,611 340,319 339,881 302,334 384,329
Other ............................. 346,272 292,045 354,016 199,500 179,144
Deposits .............................. 2,355,216 2,205,421 1,990,830 1,906,351 1,113,302
Borrowings ............................ 457,966 397,135 559,040 429,567 335,645
Stockholders' equity .................. $ 728,174 $ 283,696 $ 260,617 $ 244,540 $ 232,616
Common shares outstanding(1) .......... 66,326 64,681 64,158 63,808 66,372
Selected operations data:
Interest income ....................... $ 169,959 $ 167,637 $ 178,368 $ 137,040 $ 107,814
Interest expense ...................... 62,544 76,107 99,352 76,862 57,060
----------- ----------- ----------- ----------- -----------
Net interest income ............... 107,415 91,530 79,016 60,178 50,754
Provision for credit losses ........... 7,929 6,824 4,160 2,258 2,466
----------- ----------- ----------- ----------- -----------
Net interest income after provision
for credit losses ............ 99,486 84,706 74,856 57,920 48,288
Noninterest income .................... 43,379 41,787 34,625 26,835 21,728
Noninterest expense ................... 88,277 77,331 75,889 54,670 41,580
----------- ----------- ----------- ----------- -----------
Income from continuing operations
before income taxes .......... 54,588 49,162 33,592 30,085 28,436
Income taxes from continuing operations 18,646 18,752 12,427 10,668 9,765
----------- ----------- ----------- ----------- -----------
Income from continuing operations . 35,942 30,410 21,165 19,417 18,671
Income (loss) from discontinued
operations, net of tax(2) ......... 164 385 55 102 (231)
----------- ----------- ----------- ----------- -----------
Net income ........................ $ 36,106 $ 30,795 $ 21,220 $ 19,519 $ 18,440
=========== =========== =========== =========== ===========
Adjusted net income(3) ............ $ 36,106 $ 30,795 $ 25,962 $ 21,633 $ 18,992
=========== =========== =========== =========== ===========
Stock and related per share data(1):
Earnings per common share:
Basic ............................. $ 0.55 $ 0.48 $ 0.33 $ 0.30 $ 0.27
Diluted ........................... 0.53 0.47 0.33 0.30 0.27
Adjusted earnings per common share(3):
Basic ............................. 0.55 0.48 0.41 0.34 0.27
Diluted ........................... 0.53 0.47 0.40 0.34 0.27
Cash dividends ....................... 0.22 0.17 0.14 0.11 0.05
Book value ........................... 10.98 4.39 4.06 3.83 3.50
Market Price (NASDAQ: FNFG):
High .............................. 16.55 12.41 6.92 4.28 4.30
Low ............................... 10.11 6.07 4.16 3.19 3.48
Close ............................. $ 14.97 $ 10.10 $ 6.51 $ 4.18 $ 3.96
21
At or for the year ended December 31,
---------------------------------------------------------------
2003 2002 2001 2000 1999
------- ------- ------- ------- -------
(Dollars in thousands)
Selected financial ratios and other data:
Performance ratios(4):
Return on average assets ........................ 1.02% 1.08% 0.79% 0.98% 1.13%
Adjusted return on average assets(3) ............ 1.02 1.08 0.97 1.09 1.17
Return on average equity ........................ 5.19 11.22 8.30 8.38 7.52
Adjusted return on average equity(3) ............ 5.19 11.22 10.16 9.29 7.75
Return on average tangible equity(5) ............ 6.15 15.90 12.34 10.12 7.97
Adjusted return on average tangible
equity(3)(5) ............................... 6.15 15.90 15.09 11.22 8.21
Net interest rate spread ........................ 2.90 3.30 2.99 2.82 2.72
Net interest margin ............................. 3.33 3.52 3.25 3.26 3.33
As a percentage of average assets:
Noninterest income ........................... 1.23 1.46 1.29 1.35 1.34
Noninterest expense(3) ....................... 2.50 2.71 2.66 2.65 2.53
------- ------- ------- ------- -------
Net overhead .............................. 1.27 1.25 1.37 1.30 1.19
Efficiency ratio(3) ............................. 58.54 58.01 62.74 60.57 56.81
Dividend payout ratio ........................... 40.00% 35.42% 41.86% 35.44% 20.30%
Capital Ratios(6):
Total risk-based capital ........................ 19.04% 11.34% 11.36% 11.13% 23.56%
Tier 1 risk-based capital ....................... 17.94 10.27 10.27 9.96 22.40
Tier 1 (core) capital ........................... 11.92 6.54 6.71 6.78 13.51
Tangible capital ................................ 11.87 6.54 N/A N/A N/A
Ratio of stockholders' equity to total assets ... 20.29% 9.67% 9.12% 9.32% 13.59%
Asset quality ratios:
Total non-accruing loans ........................ $12,305 $ 7,478 $11,480 $ 6,483 $ 1,929
Other non-performing assets ..................... 543 1,423 665 757 1,073
Allowance for credit losses ..................... 25,420 20,873 18,727 17,746 9,862
Net loan charge-offs ............................ $ 5,383 $ 4,678 $ 3,179 $ 735 $ 614
Total non-accruing loans to total loans ......... 0.54% 0.37% 0.61% 0.35% 0.19%
Total non-performing assets as a percentage
of total assets ............................ 0.36 0.30 0.42 0.28 0.18
Allowance for credit losses to non-accruing loans 206.58 279.13 163.13 273.73 511.25
Allowance for credit losses to total loans ...... 1.11 1.05 1.00 0.96 0.99
Net charge-offs to average loans ................ 0.24% 0.24% 0.17% 0.06% 0.07%
Other data:
Number of banking centers ....................... 47 38 37 36 18
Full time equivalent employees .................. 944 945 919 930 625
22
2003 2002
--------------------------------------------- -------------------------------------------
Fourth Third Second First Fourth Third Second First
quarter quarter quarter quarter quarter quarter quarter quarter
-------- -------- -------- -------- -------- -------- -------- --------
Selected Quarterly Data: (In thousands except per share amounts)
Interest income ...................... $ 42,450 $ 41,984 $ 42,602 $ 42,923 $ 40,654 $ 41,914 $ 42,536 $ 42,533
Interest expense ..................... 14,197 14,836 15,976 17,535 17,103 18,857 19,828 20,319
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income ............. 28,253 27,148 26,626 25,388 23,551 23,057 22,708 22,214
Provision for credit losses .......... 2,007 1,757 2,208 1,957 1,835 1,729 1,730 1,530
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income after
provision for credit losses . 26,246 25,391 24,418 23,431 21,716 21,328 20,978 20,684
Noninterest income ................... 11,153 11,375 10,804 10,047 11,965 9,973 10,591 9,258
Noninterest expense .................. 22,360 22,022 20,782 21,729 20,438 19,298 18,449 18,469
Amortization of intangibles .......... 378 398 290 318 175 178 162 162
-------- -------- -------- -------- -------- -------- -------- --------
Income from continuing
operations before income taxes 14,661 14,346 14,150 11,431 13,068 11,825 12,958 11,311
Income taxes from continuing
operations ....................... 4,551 5,042 5,073 3,980 4,735 4,018 6,085 3,914
-------- -------- -------- -------- -------- -------- -------- --------
Income from continuing operations .... 10,110 9,304 9,077 7,451 8,333 7,807 6,873 7,397
Income (loss) from discontinued
operations, net of tax(2) ........ (22) -- 23 163 69 129 134 53
-------- -------- -------- -------- -------- -------- -------- --------
Net income .................. $ 10,088 $ 9,304 $ 9,100 $ 7,614 $ 8,402 $ 7,936 $ 7,007 $ 7,450
======== ======== ======== ======== ======== ======== ======== ========
Earnings per share:
Basic ........................... $ 0.15 $ 0.14 $ 0.14 $ 0.12 $ 0.13 $ 0.12 $ 0.11 $ 0.12
Diluted ......................... 0.15 0.14 0.13 0.11 0.13 0.12 0.11 0.11
Market price (NASDAQ:FNFG):
High ............................ 15.64 16.55 14.20 11.92 12.39 12.41 11.59 7.52
Low ............................. 13.85 13.70 11.40 10.11 10.03 10.31 6.57 6.07
Close ........................... 14.97 15.09 13.92 11.75 10.10 12.21 10.73 6.74
Cash Dividends ....................... $ 0.06 $ 0.06 $ 0.05 $ 0.05 $ 0.05 $ 0.04 $ 0.04 $ 0.04
- ----------
(1) All per share data and references to the number of shares outstanding for
purposes of calculating per share amounts are adjusted to give recognition
to the 2.58681 exchange ratio applied in the January 17, 2003 conversion.
(2) Effective February 18, 2003, First Niagara Bank sold NOVA Healthcare
Administrators, Inc. its wholly- owned third-party benefit plan
administrator subsidiary. For the periods presented, the Company has
reported the results of operations from NOVA as "Discontinued Operations."
First quarter 2003 amounts include the net gain realized on the sale of
$208 thousand.
(3) With the adoption of SFAS No. 142 "Goodwill and Other Intangibles" on
January 1, 2002, the Company is no longer required to amortize goodwill.
Goodwill amortization of $4.7 million, $2.1 million and $552 thousand has
been excluded from 2001, 2000 and 1999 adjusted net income, respectively,
for consistency purposes. See note 7 of the "Notes to Consolidated
Financial Statements" filed herewith in Part II, Item 8, "Financial
Statements and Supplementary Data". The 2001, 2000 and 1999 efficiency
ratio and noninterest expense as a percentage of average assets ratio,
excludes $4.6 million, $2.0 million and $404 thousand of goodwill
amortization from continuing operations, respectively. Without excluding
these amounts the 2001, 2000 and 1999 efficiency ratio and noninterest
expense as a percentage of average assets ratio would have been 66.78%,
62.83% and 57.37%, respectively, and 2.83%, 2.74% and 2.56%, respectively.
(4) Computed using daily averages.
(5) Excludes average goodwill and other intangibles of $109.2 million, $80.9
million, $83.6 million, $40.1 million and $13.8 million for 2003, 2002,
2001, 2000 and 1999, respectively.
(6) Effective November 8, 2002, First Niagara converted to a federal charter
subject to OTS capital requirements. These capital requirements apply only
to First Niagara and do not consider additional capital retained by FNFG.
Prior to converting to federal charters, FNFG and First Niagara were
required to maintain minimum capital ratios calculated in a similar manner
to, but not entirely the same as, the framework of the OTS. Amounts prior
to 2002 have not been recomputed to reflect OTS requirements.
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The following is an analysis of the financial condition and results of
operations of the Company. This item should be read in conjunction with the
consolidated financial statements and related notes filed herewith in Part II,
Item 8, "Financial Statements and Supplementary Data" and the description of the
Company's business filed here with in Part I, Item I, "Business."
Overview
The Company provides financial services to individuals and businesses in Upstate
New York. The Company's business is primarily accepting deposits from customers
through its banking centers and investing those deposits, together with funds
generated from operations and borrowings, in residential mortgages, commercial
real estate loans, commercial business loans and leases, consumer loans, and
investment securities. Additionally, the Company offers risk management, as well
as wealth management services.
Total assets increased to $3.59 billion at December 31, 2003 from $2.93 billion
at December 31, 2002. This 22% increase resulted principally from the investment
of the $390.9 million of capital raised from the Offering and the concurrent
$411.0 million of assets acquired from FLBC in January 2003. Given the
historically low interest rate environment, the Company invested a portion of
the proceeds from the Offering in short-term investments. Although this strategy
forgoes some short-term profits, management believes this initiative will better
position the Company for long-term growth and profitability when interest rates
begin to rise. During 2003, the Company furthered its commercial lending and
banking initiatives. Excluding the loans acquired with FLBC, commercial loans
increased 15%. During the year, the Company also continued its de novo branching
strategy, which contributed to an increase in core deposits and expanded the
Company's retail presence in target markets.
Net income for the year ended December 31, 2003 increased 17% to $36.1 million,
or $0.53 per diluted share from $30.8 million, or $0.47 per diluted share for
the year ended December 31, 2002. During 2003, the Company benefited from the
investment of funds raised in the Offering, the acquisition of FLBC in January
and two insurance agencies in July, and increased commercial real estate and
business lending activity. These benefits were partially offset by the impact of
the low interest rate environment on its investment and loan portfolio yields,
which reduced the Company's net interest rate spread. In addition, an increase
in the provision for credit losses, costs incurred in connection with the
pending acquisition of TFC and the unexpected passing of the Company's CEO
impacted earnings.
CRITICAL ACCOUNTING ESTIMATES
Management of the Company evaluates those accounting estimates that are judged
to be critical - those most important to the portrayal of the Company's
financial condition and results, and that require management's most difficult,
subjective and complex judgements. Management considers the accounting estimates
relating to the adequacy of the allowance for credit losses and the analysis of
the carrying value of goodwill for impairment to be critical. The judgments made
regarding the allowance for credit losses and goodwill impairment can have a
material effect on the results of operations of the Company.
A more detailed description of the Company's methodology for calculating the
allowance for credit losses and assumptions made is included within the "Lending
Activities" section filed herewith in Part I, Item 1, "Business."
Goodwill is not subject to amortization but must be tested for impairment at
least annually or more frequently if events or changes in circumstances indicate
that the asset might be impaired. Impairment testing requires that the fair
value of each reporting unit be compared to its carrying amount, including
goodwill. Reporting units were identified based upon an analysis of each of the
Company's individual operating segments. A reporting unit is defined as any
distinct, separately identifiable component of an operating segment for which
complete, discrete financial information is available that management regularly
reviews. Goodwill was allocated to the carrying value of each reporting unit
based on its relative fair value at the time it was acquired. Determining the
fair value of a reporting unit requires a high degree of subjective management
judgment. Discounted cash flow valuation models are utilized that incorporate
such variables as revenue growth rates, expense trends, interest rates and
terminal values. Based upon an evaluation of key data and market factors,
management selects from a range the specific variables to be incorporated into
the valuation model. Future changes in the economic environment or the
operations of the reporting units could cause changes to these variables, which
could give rise to declines in the estimated fair value of the reporting unit.
Declines in fair value could result in impairment being identified.
24
The Company has established November 1st of each year as the date for conducting
its annual goodwill impairment assessment. The variables are selected as of that
date and the valuation models are run to determine the fair value of each
reporting unit. At November 1, 2003, the Company did not identify any individual
reporting unit where fair value was less than carrying value, including
goodwill.
ANALYSIS OF FINANCIAL CONDITION
Lending Activities
Loan Portfolio Composition. Set forth below is selected information concerning
the composition of the Company's loan portfolio in dollar amounts and in
percentages as of the dates indicated:
At December 31,
-------------------------------------------------------------------------------
2003 2002 2001
---------------------- ----------------------- ----------------------
Amount Percent Amount Percent Amount Percent
----------- ------- ----------- ------- ----------- -------
(Dollars in thousands)
Real estate loans:
Residential ................ $ 949,703 41.54% $ 933,020 46.82% $ 988,746 52.87%
Home equity ................ 179,172 7.84 136,986 6.87 114,443 6.12
Commercial and multi-family 653,762 28.60 473,493 23.76 392,896 21.00
Commercial construction .... 86,154 3.76 101,633 5.10 56,394 3.02
----------- ------ ----------- ------ ----------- ------
Total real estate loans 1,868,791 81.74 1,645,132 82.55 1,552,479 83.01
Commercial business loans ...... 215,000 9.41 178,555 8.96 135,621 7.25
Consumer loans ................. 202,371 8.85 169,155 8.49 182,126 9.74
----------- ------ ----------- ------ ----------- ------
Total loans ................ 2,286,162 100.00% 1,992,842 100.00% 1,870,226 100.00%
----------- ====== ----------- ====== ----------- ======
Net deferred costs and
unearned discounts ........... 8,461 2,591 1,642
Allowance for credit losses .... (25,420) (20,873) (18,727)
----------- ----------- -----------
Total loans, net ........... $ 2,269,203 $ 1,974,560 $ 1,853,141
=========== =========== ===========
At December 31,
----------------------------------------------------
2000 1999
----------------------- -----------------------
Amount Percent Amount Percent
----------- ------- ----------- -------
(Dollars in thousands)
Real estate loans:
Residential ................ $ 1,095,471 59.53% $ 616,024 62.19%
Home equity ................ 104,254 5.67 22,499 2.27
Commercial and multi-family 329,427 17.90 195,410 19.73
Commercial construction .... 29,195 1.59 22,131 2.23
----------- ------ ----------- ------
Total real estate loans 1,558,347 84.69 856,064 86.42
Commercial business loans ...... 93,730 5.09 24,301 2.45
Consumer loans ................. 188,129 10.22 110,233 11.13
----------- ------ ----------- ------
Total loans ................ 1,840,206 100.00% 990,598 100.00%
----------- ====== ----------- ======
Net deferred costs and
unearned discounts ........... 714 4,892
Allowance for credit losses .... (17,746) (9,862)
Total loans, net ........... $ 1,823,174 $ 985,628
=========== ===========
Total loans outstanding grew $293.3 million from December 31, 2002 to December
31, 2003. Approximately $203.1 million of this increase is attributable to the
acquisition of FLBC in January 2003, which added $66.4 million of residential
mortgages, $30.1 million of home equity loans, $64.6 million of commercial real
estate loans, $21.4 million of consumer loans and $20.6 million of commercial
business loans. Additionally, the Company continued to shift its portfolio mix
from residential mortgage loans to commercial real estate and business loans.
Excluding the loans acquired with FLBC, commercial real estate loans increased
$100.2 million or 17% from December 31, 2002 to December 31, 2003, while
commercial business loans increased $15.9 million or 9% during the year. Even
though this commercial growth was below the Company's 20% goal for 2003,
management believes it is a noteworthy achievement given the competitive lending
environment and the Company's ongoing commitment to strong credit quality. This
loan portfolio shift was achieved through the Company's continued emphasis on
commercial originations, including the hiring of seasoned commercial loan
officers, and management's strategy of holding fewer long-term fixed-rate
residential real estate loans in portfolio. This initiative is expected to
benefit the Company during periods of higher interest rates and help improve net
interest rate margins. In addition, excluding acquired loans, home equity and
consumer loans increased 9% and 7%, respectively, during 2003. This growth
reflects the Company's expanding retail base, the introduction of the UltraFlex
home equity line of credit in June 2003 and an increased focus on indirect auto
lending.
25
Allowance for Credit Losses. The following table sets forth the allocation of
the allowance for credit losses by loan category as of the dates indicated:
At December 31,
----------------------------------------------------------------------------
2003 2002 2001
---------------------- ---------------------- ----------------------
Percent Percent Percent
of loans of loans of loans
Amount of in each Amount of in each Amount of in each
allowance category allowance category allowance category
for credit to total for credit to total for credit to total
losses loans losses loans losses loans
---------- -------- ---------- -------- ---------- --------
(Dollars in thousands)
Residential ............... $ 1,763 42% $ 1,828 47% $ 1,996 53%
Home equity ............... 509 8 524 7 614 6
Commercial and multi-family 7,137 32 4,917 29 4,824 24
Commercial business ....... 7,665 9 7,329 9 4,883 7
Consumer .................. 3,781 9 3,811 8 3,379 10
Unallocated ............... 4,565 -- 2,464 -- 3,031 --
------- ------- ------- ------- ------- -------
Total ................ $25,420 100% $20,873 100% $18,727 100%
======= ======= ======= ======= ======= =======
At December 31,
-------------------------------------------------
2000 1999
---------------------- ----------------------
Percent Percent
of loans of loans
Amount of in each Amount of in each
allowance category allowance category
for credit to total for credit to total
losses loans losses loans
---------- -------- ---------- --------
(Dollars in thousands)
Residential ............... $ 3,248 60% $ 1,522 62%
Home equity ............... 885 6 352 2
Commercial and multi-family 4,027 19 1,944 22
Commercial business ....... 4,307 5 1,790 2
Consumer .................. 3,014 10 1,739 12
Unallocated ............... 2,265 -- 2,515 --
------- ------- ------- -------
Total ................ $17,746 100% $ 9,862 100%
======= ======= ======= =======
The allowance for credit losses increased to $25.4 million at December 31, 2003
from $20.9 million at December 31, 2002 primarily due to $2.0 million of
allowance acquired with FLBC, commercial loan growth and a higher level of
classified commercial loans at December 31, 2003 compared to December 31, 2002.
The $2.1 million increase in the unallocated portion of the allowance for credit
losses during 2003 reflects the continuing weak economy, the growth in the
Company's commercial real estate and business loans and an increase in
non-performing loans in the commercial portfolio. The allowance for credit
losses represented 1.11% of total loans at December 31, 2003, compared to 1.05%
at December 31, 2002.
While management uses available information to recognize losses on loans, future
credit loss provisions may be necessary based on changes in economic conditions.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the allowance for credit losses and may
require the Company to recognize additional provisions based on their judgment
of information available to them at the time of their examination. To the best
of management's knowledge, the allowance for credit losses includes all losses
at each reporting date that are both probable and reasonable to estimate.
However, there can be no assurance that the allowance for loan losses will be
adequate to cover all losses that may in fact be realized in the future or that
additional provisions for loan losses will not be required.
26
Non-Accruing Loans and Non-Performing Assets. The following table sets forth
information regarding non-accruing loans and other non-performing assets:
At December 31,
---------------------------------------------------------------
2003 2002 2001 2000 1999
------- ------- ------- ------- -------
(Dollars in thousands)
Non-accruing loans(1):
Real estate:
Residential ............... $ 3,905 $ 4,071 $ 4,833 $ 3,543 $ 974
Home equity ............... 401 332 491 641 130
Commercial and multi-family 3,878 1,225 2,402 926 640
Commercial business ........... 3,583 1,198 3,244 858 152
Consumer ...................... 538 652 510 515 33
------- ------- ------- ------- -------
Total non-accruing loans .. 12,305 7,478 11,480 6,483 1,929
------- ------- ------- ------- -------
Non-performing assets:
Real estate owned(2) .......... 543 1,423 665 757 1,073
------- ------- ------- ------- -------
Total non-performing assets $12,848 $ 8,901 $12,145 $ 7,240 $ 3,002
======= ======= ======= ======= =======
Total non-performing assets as a
percentage of total assets .... 0.36% 0.30% 0.42% 0.28% 0.18%
======= ======= ======= ======= =======
Total non-accruing loans as a
percentage of total loans ..... 0.54% 0.37% 0.61% 0.35% 0.19%
======= ======= ======= ======= =======
(1) Loans generally are placed on non-accrual status when they become 90
days or more past due or if they have been identified by the Company
as presenting uncertainty with respect to the collectibility of
interest or principal.
(2) Real estate owned balances are shown net of related valuation
allowances.
Non-performing assets were $12.8 million at December 31, 2003 compared to $8.9
million at December 31, 2002. This increase was primarily attributable to the
higher level of commercial real estate and business loans at the end of 2003
compared to 2002. Even with this increase, the Company's non-performing assets
as a percentage of total assets ratio of 0.36% at December 31, 2003 remains
comparable to the median ratio for similar sized thrifts and below the median
ratio for comparable sized banks. In December 2003, the Company received a $1.0
million pay-off on a previously foreclosed commercial mortgage participation
loan, which was the primary reason for the $880 thousand decrease in real estate
owned from December 31, 2002.
27
Investing Activities
Securities Portfolio. At December 31, 2003, all of the Company's investment
securities were classified as available for sale in order to maintain the
necessary flexibility in satisfying future investment and lending requirements.
The following table sets forth certain information with respect to the amortized
cost and fair values of the Company's portfolio as of the dates indicated:
At December 31,
-----------------------------------------------------------------------------
2003 2002 2001
----------------------- ----------------------- -----------------------
Amortized Fair Amortized Fair Amortized Fair
cost value cost value cost value
---------- -------- ---------- -------- ---------- --------
Investment securities: (Dollars in thousands)
Debt securities:
U.S. Government agencies .............. $ 287,604 $287,058 $ 229,582 $230,583 $ 244,411 $246,136
States and political subdivisions ..... 36,766 38,189 32,957 34,566 26,696 27,208
Corporate ............................. 13,708 13,610 14,665 14,563 27,264 27,026
---------- -------- ---------- -------- ---------- --------
Total debt securities .......... 338,078 338,857 277,204 279,712 298,371 300,370
---------- -------- ---------- -------- ---------- --------
Asset-backed securities ...................... 2,363 2,402 3,776 3,837 28,062 28,850
Other ........................................ 5,009 5,013 8,630 8,496 25,983 24,796
---------- -------- ---------- -------- ---------- --------
Total investment securities ..... $ 345,450 $346,272 $ 289,610 $292,045 $ 352,416 $354,016
========== ======== ========== ======== ========== ========
Average remaining life of investment
securities(1) ........................... 2.53 years 2.31 years 2.09 years
========== ========== ==========
Mortgage-backed securities:
FNMA .................................. $ 207,480 $206,798 $ 12,619 $ 13,790 $ 18,213 $ 19,169
FHLMC ................................. 121,639 121,219 51,024 52,960 37,081 38,339
GNMA .................................. 9,959 10,304 9,910 10,569 16,094 16,799
CMO's ................................. 161,922 161,290 262,161 263,000 265,489 265,574
---------- -------- ---------- -------- ---------- --------
Total mortgage-backed securities .. $ 501,000 $499,611 $ 335,714 $340,319 $ 336,877 $339,881
========== ======== ========== ======== ========== ========
Average remaining life of mortgage-
backed securities(1) .................... 3.65 years 1.64 years 4.82 years
========== ========== ==========
Total securities available for sale $ 846,450 $845,883 $ 625,324 $632,364 $ 689,293 $693,897
========== ======== ========== ======== ========== ========
Average remaining life of investment
securities available for sale(1) ........ 3.20 years 1.94 years 3.48 years
========== ========== ==========
(1) Average remaining life does not include other securities available
for sale and is computed utilizing estimated maturities and
prepayment assumptions.
The Company's available for sale investment securities increased $213.5 million
to $845.9 million at December 31, 2003 from $632.4 million at December 31, 2002.
This reflects the $146.1 million of investment securities acquired with FLBC in
2003 and the investment of a portion of the proceeds raised in the Offering. The
remainder of the proceeds were invested in shorter-term investments with low
risk of prepayment. This was done to position the Company's balance sheet for
the anticipated increase in interest rates while limiting earnings volatility
should interest rates fall, as well as in anticipation of funding needs for
future acquisitions. Management believes this strategy will benefit the Company
in the long-term when interest rates begin to rise. As a result, federal funds
sold and other short-term investments increased to $124.3 million at December
31, 2003 from $45.2 million at December 31, 2002.
28
Funding Activities
Deposits. The following tables set forth information regarding the average daily
balance and rate of deposits for the years indicated:
For the year ended December 31,
--------------------------------------------------------------------------------------------------
2003 2002 2001
-------------------------------- -------------------------------- ------------------------------
Percent of Percent of Percent of
total Weighted total Weighted total Weighted
Average average average Average average average Average average average
balance deposits rate balance deposits rate balance deposits rate
---------- ---------- -------- ---------- ---------- -------- ---------- --------- ------
(Dollars in thousands)
Savings ........................ $ 670,785 28.54% 1.01% $ 590,965 27.93% 2.16% $ 417,256 21.41% 2.62%
Interest-bearing checking ...... 525,346 22.35 0.91 507,305 23.98 1.54 545,118 27.97 2.91
Noninterest-bearing checking ... 138,675 5.90 -- 115,977 5.48 -- 90,023 4.62 --
---------- ------ ---------- ------ ---------- ------
Total transaction accounts . 1,334,806 56.79 0.87 1,214,247 57.39 1.69 1,052,397 54.00 2.55
Mortgagors' payments held in
escrow ....................... 16,871 0.72 -- 17,579 0.83 1.69 19,198 0.98 1.71
---------- ------ ---------- ------ ---------- ------
Total ....................... 1,351,677 57.51 0.86 1,231,826 58.22 1.69 1,071,595 54.98 2.53
---------- ------ ---------- ------ ---------- ------
Certificates of deposit:
Less than 6 months ............. 327,041 13.92 2.76 292,232 13.81 3.77 342,596 17.58 5.55
Over 6 through 12 months ....... 271,409 11.55 2.56 231,044 10.92 3.45 241,709 12.40 5.34
Over 12 through 24 months ...... 132,010 5.62 3.14 150,986 7.14 3.72 100,549 5.16 5.20
Over 24 months ................. 68,618 2.92 4.36 38,128 1.80 4.85 34,295 1.76 5.56
Over $100,000 .................. 199,350 8.48 3.09 171,477 8.11 3.70 158,279 8.12 5.18
---------- ------ ---------- ------ ---------- ------
Total certificates of deposit 998,428 42.49 2.93 883,867 41.78 3.71 877,428 45.02 5.39
---------- ------ ---------- ------ ---------- ------
Total average deposits ...... $2,350,105 100.00% 1.74% $2,115,693 100.00% 2.54% $1,949,023 100.00% 3.82%
========== ====== ========== ====== ========== ======
The increase in deposits in 2003 resulted primarily from the acquisition of
FLBC, which added a total of $259.5 million of deposits, including $46.4 million
of savings accounts, $36.7 million of interest bearing checking accounts, $160.7
million of certificates of deposit, $15.3 million of noninterest bearing
deposits and $388 thousand of escrow deposits. During 2003, the Company
continued to focus on increasing its core deposit base, which included growing
its commercial business operations and the opening of three new banking centers.
Excluding the accounts acquired with FLBC and $102.2 million of deposits held at
December 31, 2002 related to the Conversion and Offering, core deposits
increased $40.9 million, or 3%, during 2003. Mitigating that growth was a $48.5
million decrease in certificates of deposit as the Company opted to fund
higher-rate account run-off with lower cost wholesale borrowings and proceeds
from the Offering.
29
Borrowings. The following table sets forth certain information as to the
Company's borrowings for the years indicated:
At or for the year ended December 31,
--------------------------------------
2003 2002 2001
-------- -------- --------
(Dollars in thousands)
Period end balance:
FHLB advances ............................ $214,501 $236,003 $315,416
Repurchase agreements .................... 243,465 155,132 235,124
Other borrowings ......................... -- 6,000 8,500
-------- -------- --------
Total borrowings ......................... $457,966 $397,135 $559,040
======== ======== ========
Maximum balance:
FHLB advances ............................ $256,820 $315,416 $315,416
Repurchase agreements .................... 243,465 235,124 235,124
Other borrowings ......................... 6,000 8,500 16,000
Average balance:
FHLB advances ............................ $231,729 $249,974 $277,813
Repurchase agreements .................... 199,248 157,890 136,452
Other borrowings ......................... 322 6,201 11,278
Period end weighted average interest rate:
FHLB advances ............................ 5.37% 5.52% 5.01%
Repurchase agreements .................... 4.58 5.09 3.97
Other borrowings ......................... -- 2.19 3.01
Borrowed funds totaled $458.0 million at December 31, 2003 and $397.1 million at
December 31, 2002. This $60.8 million increase resulted from the FLBC
acquisition, which added $75.6 million of borrowings to the Company's statement
of condition. Excluding the debt acquired, borrowed funds decreased $14.8
million as the Company funded long-term borrowing run-off with proceeds from the
Offering.
Equity Activities
Stockholders' equity was $728.2 million at December 31, 2003 compared to $283.7
million at December 31, 2002. This $444.5 million increase was primarily
attributable to the Offering and Conversion completed in January 2003, which
added $389.9 million of new capital, net of $20.5 million of FNFG shares
contributed to the Company's ESOP plan. In addition, $33.6 million of common
stock was issued in connection with the FLBC acquisition. Common stock dividends
paid during the year of $0.22 per share, totaled $14.6 million, and represented
40% of 2003 net income of $36.1 million.
In July 2003 the Company announced that it had received a regulatory
non-objection from the OTS and approval from its Board of Directors to its
request to repurchase up to 2.1 million (3%) of its outstanding common stock in
order to fund vested stock options. The regulatory non-objection was necessary
because the repurchase program commenced less than one year from the date of the
Conversion. The extent to which shares are repurchased will depend on a number
of factors including market trends and prices, economic conditions, and
alternative uses for capital. As of December 31, 2003, only 110,000 shares had
been repurchased under this program at an average cost of $14.58 per share, as
the Company was restricted from repurchasing its shares for the majority of the
second half of the year due to internal and regulatory trading quiet periods.
However, since mid-January 2004, the Company has continued its share
repurchases, and as of March 10, 2004, a total of 575,000 shares have been
repurchased under this program at an average cost of $14.65 per share.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003 AND DECEMBER 31,
2002
Net Income
Net income for the year ended December 31, 2003 increased 17% to $36.1 million,
or $0.53 per diluted share from $30.8 million, or $0.47 per diluted share for
the year ended December 31, 2002. During 2003, the Company benefited from the
investment of funds raised in the Offering, the acquisition of FLBC in January
and two insurance agencies in July, and increased commercial real estate and
business lending activity. These benefits were partially offset by the impact of
the low interest rate environment on its investment and loan portfolio yields,
which reduced the Company's net interest rate spread. In addition, an increase
30
in the provision for credit losses, costs incurred in connection with the
pending acquisition of TFC and the unexpected passing of the Company's CEO
impacted earnings. As discussed further in note 2 of the "Notes to Consolidated
Financial Statements," as a result of the Conversion and Offering former public
stockholders of FNFG received an exchange ratio of 2.58681 new shares for each
share of FNFG held as of the close of business on January 17, 2003. Share and
per share data have been adjusted in this annual report on Form 10-K to give
recognition to this exchange ratio.
Net Interest Income
Average Balance Sheet. The following table sets forth certain information
relating to the consolidated statements of condition and reflects the average
yields earned on interest-earning assets, as well as the average rates paid on
interest-bearing liabilities for the years indicated. Such yields and rates were
derived by dividing interest income or expense by the average balances of
interest-earning assets or interest-bearing liabilities, respectively, for the
years shown. All average balances are average daily balances. Non-accruing loans
and the tax benefits of some of the Company's investment securities have not
been factored into the yield calculations in this table:
For the year ended December 31,
---------------------------------------------------------------------------------------
2003 2002
---------------------------------------- ----------------------------------------
Average Interest Average Interest
outstanding earned/ outstanding earned/
balance paid Yield/rate balance paid Yield/rate
----------- ---------- ---------- ------------ ----------- ----------
(Dollars in thousands)
Interest-earning assets:
Federal funds sold and other short-
term investments ................. $ 220,330 $ 2,692 1.22% $ 137,639 $ 2,446 1.78%
Mortgage-backed securities(1) ...... 425,253 10,397 2.44 320,569 16,100 5.02
Other investment securities(1) ..... 312,450 6,939 2.22 192,992 7,496 3.88
Loans(2) ........................... 2,245,055 148,995 6.64 1,920,101 140,459 7.32
Other interest-earning assets ...... 23,120 936 4.07 25,841 1,136 4.40
----------- ----------- ---- ----------- ----------- ----
Total interest-earning assets .... 3,226,208 $ 169,959 5.27% 2,597,142 $ 167,637 6.45%
----------- ----------- ---- ----------- ----------- ----
Allowance for credit losses ........... (24,328) (19,815)
Noninterest-earning assets(3)(4) ...... 329,817 275,472
----------- -----------
Total assets ..................... $ 3,531,697 $ 2,852,799
=========== ===========
Interest-bearing liabilities:
Savings ............................ $ 670,785 $ 6,809 1.01% $ 590,965 $ 12,750 2.16%
Interest-bearing checking .......... 525,346 4,767 0.91 507,305 7,791 1.54
Certificates of deposit ............ 998,428 29,232 2.93 883,867 32,774 3.71
Mortgagors' payments held in escrow ... 16,871 -- -- 17,579 296 1.69
Borrowed funds ..................... 431,299 21,736 5.04 414,065 22,496 5.43
----------- ----------- ---- ----------- ----------- ----
Total interest-bearing liabilities 2,642,729 $ 62,544 2.37% 2,413,781 $ 76,107 3.15%
----------- ----------- ---- ----------- ----------- ----
Noninterest-bearing deposits .......... 138,675 115,977
Other noninterest-bearing liabilities . 54,379 48,508
----------- -----------
Total liabilities ................ 2,835,783 2,578,266
Stockholders' equity(3) ............... 695,914 274,533
----------- -----------
Total liabilities and
stockholders' equity ..... $ 3,531,697 $ 2,852,799
=========== ===========
Net interest income ................... $ 107,415 $ 91,530
=========== ===========
Net interest rate spread .............. 2.90% 3.30%
==== ====
Net earning assets .................... $ 583,479 $ 183,361
=========== ===========
Net interest income as a percentage
of average interest-earning assets .. 3.33% 3.52%
=========== ===========
Ratio of average interest-earning
assets to average interest-bearing
liabilities ......................... 122.08% 107.60%
=========== ===========
For the year ended December 31,
--------------------------------------------
2001
-------------------------------------------
Average Interest
outstanding earned/
balance paid Yield/rate
----------- ---------- ----------
(Dollars in thousands)
Interest-earning assets:
Federal funds sold and other short-
term investments ................. $ 39,533 $ 1,503 3.80%
Mortgage-backed securities(1) ...... 312,863 20,138 6.44
Other investment securities(1) ..... 206,415 10,888 5.27
Loans(2) ........................... 1,845,812 144,274 7.82
Other interest-earning assets ...... 24,544 1,565 6.38
----------- ---------- ----
Total interest-earning assets .... 2,429,167 $ 178,368 7.34%
----------- ---------- ----
Allowance for credit losses ........... (18,469)
Noninterest-earning assets(3)(4) ...... 268,633
-----------
Total assets ..................... $ 2,679,331
===========
Interest-bearing liabilities:
Savings ............................ $ 417,256 $ 10,919 2.62%
Interest-bearing checking .......... 545,118 15,878 2.91
Certificates of deposit ............ 877,428 47,284 5.39
Mortgagors' payments held in escrow ... 19,198 328 1.71
Borrowed funds ..................... 425,543 24,943 5.86
----------- ---------- ----
Total interest-bearing liabilities 2,284,543 $ 99,352 4.35%
----------- ---------- ----
Noninterest-bearing deposits .......... 90,023
Other noninterest-bearing liabilities . 49,128
-----------
Total liabilities ................ $ 2,423,694
Stockholders' equity(3) ............... 255,637
-----------
Total liabilities and
stockholders' equity ..... $ 2,679,331
===========
Net interest income ................... $ 79,016
==========
Net interest rate spread .............. 2.99%
====
Net earning assets .................... $ 144,624
===========
Net interest income as a percentage
of average interest-earning assets .. 3.25%
==========
Ratio of average interest-earning
assets to average interest-bearing
liabilities ......................... 106.33%
===========
(1) Amounts shown are at amortized cost.
(2) Net of deferred costs, unearned discounts and non-accruing loans.
(3) Includes unrealized gains/losses on securities available for sale.
(4) Includes non-accruing loans and the cash surrender value of bank-owned
life insurance, earnings from which are reflected in other noninterest
income.
31
Net interest income rose 17% when comparing 2003 to 2002. The major factors
contributing to this increase were the investment of the proceeds from the
Offering, and the acquisition of FLBC, which increased average net earning
assets by a total of $400.1 million during 2003. Offsetting the benefits of the
additional net earning assets was a 40 basis point decline in net interest rate
spread due to the low interest rate environment throughout the year.
Rate/Volume Analysis. The following table presents the extent to which changes
in interest rates and changes in the volume of interest-earning assets and
interest-bearing liabilities have affected the Company's interest income and
interest expense during the years indicated. Information is provided in each
category with respect to: (i) changes attributable to changes in volume (changes
in volume multiplied by prior rate); (ii) changes attributable to changes in
rate (changes in rate multiplied by prior volume); and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate:
For the year ended December 31,
---------------------------------------------------------------------
2003 vs. 2002 2002 vs. 2001
------------------------------- ----------------------------------
Increase/(decrease) Increase/(decrease)
due to Total due to Total
------------------- increase --------------------- increase
Volume Rate (decrease) Volume Rate (decrease)
-------- -------- ---------- -------- -------- ----------
(In thousands)
Interest-earning assets:
Federal funds sold and other short-term
investments ..................................... $ 1,168 $ (922) $ 246 $ 2,095 $ (1,152) $ 943
Mortgage-backed securities ........................ 4,208 (9,911) (5,703) 485 (4,523) (4,038)
Other investment securities ....................... 3,466 (4,023) (557) (671) (2,721) (3,392)
Loans ............................................. 22,347 (13,811) 8,536 5,663 (9,478) (3,815)
Other ............................................. (120) (80) (200) 79 (508) (429)
-------- -------- -------- -------- -------- --------
Total interest-earning assets .............. $ 31,069 $(28,747) $ 2,322 $ 7,651 $(18,382) $(10,731)
======== ======== ======== ======== ======== ========
Interest-bearing liabilities:
Savings ........................................... $ 1,496 $ (7,437) $ (5,941) $ 3,968 $ (2,137) $ 1,831
Interest-bearing checking ......................... 268 (3,292) (3,024) (1,035) (7,052) (8,087)
Certificates of deposit ........................... 3,907 (7,449) (3,542) 345 (14,855) (14,510)
Mortgagors' payments held in escrow ............... (11) (285) (296) (27) (5) (32)
Borrowed funds .................................... 912 (1,672) (760) (661) (1,786) (2,447)
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities ......... $ 6,572 $(20,135) $(13,563) $ 2,590 $(25,835) $(23,245)
======== ======== ======== ======== ======== ========
Net interest income ........................ $ 15,885 $ 12,514
======== ========
The increase in interest income in 2003 compared to 2002 reflects the impact of
a $629.1 million increase in average interest earning assets from 2002 to 2003
due primarily to the investment of the proceeds from the Offering, the
acquisition of FLBC and increased commercial real estate and business loans. The
benefits of the increase in earning assets, however, were substantially offset
by a 118 basis point decrease in the rate earned on those assets from 2002 to
2003. This was attributable to the declining interest rate environment, which
caused the Company's variable-rate interest-earning assets to reprice to lower
rates and fixed-rate interest earning assets, mainly residential mortgages and
mortgage-backed securities ("MBS"), to significantly prepay. The higher level of
principal prepayments received on MBS's reduced the effective yield earned on
those assets as the Company was required to amortize approximately $8.2 million
of purchase premiums in 2003 compared to $2.8 million in 2002. That additional
amortization reduced the yield earned on those securities by 128 basis points.
Additionally, the rate on interest earning assets was impacted by the Company's
strategic decision to invest the funds from the Offering and excess funds from
operations in lower yielding short-term investments.
The major factor contributing to the decrease in interest expense from 2002 to
2003 was a 78 basis point reduction in the rate paid on interest-bearing
liabilities. This was largely due to the low interest rate environment, which
caused the Company's variable rate interest-bearing liabilities to reprice to
lower rates throughout the year. Additionally, the rate paid on interest-bearing
liabilities benefited from the Company's decision to replace higher-rate
liabilities, such as time deposits and long-term borrowings, with cash flow from
wholesale funding and the Offering.
32
Provision for Credit Losses
The following table sets forth the analysis of the allowance for credit losses,
including charge-off and recovery data, for the years indicated:
For the year ended December 31,
---------------------------------------------------------------
2003 2002 2001 2000 1999
------- ------- ------- ------- -------
(Dollars in thousands)
Balance at beginning of year .......... $20,873 $18,727 $17,746 $ 9,862 $ 8,010
Charge-offs:
Real estate:
Residential .................. 518 370 382 175 101
Home equity .................. -- -- 158 28 35
Commercial and multi-family .. 416 390 901 131 146
Commercial business .............. 3,279 2,472 1,059 204 6
Consumer ......................... 2,547 2,572 1,571 534 447
------- ------- ------- ------- -------
Total ................... 6,760 5,804 4,071 1,072 735
------- ------- ------- ------- -------
Recoveries:
Real estate:
Residential .................. 74 107 30 22 --
Home equity .................. -- -- -- 13 --
Commercial and multi-family .. 154 270 268 31 41
Commercial business .............. 528 213 169 47 --
Consumer ......................... 621 536 425 224 80
------- ------- ------- ------- -------
Total ................... 1,377 1,126 892 337 121
------- ------- ------- ------- -------
Net charge-offs ....................... 5,383 4,678 3,179 735 614
Provision for credit losses ........... 7,929 6,824 4,160 2,258 2,466
Allowance obtained through acquisitions 2,001 -- -- 6,361 --
------- ------- ------- ------- -------
Balance at end of year ................ $25,420 $20,873 $18,727 $17,746 $ 9,862
======= ======= ======= ======= =======
Ratio of net charge-offs to average
loans outstanding during the year 0.24% 0.24% 0.17% 0.06% 0.07%
======= ======= ======= ======= =======
Ratio of allowance for credit losses
to total loans at year-end ...... 1.11% 1.05% 1.00% 0.96% 0.99%
======= ======= ======= ======= =======
Ratio of allowance for credit losses
to non-accruing loans at year-end 206.58% 279.13% 163.13% 273.73% 511.25%
======= ======= ======= ======= =======
As a percentage of average loans outstanding, net charge-offs for 2003 remained
consistent with the 2002 level. During 2003, the Company continued to experience
a low level of charge-offs in its commercial and residential real estate loan
portfolios. The increase in net charge-offs for the year resulted primarily from
higher risk commercial business loans and leases and the weaker economic
conditions in 2003. That trend, as well as an increase in non-accruing
commercial real estate and business loans led the Company to raise its provision
for credit losses to $7.9 million in 2003 from $6.8 million in 2002, which
increased the ratio of the allowance to total loans to 1.11% at December 31,
2003.
33
Noninterest Income
In 2003, the Company earned $43.4 million of noninterest income from continuing
operations, compared to $41.8 million for 2002. Banking services income
increased $2.2 million, due to fees earned on accounts acquired from FLBC, and
higher transaction account activity and debit card usage on all accounts.
Additionally, during 2003 risk management services income grew $2.2 million, or
17%, as a result of the acquisition of two Rochester, N.Y. insurance agencies
and higher contingent profit sharing commissions. Additional bank-owned life
insurance acquired with FLBC and death benefit proceeds received due to the
unexpected passing of the Company's CEO, resulted in bank-owned life insurance
income increasing $796 thousand from the prior year. These increases were
partially offset by higher mortgage servicing rights amortization, due to
continuing prepayments during this low interest rate environment, which is
recorded as an offset to lending and leasing income. Also effecting the
year-over-year comparison were $1.0 million of losses incurred in 2002 on the
sale of investment securities, primarily due to the weak equity markets, and a
$2.4 million gain recognized on the sale of a banking center in 2002.
Noninterest Expenses
Noninterest expenses from continuing operations for 2003 increased $10.9 million
over 2002. This 14% variance was mainly the result of the banking and insurance
agency acquisitions in 2003, which accounted for approximately $7.5 million of
this increase. Additionally, compensation expense was higher by $1.0 million due
to the ESOP shares purchased in the Offering and the rise in the Company's stock
price. The remainder of this variance in noninterest expense is primarily
attributable to the addition of three new banking centers in 2003, higher
professional and regulatory fees due to the Company now being fully public and
regulated by the OTS, $387 thousand of expense related to the pending TFC
acquisition and approximately $750 thousand from the unexpected passing of the
Company's CEO and related transition.
Income Taxes
The effective tax rate from continuing operations decreased to 34.2% for 2003
compared to 38.1% for 2002. However, excluding the $1.8 million New York State
bad debt tax expense recapture charge recorded in 2002, which caused the 2002
effective tax rate to increase 363 basis points, the effective tax rate for 2003
is consistent with the 2002 effective rate.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002 AND DECEMBER 31,
2001
Net Income
Net income for the year ended December 31, 2002 increased 45% to $30.8 million,
or $0.47 per diluted share from $21.2 million, or $0.33 per diluted share for
the year ended December 31, 2001. On January 1, 2002, the Company adopted a new
accounting standard, which no longer required goodwill to be amortized.
Adjusting 2001 amounts to exclude the effects of goodwill amortization, similar
to the 2002 results, net income for 2002 increased $4.8 million or 19% from
2001. Net income growth in 2002 can mainly be attributed to a $12.5 million
increase in net interest income as a result of the declining interest rate
environment, expansion of the Company's noninterest income and effective cost
control. During 2002 the Company recorded a $1.8 million tax charge related to
the recapture of excess bad debt reserves for New York State tax purposes,
triggered by its decision to combine its three banking subsidiaries.
Additionally, during 2002 the Company realized a $998 thousand gain from the
curtailment of its defined benefit pension plan, a $2.4 million gain from the
sale of its Lacona Banking Center and recorded $1.0 million in losses from the
sale of investment securities.
Net Interest Income
Net interest income rose 16% to $91.5 million for the year ended December 31,
2002 from $79.0 million for the year ended December 31, 2001. Additionally, the
Company's net interest margin increased to 3.52% for 2002 from 3.25% for 2001.
These variances primarily resulted from a 31 basis point increase in the net
interest rate spread, as the Company's interest-bearing liabilities repriced
faster than its interest-earning assets during the declining rate environment in
2002. Additionally, the Company's net interest rate spread benefited from the
redeployment of funds from lower yielding residential mortgages into higher
yielding commercial real estate and business loans. The increase in net interest
income and margin can also be attributed to the higher level of average net
earning assets in 2002 as compared to 2001, which was mainly caused by a $26.0
million increase in average noninterest-bearing demand deposits.
34
Interest income decreased $10.7 million for the year ended December 31, 2002
compared to the year ended December 31, 2001. This variance reflects an 89 basis
point decline in the overall yield on interest-earning assets from 7.34% for
2001 to 6.45% for 2002 as a result of the lower interest rate environment, which
caused interest-earning assets to reprice at lower rates. Additionally, the
yield on interest-earning assets was reduced by management's strategic decision
to invest excess funds from operations in lower yielding short-term investments.
The decreased rate on interest-earning assets was partially offset by an
increase in average interest-earning asset balances to $2.60 billion for 2002
from $2.43 billion for 2001, as a result of increased funding from deposits.
Interest expense was lower by $23.2 million in 2002 compared to 2001. This
decline is primarily due to the 120 basis point decrease in the rate paid on
interest-bearing liabilities from 4.35% to 3.15% resulting from the lower
interest rate environment in 2002. This decreased rate paid on interest-bearing
liabilities was partially offset by an increase in the average balance of
interest-bearing liabilities to $2.41 billion for 2002 from $2.28 billion for
2001. More specifically, the average balance of interest bearing deposits
increased $140.7 million when comparing 2002 to 2001, while the average balance
of borrowed funds decreased $11.5 million for the same period.
Provision for Credit Losses
Net charge-offs for 2002 amounted to $4.7 million compared to $3.2 million in
2001. This $1.5 million increase was primarily a result of having a higher level
of commercial business loans and the downturn in the economy. Additionally,
consumer loan net charge-offs increased $890 thousand when comparing 2002 to
2001, stemming from the Company's overdraft protection service, initiated in the
fourth quarter of 2001. Even though this service results in higher
net-charge-offs, the revenues received, recorded in non-interest income, are in
excess of the losses incurred. Based upon the increased level of historical net
charge-offs, the higher aggregate balance of commercial loans and the weak
economy in 2002, the Company increased the provision for credit losses to $6.8
million in 2002 from $4.2 million in 2001.
Noninterest Income
For 2002 the Company had $41.8 million in noninterest income from continuing
operations, an increase of 21% over the $34.6 million for 2001. This variance
was primarily due to the $2.4 million pre-tax gain realized on the sale of the
Lacona Banking Center, increased banking services income, as well as higher
revenue from the Company's financial services subsidiaries. The primary driver
behind banking services income for 2002 was the Company's overdraft protection
service, initiated in the fourth quarter of 2001. During 2002, the Company
benefited from strong annuity and insurance markets, which caused risk
management and wealth management revenue to increase $2.1 million. The above
variances were partially offset by a $1.1 million decrease in covered call
option premium income, as a result of the Company's decision to exit this
program in 2002, and increased losses incurred on the sale of investment
securities of $961 thousand, primarily due to weak equity markets.
Noninterest Expenses
Adjusting 2001 amounts for the change in accounting for goodwill, noninterest
expenses from continuing operations for 2002 were higher than 2001 amounts by
$6.2 million. This increase is mainly attributable to higher salaries and
benefits expense of $3.9 million, higher technology and communications expense
of $1.4 million and increased marketing and advertising costs of $489 thousand.
During 2002, the Company incurred approximately $1.3 million of other
noninterest expenses in connection with the consolidation of its three banks and
"First Niagara" branding campaign. These costs are comparable to the $700
thousand in expenses recorded in 2001 related to the integration of the
Company's acquisitions and severance from various reorganization initiatives.
The higher salaries and benefits expense in 2002 was primarily due to internal
growth, the consolidation project mentioned above and a $545 thousand increase
in stock based compensation expense as a result of the rise in the Company's
stock price. These increases were partially offset by a $998 thousand
curtailment gain realized in 2002 from the freezing of the Company's defined
benefit pension plan. The increase in technology and communications expense is
mainly due to the consolidation related costs mentioned above, internal growth
and the upgrading of systems.
Income Taxes
The effective tax rate from continuing operations increased to 38.1% for 2002
compared to 32.4% for 2001, adjusted for goodwill amortization. Excluding the
$1.8 million New York State bad debt tax expense recapture charge, the effective
tax rate for 2002 increased to 34.5% as First Niagara Bank was no longer able to
take advantage of certain provisions in the New York State tax law in 2002.
35
LIQUIDITY AND CAPITAL RESOURCES
The Company's funding sources include income from operations, deposits and
borrowings, principal payments on loans and investment securities, proceeds from
the maturities and sale of investment securities, as well as proceeds from the
sale of mortgage loans in the secondary market. While maturities and scheduled
amortization of loans and securities are predictable sources of funds, deposit
outflows and mortgage prepayments are greatly influenced by the general level of
interest rates, economic conditions and competition.
The primary investing activities of the Company are the origination of
residential mortgages, commercial real estate, business and consumer loans, as
well as the purchase of mortgage-backed and other investment securities. During
2003, loan originations totaled $973.7 million compared to $764.9 million and
$534.3 million for 2002 and 2001, respectively, while purchases of investment
securities totaled $928.7 million, $756.7 million and $434.6 million for the
same years, respectively. The increase in loan originations reflects the
Company's expanded retail platform of nine additional banking centers in 2003,
the continued focus on growing commercial business operations and the strong
refinance market in 2003. The increase in investment security purchases during
2003 is primarily due to the investment of funds from the Offering, as well as
the reinvestment of funds received from the high level of loan and
mortgage-backed security prepayments.
During 2003, cash flow provided by the sale, maturity and principal payments
received on securities available for sale amounted to $840.0 million compared to
$816.3 million and $245.4 million in 2002 and 2001, respectively. In 2003,
funding provided by the deposits acquired from FLBC amounted to $259.5 million.
Deposit growth provided $165.0 million and $84.5 million of funding for the
years ending December 31, 2002 and 2001, respectively. Borrowings, excluding
those acquired, decreased $14.8 million from the end of 2002 as the proceeds
from the offering were more than adequate to meet the funding needs of the
Company.
Maturity Schedule of Certificates of Deposit. The following table indicates the
funding obligations of the Company relating to certificates of deposit by time
remaining until maturity:
At December 31, 2003
----------------------------------------------------------------
3 months Over 3 to 6 Over 6 to 12 Over 12
or less months months months Total
-------- ----------- ------------ -------- --------
(In thousands)
Certificates of deposit less than $100,000 ....... $212,939 $161,627 $242,862 $176,140 $793,568
Certificates of deposit of $100,000 or more ...... 44,637 44,416 70,679 38,245 197,977
-------- -------- -------- -------- --------
Total certificates of deposit $257,576 $206,043 $313,541 $214,385 $991,545
======== ======== ======== ======== ========
In addition to the funding requirements of certificates of deposit, the Company
has contractual obligations related to its borrowings, operating leases and
purchase contracts as follows:
At December 31, 2003
-----------------------------------------------------------------
Less than 1 Over 1 to 3 Over 3 to 5 Over 5
year years years years Total
----------- ----------- ----------- -------- --------
(In thousands)
Borrowings ................................ $ 87,148 $155,507 $117,324 $ 97,987 $457,966
Operating leases .......................... 2,206 4,114 3,370 7,090 16,780
Purchase obligations ...................... 278 556 510 -- 1,344
-------- -------- -------- -------- --------
Total contractual obligations $ 89,632 $160,177 $121,204 $105,077 $476,090
======== ======== ======== ======== ========
Included in the above borrowing amounts are advances and reverse repurchase
agreements that have call provisions that could accelerate their maturity if
interest rates were to rise significantly from current levels as follows: $151.0
million in 2004; $0 in 2005; and $27.1 million in 2006.
36
Loan Commitments. In the ordinary course of business the Company extends
commitments to originate residential and commercial loans and other consumer
loans. Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since the Company does not expect all of the
commitments to be funded, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. Collateral may be obtained based upon
management's assessment of the customers' creditworthiness. Commitments to
extend credit may be written on a fixed rate basis exposing the Company to
interest rate risk given the possibility that market rates may change between
the commitment date and the actual extension of credit. The Company had
outstanding commitments to originate loans of approximately $115.9 million and
$124.6 million at December 31, 2003 and 2002, respectively. Commitments to sell
residential mortgages amounted to $3.8 million and $5.0 million at December 31,
2003 and 2002, respectively.
The Company extends credit to consumer and commercial customers, up to a
specified amount, through lines of credit. The borrower is able to draw on these
lines as needed, thus the funding is generally unpredictable. Unused lines of
credit amounted to $234.3 million at December 31, 2003 and generally have an
expiration period of less than one year. In addition to the above, the Company
issues standby letters of credit to third parties which guarantees payments on
behalf of commercial customers in the event that the customer fails to perform
under the terms of the contract between the customer and the third-party.
Standby letters of credit amounted to $20.4 million at December 31, 2003 and
generally have an expiration period greater than one year. Since the majority of
unused lines of credit and outstanding standby letters of credit expire without
being funded, the Company's obligation under the above commitment amounts is
substantially less than the amounts reported. It is anticipated that there will
be sufficient funds available to meet the current loan commitments and other
obligations through the sources described above. The credit risk involved in
issuing these commitments is essentially the same as that involved in extending
loans to customers and is limited to the contractual notional amount of those
instruments.
Security Yields, Maturities and Repricing Schedule. The following table sets
forth certain information regarding the carrying value, weighted average yields
and estimated maturities, including prepayment assumptions, of the Company's
available for sale securities portfolio as of December 31, 2003. Adjustable-rate
securities are included in the period in which interest rates are next scheduled
to adjust and fixed-rate securities are included based upon the weighted average
life date. The tax benefits of some of the Company's investment securities have
not been factored into the yield calculations in this table. Amounts are shown
at fair value:
At December 31, 2003
-----------------------------------------------------------------------------------------------------
More than one More than five
One year or less year to five years years to ten years After ten years Total
----------------- ------------------ ------------------ ----------------- -----------------
Weighted Weighted Weighted Weighted Weighted
carrying Average carrying Average carrying Average carrying Average carrying Average
value yield value yield value yield value yield value yield
----------------- ----------------- ----------------- ----------------- -----------------
(Dollars in thousands)
Mortgage-backed securities:
CMO's .................... $ 20,023 4.52% $113,374 3.91% $ 25,232 4.05% $ 2,661 5.53% $161,290 4.03%
FNMA ..................... 846 5.75 147,138 4.01 55,181 3.85 3,633 6.22 206,798 4.01
FHLMC .................... 1,881 3.95 103,323 2.86 14,885 3.98 1,130 6.96 121,219 3.05
GNMA ..................... 742 6.89 7,527 5.28 1,029 9.37 1,006 6.94 10,304 5.97
-------- -------- -------- -------- --------
Total mortgage-backed
securities ... 23,492 4.59 371,362 3.69 96,327 3.98 8,430 6.19 499,611 3.83
-------- -------- -------- -------- --------
Debt securities:
U.S. Government agencies . 107,526 1.90 179,532 1.91 -- -- -- -- 287,058 1.91
States and political
subdivisions .......... 11,390 2.14 22,214 3.39 4,585 4.83 -- -- 38,189 3.19
Corporate ................ -- -- 11,685 3.38 -- -- 1,925 2.80 13,610 3.30
-------- -------- -------- -------- --------
Total debt securities ... 118,916 1.92 213,431 2.15 4,585 4.83 1,925 2.80 338,857 2.11
-------- -------- -------- -------- --------
Asset-backed securities .. 74 5.73 -- -- 1,427 1.88 901 1.67 2,402 1.92
Other(1) ................. -- -- -- -- -- -- -- -- 5,013 2.33
-------- -------- -------- -------- --------
Total securities
available for sale ... $142,482 2.37% $584,793 3.12% $102,339 3.99% $ 11,256 5.25% $845,883 3.12%
======== ======== ======== ======== ========
(1) Estimated maturities do not include other securities available for sale.
37
Loan Maturity and Repricing Schedule. The following table sets forth certain
information as of December 31, 2003, regarding the amount of loans maturing or
repricing in the Company's portfolio. Demand loans having no stated schedule of
repayment and no stated maturity and overdrafts are reported as due in one year
or less. Adjustable- and floating-rate loans are included in the period in which
interest rates are next scheduled to adjust rather than the period in which they
contractually mature, and fixed-rate loans (including bi-weekly loans) are
included in the period in which the final contractual repayment is due. No
adjustments have been made for prepayment of principal:
One
Within through After
one five five
year years years Total
---------- ---------- ---------- ----------
(In thousands)
Real estate loans:
Residential ............... $ 118,987 $ 293,332 $ 537,384 $ 949,703
Home equity ............... 103,547 29,518 46,107 179,172
Commercial and multi-family 245,011 311,821 96,930 653,762
Commercial construction ... 78,386 7,141 627 86,154
---------- ---------- ---------- ----------
Total real estate loans .......... 545,931 641,812 681,048 1,868,791
---------- ---------- ---------- ----------
Commercial business loans ........ 140,170 71,931 2,899 215,000
Consumer loans ................... 94,153 95,165 13,053 202,371
---------- ---------- ---------- ----------
Total loans ........ $ 780,254 $ 808,908 $ 697,000 $2,286,162
========== ========== ========== ==========
For the loans reported above, the following table sets forth at December 31,
2003, the dollar amount of all fixed-rate and adjustable-rate loans due after
December 31, 2004:
Due after December 31, 2004
------------------------------------------
Fixed Adjustable Total
---------- ---------- ----------
(In thousands)
Real estate loans:
Residential .................. $ 736,325 $ 94,391 $ 830,716
Home equity .................. 75,625 -- 75,625
Commercial and multi-family .. 167,409 241,342 408,751
Commercial construction ...... 7,768 -- 7,768
---------- ---------- ----------
Total real estate loans 987,127 335,733 1,322,860
---------- ---------- ----------
Commercial business loans ........... 72,963 1,867 74,830
Consumer loans ...................... 108,218 -- 108,218
---------- ---------- ----------
Total loans ........... $1,168,308 $ 337,600 $1,505,908
========== ========== ==========
The Company has lines of credit with the FHLB, FRB and a commercial bank that
provide a secondary funding source for lending, liquidity and asset and
liability management. At December 31, 2003, the FHLB line of credit totaled
$895.6 million with $214.5 million outstanding. The FRB and commercial bank
lines of credit totaled $36.5 million and $25.0 million, respectively, with no
borrowings outstanding on either line as of December 31, 2003. FNFG's ability to
pay dividends to its shareholders and make acquisitions is primarily dependent
upon the ability of First Niagara to pay dividends to FNFG. The payment of
dividends by First Niagara is subject to continued compliance with minimum
regulatory capital requirements. In addition, regulatory approval is required
prior to First Niagara declaring dividends in excess of net income for that year
plus net income retained in the two preceding years.
Cash, interest-bearing demand accounts at correspondent banks, federal funds
sold, and other short-term investments are the Company's most liquid assets. The
level of these assets are monitored daily and are dependent on operating,
financing, lending and investing activities during any given period. Excess
short-term liquidity is usually invested in overnight federal funds sold. In the
event that funds beyond those generated internally are required due to higher
than expected loan commitment fundings, deposit outflows or the amount of debt
being called, additional sources of funds are available through the use of
repurchase agreements, the sale of loans or investments or the Company's various
lines of credit. As of December 31, 2003, the total of cash, interest-bearing
demand accounts, federal funds sold and other short-term investments was $174.3
million, or 4.9% of total assets. On January 16, 2004, FNFG deployed $152
million of its cash and cash equivalents to fund the acquisition of TFC.
38
FOURTH QUARTER RESULTS
Net income for the quarter ended December 31, 2003 increased 20% to $10.1
million, or $0.15 per diluted share from $8.4 million, or $0.13 per diluted
share for the same period of 2002. On a linked quarter basis, net income
increased 8% from $9.3 million or $0.14 per diluted share for the 2003 third
quarter.
Net interest income was $28.3 million for the fourth quarter of 2003, a $1.1
million increase from the third quarter of 2003. This improvement reflects a 16
basis point increase in the Company's net interest rate spread. The increase in
net interest rate spread was attributable to the Company's active asset and
liability management strategies and reduced mortgage-backed security premium
amortization. The effects of those changes more than offset the impact of the
reduction in loan portfolio yield, which declined due to the historically low
interest rate environment. As a result, the Company's net interest margin
improved 14 basis points to 3.50% for the quarter, compared to 3.36% in the
third quarter of 2003.
A $2.0 million provision for credit losses was recognized for the quarter ended
December 31, 2003 as credit quality remained stable and loan loss experience
continued at low levels. Total non-performing assets were approximately $12.9
million at December 31, 2003 and September 30, 2003.
For the fourth quarter of 2003, the Company had $11.2 million of noninterest
income, which is comparable to the third quarter of 2003 level of $11.4 million.
Increases in risk management services, as well as lending and leasing income
were offset by a decrease in bank-owned life insurance earnings due to death
benefit proceeds received in the third quarter of 2003. Additionally, banking
services income declined $179 thousand as a result of the MasterCard/Visa
settlement in August 2003.
Noninterest expense for the three months ended December 31, 2003 was $22.7
million versus $22.4 million for the three months ended September 30, 2003. This
increase is attributable to $387 thousand of conversion and travel costs
incurred during the fourth quarter related to the Company's pending acquisition
of TFC. In the 4th and 3rd quarters of 2003, the Company incurred $303 thousand
and $447 thousand, respectively, of other noninterest expenses in connection
with its CEO transition, and the unexpected passing of the Company's CEO in
August.
The effective tax rate from continuing operations decreased to 31.04% for the
quarter ended December 31, 2003 compared to 35.15% for the quarter ended
September 30, 2003. This decrease was mainly due to adjustments made during the
fourth quarter to finalize the year-end tax calculation.
Total loans were $2.29 billion at December 31, 2003 compared to $2.30 billion at
September 30, 2003. This slight decrease was primarily attributable to a $16.5
million decline in residential mortgage loans, as the Company continued to
strategically lower its reliance on long-term fixed-rate residential loans.
Additionally, the combined commercial real estate and business loan portfolios
declined $4.1 million during the quarter as a result of lower line of credit
utilization and the anticipated completion and subsequent repayment of two
commercial real-estate construction projects. Total deposits were $2.36 billion
at December 31, 2003 compared to $2.32 billion at September 30, 2003. This
increase was across various product types and reflects the Company's focus on
increasing its core deposit base, in particular non-interest bearing checking
accounts.
IMPACT OF NEW ACCOUNTING STANDARDS
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." This Interpretation enhances the disclosures to be made
by a guarantor in its financial statements about its obligations under certain
guarantees that it has issued. It also requires a guarantor to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The initial recognition and measurement
provisions of Interpretation No. 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002. The Company adopted
Interpretation No. 45 effective January 1, 2003, which did not have a material
impact on the Company's consolidated financial statements.
39
In January 2003, as amended in December 2003, the FASB issued Interpretation No.
46, "Consolidation of Variable Interest Entities," which clarifies the
application of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements." More specifically, the Interpretation explains how to identify
variable interest entities and how to determine whether or not those entities
should be consolidated. The Interpretation requires the primary beneficiaries of
variable interest entities to consolidate the variable interest entities if they
are subject to a majority of the risk of loss or are entitled to receive a
majority of the residual returns. It also requires that both the primary
beneficiary and all other enterprises with a significant variable interest in a
variable interest entity make certain disclosures. Interpretation No. 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal period ending after December 15, 2003, to
variable interest entities in which an enterprise holds a variable interest that
it acquired before February 1, 2003. The provisions of this Interpretation did
not have a material impact on the Company's consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The principal objective of the Company's interest rate risk management is to
evaluate the interest rate risk inherent in certain assets and liabilities,
determine the appropriate level of risk given the Company's business strategy,
operating environment, capital and liquidity requirements and performance
objectives, and manage the risk consistent with the Board's approved guidelines
to reduce the vulnerability of operations to changes in interest rates. The
asset and liability committee ("ALCO") is comprised of senior management and
selected banking officers who are responsible for reviewing the Company's
activities and strategies, the effect of those strategies on the net interest
margin, the fair value of the portfolio and the effect that changes in interest
rates will have on the portfolio and exposure limits.
The Company utilizes the following strategies to manage interest rate risk: (1)
emphasizing the origination and retention of residential fixed-rate mortgage
loans having terms to maturity of less than twenty years, residential and
commercial adjustable-rate mortgage loans, and home equity loans; (2) selling
substantially all newly originated 20-30 fixed-rate, residential mortgage loans
into the secondary market without recourse and on a servicing retained basis;
(3) investing in shorter term securities which generally bear lower yields as
compared to longer term investments, but which better position the Company for
increases in market interest rates; and (4) growing non-interest bearing
deposits through increased commercial loan operations. In the past, the Company
has periodically entered into interest rate swap agreements in order to manage
the interest rate risk related to the repricing of its money market deposit
accounts. The last of the Company's interest rate swap agreements expired in
December 2002. The Company intends to continue to analyze the future utilization
of swap agreements as part of its overall asset and liability management
process.
Gap Analysis. The matching of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities are "interest rate
sensitive" and by monitoring a Company's interest rate sensitivity "gap." An
asset or liability is said to be interest rate sensitive within a specific time
period if it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
same time period. At December 31, 2003, the Company's one-year gap position, the
difference between the amount of interest-earning assets maturing or repricing
within one year and interest-bearing liabilities maturing or repricing within
one year, as a percentage of interest-earning assets was a positive 9.73%. A gap
is considered positive when the amount of interest rate sensitive assets exceeds
the amount of interest rate sensitive liabilities. A gap is considered negative
when the amount of interest rate sensitive liabilities exceeds the amount of
interest rate sensitive assets. Accordingly, during a period of rising interest
rates, an institution with a negative gap position is likely to experience a
decline in net interest income as the cost of its interest-bearing liabilities
increase at a rate faster than its yield on interest-earning assets. In
comparison, an institution with a positive gap, such as the Company, is likely
to realize an increase in its net interest income in a rising interest rate
environment. Given the results of the Company's net interest income simulation
modeling analysis discussed below, which management believes is a better
indicator of the Company's interest rate risk exposure, management believes that
its positive gap position will benefit the Company's as interest rates rise.
40
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 2003, which are
anticipated by the Company, based upon certain assumptions, to reprice or mature
in each of the future time periods shown. Except as stated below, the amount of
assets and liabilities shown which reprice or mature during a particular period
were determined in accordance with the earlier of the repricing date or the
contractual maturity of the asset or liability. The table sets forth an
approximation of the projected repricing of assets and liabilities at December
31, 2003, on the basis of contractual maturities, anticipated prepayments, and
scheduled rate adjustments within the selected time intervals. Residential and
commercial real estate loans were projected to repay at rates between 4% and 16%
annually, while mortgage-backed securities were projected to prepay at rates
between 20% and 45% annually. Savings and interest bearing and noninterest
bearing checking accounts were assumed to decay, or run-off, between 8% and 17%
annually. While the Company believes such assumptions to be reasonable, there
can be no assurance that assumed prepayment rates and decay rates will
approximate actual future loan prepayment and deposit withdrawal activity:
Amounts maturing or repricing as of December 31, 2003
-------------------------------------------------------------------------
Less than 3-6 6 months
3 months months to 1 year 1-3 years 3-5 years
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Interest-earning assets:
Federal funds sold and other
short-term investments .................... $ 124,255 $ -- $ -- $ -- $ --
Mortgage-backed securities(1) ................. 47,963 40,927 68,616 156,463 96,855
Other investment securities(1) ................ 42,478 30,439 62,200 179,664 19,344
Loans(2) ...................................... 581,985 125,282 257,772 672,270 439,455
Other ......................................... -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Total interest-earning assets ........... 796,681 196,648 388,588 1,008,397 555,654
---------- ---------- ---------- ---------- ----------
Interest-bearing liabilities:
Savings ....................................... 85,425 12,104 24,208 96,833 96,833
Interest-bearing checking ..................... 14,434 14,434 28,868 115,474 115,474
Certificates of deposit ....................... 257,576 206,043 313,541 189,403 22,727
Mortgagors' payments held in escrow ........... 3,928 3,928 7,856 -- --
Borrowed funds ................................ 34,909 19,877 37,245 150,230 117,650
---------- ---------- ---------- ---------- ----------
Total interest-bearing liabilities ...... 396,272 256,386 411,718 551,940 352,684
---------- ---------- ---------- ---------- ----------
Interest rate sensitivity gap .................... $ 400,409 ($ 59,738) ($ 23,130) $ 456,457 $ 202,970
========== ========== ========== ========== ==========
Cumulative interest rate sensitivity gap ......... $ 400,409 $ 340,671 $ 317,541 $ 773,998 $ 976,968
========== ========== ========== ========== ==========
Ratio of interest-earning assets to
interest-bearing liabilities .................. 201.04% 76.70% 94.38% 182.70% 157.55%
Ratio of cumulative gap to interest-earning assets 12.27% 10.44% 9.73% 23.73% 29.95%
Amounts maturing or repricing
as of December 31, 2003
-----------------------------------------
Over 10
5-10 years years Total
---------- ---------- ----------
(Dollars in thousands)
Interest-earning assets:
Federal funds sold and other
short-term investments .................... $ -- $ -- $ 124,255
Mortgage-backed securities(1) ................. 90,176 -- 501,000
Other investment securities(1) ................ 9,214 2,111 345,450
Loans(2) ...................................... 191,787 2,819 2,271,370
Other ......................................... -- 20,121 20,121
---------- ---------- ----------
Total interest-earning assets ........... 291,177 25,051 3,262,196
---------- ---------- ----------
Interest-bearing liabilities:
Savings ....................................... 242,083 96,834 654,320
Interest-bearing checking ..................... 216,753 33,530 538,967
Certificates of deposit ....................... 2,080 175 991,545
Mortgagors' payments held in escrow ........... -- -- 15,712
Borrowed funds ................................ 94,496 3,559 457,966
---------- ---------- ----------
Total interest-bearing liabilities ...... 555,412 134,098 2,658,510
---------- ---------- ----------
Interest rate sensitivity gap .................... ($ 264,235) ($ 109,047) $ 603,686
========== ========== ==========
Cumulative interest rate sensitivity gap ......... $ 712,733 $ 603,686
========== ==========
Ratio of interest-earning assets to
interest-bearing liabilities .................. 52.43% 18.68% 122.71%
Ratio of cumulative gap to interest-earning assets 21.85% 18.51%
(1) Amounts shown are at amortized cost.
(2) Amounts shown include principal balance net of deferred costs, unearned
discounts, negative balance deposits reclassified to loans and
non-accruing loans.
Certain shortcomings are inherent in the method of analysis presented in the gap
table. For example, although certain assets and liabilities may have similar
maturities or periods to repricing, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate loans, have
features, which restrict changes in interest rates, both on a short-term basis
and over the life of the asset. Further, in the event of changes in interest
rates, prepayment and early withdrawal levels would likely deviate significantly
from those assumed in calculating the table. Finally, the ability of many
borrowers to service their adjustable-rate loans may decrease in the event of an
interest rate increase.
As a result of these shortcomings, the Company focuses more attention on
simulation modeling, such as the net interest income analysis discussed below,
rather than gap analysis. Even though the gap analysis reflects a ratio of
cumulative gap to total interest-earning assets within the Company's targeted
range of acceptable limits, the net interest income simulation modeling is
considered by management to be more informative in forecasting future income.
41
Net Interest Income Analysis. The accompanying table sets forth as of December
31, 2003 and 2002 the estimated impact on the Company's net interest income
resulting from changes in interest rates during the next twelve months. These
estimates require making certain assumptions including loan and mortgage-related
investment prepayment speeds, reinvestment rates, and deposit maturities and
decay rates similar to the gap analysis. These assumptions are inherently
uncertain and, as a result, the Company cannot precisely predict the impact of
changes in interest rates on net interest income. Actual results may differ
significantly due to timing, magnitude and frequency of interest rate changes
and changes in market conditions. During 2003, management of the Company
continued to actively manage its balance sheet by selling long-term fixed rate
residential mortgages originated, increasing its emphasis on variable rate
commercial loans, replacing amortizing investment securities with fixed maturity
investment securities, and investing the proceeds from the Offering in
short-term/liquid assets. These initiatives, coupled with an active pursuit of
long-term core deposit funding, have positively impacted the Company's interest
rate sensitivity position since December 31, 2002, which should benefit the
Company during periods of higher interest rates, as follows:
Calculated increase (decrease) at December 31,
------------------------------------------------
2003 2002
------------------------ ----------------------
Changes in Net interest Net interest
interest rates income % Change income % Change
----------------- ------------ -------- ------------ --------
(Dollars in thousands)
+200 basis points $ 959 0.82% $ 64 0.07%
+100 basis points 627 0.54 97 0.10
-100 basis points (966) (0.83) (1,014) (1.09)
As is the case with the gap table, certain shortcomings are inherent in the
methodology used in the above interest rate risk measurements. Modeling changes
in net interest income requires the making of certain assumptions that may or
may not reflect the manner in which actual yields respond to changes in market
interest rates. In this regard, the net interest income table presented assumes
that the composition of the Company's interest sensitive assets and liabilities
existing at the beginning of a period remains constant over the period being
measured and also assumes that a particular change in interest rates is
reflected uniformly across the yield curve regardless of the duration to
maturity or repricing of specific assets and liabilities. Accordingly, although
the net interest income table provides an indication of the Company's interest
rate risk exposure at a particular point in time, such measurements are not
intended to and do not provide a precise forecast of the effect of changes in
market interest rates on the Company's net interest income and will differ from
actual results.
42
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Independent Auditors' Report
The Board of Directors
First Niagara Financial Group, Inc.:
We have audited the accompanying consolidated statements of condition of First
Niagara Financial Group, Inc. and subsidiaries (the Company) as of December 31,
2003 and 2002, and the related consolidated statements of income, comprehensive
income, stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 2003. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2003 and 2002, and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 2003, in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 1, the Company adopted prospectively the provisions of
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, in 2002.
/s/ KPMG LLP
January 19, 2004
Buffalo, New York
43
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Consolidated Statements of Condition
December 31, 2003 and 2002
(In thousands except share and per share amounts)
Assets 2003 2002
----------- -----------
Cash and cash equivalents:
Cash and due from banks $ 49,997 45,358
Federal funds sold and other short-term investments 124,255 45,167
----------- -----------
Total cash and cash equivalents 174,252 90,525
Securities available for sale 845,883 632,364
Loans, net 2,269,203 1,974,560
Bank-owned life insurance 70,767 54,082
Premises and equipment, net 43,694 40,445
Goodwill, net 105,981 74,101
Intangible assets, net 8,717 6,392
Other assets 71,010 62,326
----------- -----------
Total assets $ 3,589,507 2,934,795
=========== ===========
Liabilities and Stockholders' Equity
Liabilities:
Deposits $ 2,355,216 2,205,421
Short-term borrowings 87,148 69,312
Long-term borrowings 370,818 327,823
Other liabilities 48,151 48,543
----------- -----------
Total liabilities 2,861,333 2,651,099
----------- -----------
Commitments and contingencies (note 11) -- --
Stockholders' equity:
Preferred stock, $0.01 par value, 50,000,000 shares authorized in 2003
and 5,000,000 shares authorized in 2002, none issued -- --
Common stock, $0.01 par value, 250,000,000 shares authorized and
70,813,651 shares issued in 2003 and 45,000,000 shares authorized and
29,756,250 shares issued in 2002 708 298
Additional paid-in capital 544,618 137,624
Retained earnings 217,538 196,074
Accumulated other comprehensive income (loss) (740) 2,074
Common stock held by ESOP, 4,049,659 shares in 2003 and
832,747 shares in 2002 (30,399) (11,024)
Unearned compensation - recognition and retention plan,
358,095 shares in 2003 and 203,675 shares in 2002 (2,376) (2,453)
Treasury stock, at cost, 79,422 shares in 2003 and
3,715,303 shares in 2002 (1,175) (38,897)
----------- -----------
Total stockholders' equity 728,174 283,696
----------- -----------
Total liabilities and stockholders' equity $ 3,589,507 2,934,795
=========== ===========
See accompanying notes to consolidated financial statements.
44
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Consolidated Statements of Income
Years ended December 31, 2003, 2002 and 2001
(In thousands except per share amounts)
2003 2002 2001
-------- -------- --------
Interest income:
Real estate loans $121,227 115,795 119,203
Other loans 27,768 24,664 25,071
Mortgage-backed securities 10,397 16,100 20,138
Other investment securities 6,939 7,496 10,888
Federal funds sold and other short-term investments 2,692 2,446 1,503
Other 936 1,136 1,565
-------- -------- --------
Total interest income 169,959 167,637 178,368
Interest expense:
Deposits 40,808 53,611 74,409
Borrowings 21,736 22,496 24,943
-------- -------- --------
Total interest expense 62,544 76,107 99,352
-------- -------- --------
Net interest income 107,415 91,530 79,016
Provision for credit losses 7,929 6,824 4,160
-------- -------- --------
Net interest income after provision
for credit losses 99,486 84,706 74,856
-------- -------- --------
Noninterest income:
Banking services 16,445 14,226 10,222
Risk management services 14,765 12,610 11,009
Lending and leasing 3,617 5,523 4,310
Wealth management services 3,525 3,697 3,206
Bank-owned life insurance 3,502 2,706 2,507
Net realized gains (losses) on securities available for sale 9 (1,044) (83)
Gain on sale of banking center -- 2,429 --
Other 1,516 1,640 3,454
-------- -------- --------
Total noninterest income 43,379 41,787 34,625
-------- -------- --------
Noninterest expense:
Salaries and employee benefits 50,377 45,180 41,308
Technology and communications 9,647 8,599 7,204
Occupancy and equipment 9,315 7,526 7,237
Marketing and advertising 3,205 2,612 2,123
Amortization of intangibles 1,384 677 5,310
Other 14,349 12,737 12,707
-------- -------- --------
Total noninterest expense 88,277 77,331 75,889
-------- -------- --------
Income from continuing operations before income taxes 54,588 49,162 33,592
Income taxes from continuing operations 18,646 18,752 12,427
-------- -------- --------
Income from continuing operations 35,942 30,410 21,165
Discontinued operations:
Income, including gain on sale in 2003, before income taxes 2,032 787 331
Income taxes 1,868 402 276
-------- -------- --------
Income from discontinued operations 164 385 55
-------- -------- --------
Net income $ 36,106 30,795 21,220
======== ======== ========
Earnings per common share:
Basic $ 0.55 0.48 0.33
Diluted 0.53 0.47 0.33
Weighted average common shares outstanding:
Basic 66,111 64,445 63,967
Diluted 67,754 65,883 64,696
See accompanying notes to consolidated financial statements.
45
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Years ended December 31, 2003, 2002 and 2001
(In thousands)
2003 2002 2001
-------- -------- --------
Net income $ 36,106 30,795 21,220
-------- -------- --------
Other comprehensive income (loss), net of income taxes:
Securities available for sale:
Net unrealized gains (losses) arising during the year (4,566) 836 2,381
Reclassification adjustment for realized (gains)
losses included in net income (5) 627 50
-------- -------- --------
(4,571) 1,463 2,431
-------- -------- --------
Cash flow hedges:
Net unrealized losses arising during the year -- (105) (503)
Reclassification adjustment for realized losses
included in net income -- 311 392
-------- -------- --------
-- 206 (111)
-------- -------- --------
Minimum pension liability adjustment 1,757 (2,156) --
-------- -------- --------
Total other comprehensive income (loss) before
cumulative effect of change in accounting principle (2,814) (487) 2,320
Cumulative effect of change in accounting principle
for derivatives, net of tax -- -- (95)
-------- -------- --------
Total other comprehensive income (loss) (2,814) (487) 2,225
-------- -------- --------
Total comprehensive income $ 33,292 30,308 23,445
======== ======== ========
See accompanying notes to consolidated financial statements.
46
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
Years ended December 31, 2003, 2002 and 2001
(In thousands except share and per share amounts)
Accumulated
Additional other
Common paid-in Retained comprehensive
stock capital earnings income (loss)
-------- ---------- -------- -------------
Balances at January 1, 2001 $ 298 135,776 163,836 336
Net income -- -- 21,220 --
Unrealized gain on securities available
for sale -- -- -- 2,431
Unrealized loss on interest rate swaps -- -- -- (111)
Cumulative effect of change in
accounting principle for derivatives -- -- -- (95)
Exercise of stock options -- 99 -- --
ESOP shares released -- 55 -- --
Recognition and retention plan -- (13) -- --
Common stock dividends of $0.36 per
share (equivalent to $0.14 per share
after the reorganization in 2003) -- -- (8,983) --
-------- -------- -------- --------
Balances at December 31, 2001 $ 298 135,917 176,073 2,561
Net income -- -- 30,795 --
Unrealized gain on securities available
for sale -- -- -- 1,463
Unrealized gain on interest rate swaps -- -- -- 206
Minimum pension liability adjustment -- -- -- (2,156)
Exercise of stock options -- 533 -- --
ESOP shares released -- 547 -- --
Recognition and retention plan -- 627 -- --
Common stock dividends of $0.43 per
share (equivalent to $0.17 per share
after the reorganization in 2003) -- -- (10,794) --
-------- -------- -------- --------
Balances at December 31, 2002 $ 298 137,624 196,074 2,074
Net income -- -- 36,106 --
Unrealized loss on securities available
for sale -- -- -- (4,571)
Minimum pension liability adjustment -- -- -- 1,757
Corporate reorganization:
Merger of First Niagara Financial Group,
MHC pursuant to reorganization (158) 19,607 -- --
Treasury stock retired pursuant to
reorganization (37) (38,860) -- --
Exchange of common stock pursuant
to reorganization 161 (197) -- --
Proceeds from stock offering, net of
related expenses 410 390,535 -- --
Purchase of shares by ESOP -- -- -- --
Common stock issued for the acquisition
of Finger Lakes Bancorp, Inc. 34 33,527 -- --
Purchase of treasury shares -- -- -- --
Exercise of stock options -- 165 -- --
ESOP shares released -- 966 -- --
Recognition and retention plan -- 1,251 -- --
Common stock dividends of $0.22 per
share -- -- (14,642) --
-------- -------- -------- --------
Balances at December 31, 2003 $ 708 544,618 217,538 (740)
======== ======== ======== ========
Common Unearned
stock compensation -
held by recognition and Treasury
ESOP retention plan stock Total
-------- --------------- -------- --------
Balances at January 1, 2001 (12,378) (2,280) (41,048) 244,540
Net income -- -- -- 21,220
Unrealized gain on securities available
for sale -- -- -- 2,431
Unrealized loss on interest rate swaps -- -- -- (111)
Cumulative effect of change in
accounting principle for derivatives -- -- -- (95)
Exercise of stock options -- -- 381 480
ESOP shares released 748 -- -- 803
Recognition and retention plan -- 127 218 332
Common stock dividends of $0.36 per
share (equivalent to $0.14 per share
after the reorganization in 2003) -- -- -- (8,983)
-------- -------- -------- --------
Balances at December 31, 2001 (11,630) (2,153) (40,449) 260,617
Net income -- -- -- 30,795
Unrealized gain on securities available
for sale -- -- -- 1,463
Unrealized gain on interest rate swaps -- -- -- 206
Minimum pension liability adjustment -- -- -- (2,156)
Exercise of stock options -- -- 886 1,419
ESOP shares released 606 -- -- 1,153
Recognition and retention plan -- (300) 666 993
Common stock dividends of $0.43 per
share (equivalent to $0.17 per share
after the reorganization in 2003) -- -- -- (10,794)
-------- -------- -------- --------
Balances at December 31, 2002 (11,024) (2,453) (38,897) 283,696
Net income -- -- -- 36,106
Unrealized loss on securities available
for sale -- -- -- (4,571)
Minimum pension liability adjustment -- -- -- 1,757
Corporate reorganization:
Merger of First Niagara Financial Group,
MHC pursuant to reorganization -- -- -- 19,449
Treasury stock retired pursuant to
reorganization -- -- 38,897 --
Exchange of common stock pursuant
to reorganization -- -- -- (36)
Proceeds from stock offering, net of
related expenses -- -- -- 390,945
Purchase of shares by ESOP (20,500) -- -- (20,500)
Common stock issued for the acquisition
of Finger Lakes Bancorp, Inc. -- -- -- 33,561
Purchase of treasury shares -- -- (1,604) (1,604)
Exercise of stock options -- -- 570 735
ESOP shares released 1,125 -- -- 2,091
Recognition and retention plan -- 77 (141) 1,187
Common stock dividends of $0.22 per
share -- -- -- (14,642)
-------- -------- -------- --------
Balances at December 31, 2003 (30,399) (2,376) (1,175) 728,174
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
47
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2003, 2002 and 2001
(In thousands)
2003 2002 2001
--------- --------- ---------
Cash flows from operating activities:
Net income $ 36,106 30,795 21,220
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization (accrual) of fees and discounts, net 14,082 3,853 (124)
Provision for credit losses 7,929 6,824 4,160
Depreciation of premises and equipment 6,187 5,286 4,763
Amortization of goodwill and other intangibles 1,417 873 5,711
Net (increase) decrease in loans held for sale 1,602 (1,004) 1,560
Net realized (gains) losses (217) (2,383) 83
Stock based compensation expense 3,592 2,080 1,503
Deferred income tax expense 2,854 1,096 829
(Increase) decrease in other assets (4,023) (1,834) 1,094
Increase (decrease) in other liabilities (5,951) (253) 2,829
--------- --------- ---------
Net cash provided by operating activities 63,578 45,333 43,628
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sales of securities available for sale 64,734 449,110 76,751
Proceeds from maturities of securities available for sale 381,559 196,961 65,388
Principal payments received on securities available for sale 393,707 170,181 103,301
Purchases of securities available for sale (928,709) (756,685) (434,582)
Net increase in loans (100,900) (128,740) (35,834)
Purchase of bank-owned life insurance (5,000) -- (4,000)
Acquisitions, net of cash acquired (32,542) (605) (980)
Proceeds from the sale of business, net of cash 5,235 -- --
Net cash distributed for sale of banking center -- (21,566) --
Other, net (8,762) (7,246) (6,965)
--------- --------- ---------
Net cash used in investing activities (230,678) (98,590) (236,921)
--------- --------- ---------
Cash flows from financing activities:
Net increase (decrease) in deposits (33,773) 165,038 84,479
Net proceeds from Conversion and Offering 313,906 75,952 --
(Repayments of) proceeds from short-term borrowings, net (36,458) (175,492) 59,209
Proceeds from long-term borrowings 39,890 30,000 88,100
Repayments of long-term borrowings (16,951) (16,518) (18,079)
Proceeds from exercise of stock options 459 942 406
Purchase of treasury stock (1,604) -- --
Dividends paid on common stock (14,642) (10,794) (8,983)
--------- --------- ---------
Net cash provided by financing activities 250,827 69,128 205,132
--------- --------- ---------
Net increase in cash and cash equivalents 83,727 15,871 11,839
Cash and cash equivalents at beginning of year 90,525 74,654 62,815
--------- --------- ---------
Cash and cash equivalents at end of year $ 174,252 90,525 74,654
========= ========= =========
Cash paid during the year for:
Income taxes $ 14,782 16,970 10,050
Interest expense 62,552 76,684 100,121
Acquisition and disposition of banks and financial services companies:
Assets acquired (noncash) $ 377,204 -- 141
Liabilities assumed 344,201 -- 67
Assets sold (noncash) 1,384 2,403 --
Liabilities sold 746 26,399 --
See accompanying notes to consolidated financial statements.
48
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
1) Summary of Significant Accounting Policies
First Niagara Financial Group, Inc. ("FNFG") is a Delaware corporation,
which holds all of the capital stock of First Niagara Bank ("First
Niagara"), a federally chartered savings bank. FNFG and First Niagara are
hereinafter referred to collectively as "the Company." The Company
provides financial services to individuals and businesses in Upstate New
York. The Company's business is primarily accepting deposits from
customers through its banking centers and investing those deposits,
together with funds generated from operations and borrowings, in
residential loans, commercial real estate loans, commercial business loans
and leases, consumer loans, and investment securities. Additionally, the
Company offers risk management, as well as wealth management services.
The accounting and reporting policies of the Company conform to general
practices within the banking industry and to accounting principles
generally accepted in the United States of America. Certain
reclassification adjustments were made to the 2002 and 2001 financial
statements to conform them to the 2003 presentation.
The following is a description of the Company's significant accounting
policies:
(a) Principles of Consolidation
The consolidated financial statements include the accounts of FNFG
and its subsidiaries, all of which are wholly-owned. All significant
intercompany balances and transactions have been eliminated in
consolidation.
(b) Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, cash items in the
process of collection, amounts due from banks, federal funds sold,
money market accounts and other short-term investments which have a
term of less than three months at the time of purchase.
(c) Investment Securities
All investment securities are classified as available for sale and
are carried at fair value, with unrealized gains and losses, net of
the related deferred income tax effect, reported as a component of
stockholders' equity (accumulated other comprehensive income).
Realized gains and losses are included in the consolidated
statements of income using the specific identification method. A
decline in the fair value of any available for sale security below
cost that is deemed other than temporary is charged to operations,
resulting in the establishment of a new cost basis. Premiums and
discounts on investment securities are amortized/accrued to interest
income utilizing the interest method.
(d) Loans
Loans are stated at the principal amount outstanding, adjusted for
unamortized deferred fees and costs as well as discounts and
premiums, all of which are amortized to income using the interest
method. Accrual of interest income on loans is discontinued after
payments become more than ninety days delinquent, unless the status
of a particular loan clearly indicates earlier discontinuance is
more appropriate. All uncollected interest income previously
recognized on non-accrual loans is reversed and subsequently
recognized only to the extent payments are received. When there is
doubt as to the collectibility of loan principal, interest payments
are applied to principal. Loans are generally returned to accrual
status when principal and interest payments are current, full
collectibility of principal and interest is reasonably assured and a
consistent repayment record, generally six months, has been
demonstrated. Loans are charged off against the allowance for credit
losses when it becomes evident that such balances are not fully
collectible.
49
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect
all amounts of principal and interest under the original terms of
the agreement. Such loans are measured based on the present value of
expected future cash flows discounted at the loan's effective
interest rate or, as a practical expedient, the loan's observable
market price or the fair value of the underlying collateral if the
loan is collateral dependent.
The Company enters into direct financing equipment lease
transactions with certain commercial customers. At lease inception,
the present value of future rentals and the estimated lease residual
value are recorded in commercial business loans as a net investment
in direct financing leases. Unearned interest income and sales
commissions and other direct costs incurred are capitalized and are
amortized to interest income over the lease term utilizing the
interest method.
(e) Other Real Estate Owned
Other real estate owned consists of property acquired in settlement
of loans which are initially valued at the lower of the carrying
amount of the loan or net realizable value, which is the fair value
of the property, based on appraisals at foreclosure, less estimated
selling costs. If warranted, these properties may be periodically
adjusted throughout the holding period if the net realizable value
is lower than the current basis of the asset.
(f) Allowance for Credit Losses
The allowance for credit losses is established through charges to
operations through the provision for credit losses. Management's
evaluation of the allowance is based on a continuing review of the
loan portfolio. Larger balance nonaccruing, impaired and delinquent
loans are reviewed individually and the value of any underlying
collateral is considered in determining estimates of losses
associated with those loans and the need, if any, for a specific
allowance. Losses in categories of smaller balance, homogeneous
loans are estimated based on historical experience, industry trends
and current trends in the real estate market and the current
economic environment in the Company's market areas. The unallocated
portion of the allowance for credit losses is based on management's
evaluation of various conditions, and involves a higher degree of
uncertainty because this component of the allowance is not
identified with specific problem credits or portfolio segments. The
conditions evaluated in connection with this element include the
following: changes in the composition of and growth in the loan
portfolio; industry and regional conditions; the strength and
duration of the current business cycle; existing general economic
and business conditions in the lending areas; credit quality trends,
including trends in nonaccruing loans; historical loan charge-off
experience; and the results of bank regulatory examinations.
(g) Premises and Equipment
Premises and equipment are carried at cost, net of accumulated
depreciation and amortization. Depreciation is computed on the
straight-line method over the estimated useful lives of the assets.
Leasehold improvements are amortized on the straight-line method
over the lesser of the life of the improvements or the lease term.
The Company generally amortizes buildings over a period of 20 to 39
years, furniture and equipment over a period of 3 to 10 years, and
capital leases over the respective lease term.
50
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
(h) Goodwill and Intangible Assets
The excess of the cost of acquired entities over the fair value of
identifiable tangible and intangible assets acquired, less
liabilities assumed, is recorded as goodwill. Acquired identifiable
intangible assets are amortized over their useful economic life.
Core deposit and customer list intangibles are generally amortized
based upon the projected discounted cash flows of the accounts
acquired. Effective with the Company's adoption of Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other
Intangible Assets" on January 1, 2002, the Company no longer
amortizes goodwill and any acquired intangible assets with an
indefinite useful economic life, but is required to review these
assets for impairment annually based upon guidelines specified by
the Statement. The Company has established November 1st of each year
as the date for conducting its annual goodwill impairment
assessment. The fair value of the Company's reporting units are
compared to their carrying amount, including goodwill. Reporting
units are identified based upon an analysis of each of the Company's
individual operating segments. A reporting unit is defined as any
distinct, separately identifiable component of an operating segment
for which complete, discrete financial information is available that
management regularly reviews. Discounted cash flow valuation models
that incorporate such variables as revenue growth rates, expense
trends, discount rates and terminal values are utilized to determine
the fair value of the Company's reporting units.
Prior to January 1, 2002, the Company amortized goodwill on a
straight-line basis over periods of ten to twenty years and
periodically assessed whether events or changes in circumstances
indicated that the carrying amount of goodwill might be impaired.
(i) Derivative Instruments
The Company recognizes all derivatives as either assets or
liabilities in the statement of condition and measures those
instruments at fair value. Changes in the fair value of the
derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether the derivative is used in
a qualifying hedge strategy and, if so, whether the hedge is a cash
flow or fair value hedge.
(j) Employee Benefits
The Company maintains non-contributory, qualified, defined benefit
pension plans (the "Pension Plans") that cover substantially all
employees who meet certain age and service requirements. The
actuarially determined pension benefit in the form of a life annuity
is based on the employee's combined years of service, age and
compensation. The Company's policy is to fund the minimum amount
required by government regulations. The costs of the pension plans
is based on actuarial computations of current and future benefits
for employees, and is charged to current operating expenses.
Effective February 1, 2002, the Company froze all benefit accruals
and participation in the pension plan.
The Company maintains several defined contribution plans and accrues
contributions due under those plans as earned by employees. The
Company also provides certain post-retirement benefits, principally
health care and group life insurance ("the post-retirement plan"),
to employees who meet certain age and service requirements and their
beneficiaries and dependents. The expected costs of providing these
post-retirement benefits are accrued during an employee's active
years of service. In 2001, the Company modified its post-retirement
plan so that participation was closed to those employees who did not
meet the retirement eligibility requirements by December 31, 2001.
51
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
(k) Stock-Based Compensation
The Company maintains various long-term incentive stock benefit
plans under which fixed award stock options and restricted stock
awards may be granted to certain officers, directors, key employees
and other persons providing services to the Company. SFAS No. 123,
"Accounting for Stock-Based Compensation," established accounting
and disclosure requirements using a fair value-based method of
accounting for stock-based employee compensation plans. As allowed
under SFAS No. 123, the Company has elected to continue to apply the
intrinsic value-based method of accounting prescribed by Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees," and has only adopted the disclosure
requirements of SFAS No. 123, as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure
- An Amendment of FASB Statement No. 123." As such, compensation
expense is recorded on the date the options are granted only if the
current market price of the underlying stock exceeded the exercise
price. Compensation expense related to restricted stock awards is
based upon the market value of FNFG's stock on the grant date and is
accrued ratably over the required service period.
Had the Company determined compensation cost based on the fair value
method under SFAS No. 123, net income would have been reduced to the
pro forma amounts indicated below. These amounts may not be
representative of the effects on reported net income for future
years due to changes in market conditions and the number of options
outstanding:
2003 2002 2001
---------- ---------- ----------
(In thousands, except per share amounts)
Net Income:
As reported $ 36,106 30,795 21,220
Add: Stock-based employee compensation
expense included in net income, net of
related income tax effects 900 556 420
Deduct: Stock-based employee compensation
expense determined under the fair-value
based method, net of related income tax effects (1,997) (1,172) (996)
---------- ---------- ----------
Pro forma $ 35,009 30,179 20,644
========== ========== ==========
Basic earnings per share:
As reported $ 0.55 0.48 0.33
Pro forma 0.53 0.47 0.32
Diluted earnings per share:
As reported $ 0.53 0.47 0.33
Pro forma 0.52 0.46 0.32
The per share weighted-average fair value of stock options granted
for 2003, 2002 and 2001 were $4.46, $3.95 and $1.62 on the date of
grant, respectively, using the Black Scholes option-pricing model.
52
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The following weighted-average assumptions were utilized to compute
the fair value of options granted for the respective years:
2003 2002 2001
--------- --------- ---------
Expected dividend yield 1.55% 1.51% 2.79%
Risk-free interest rate 3.02% 3.91% 5.02%
Expected life 6.5 years 6.5 years 7.5 years
Expected volatility 33.14% 33.71% 32.30%
========= ========= =========
The Company deducted 10% in each year to reflect an estimate of the
probability of forfeiture prior to vesting.
(l) Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the periods in which the
deferred tax assets or liabilities are expected to be realized or
settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through income tax expense.
(m) Earnings Per Share
Basic earnings per share ("EPS") is computed by dividing income
available to common stockholders by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts
to issue common stock were exercised or converted into common stock
or resulted in the issuance of common stock that then shared in the
earnings of the Company. All per share data and references to the
number of shares outstanding for purposes of calculating prior year
per share amounts have been restated to give recognition to the
2.58681 exchange ratio applied in the January 17, 2003 conversion
(See note 2).
(n) Comprehensive Income
Comprehensive income represents the sum of net income and items of
other comprehensive income or loss, which are reported directly in
stockholders' equity, net of tax. The Company has reported
comprehensive income and its components in the consolidated
statements of comprehensive income. Accumulated other comprehensive
income or loss, which is a component of stockholders' equity,
represents the net unrealized gain or loss on investment securities
available for sale, any cash flow hedges and the Company's minimum
pension liability, net of income taxes.
(o) Investment and Fiduciary Services
Assets held in fiduciary or agency capacity for customers are not
included in the accompanying consolidated statements of condition,
since such assets are not assets of the Company. Fee income is
recognized on the accrual method based on the fair value of assets
administered.
(p) Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and
disclosure of contingent assets and liabilities to prepare these
financial statements in conformity with accounting principles
generally accepted in the United States of America. Actual results
could differ from those estimates.
53
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
(q) New Accounting Standards
In November 2002, the Financial Accounting Standards Board ("FASB")
issued Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." This Interpretation enhances the
disclosures to be made by a guarantor in its financial statements
about its obligations under certain guarantees that it has issued.
It also requires a guarantor to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The initial recognition and
measurement provisions of Interpretation No. 45 are applicable on a
prospective basis to guarantees issued or modified after December
31, 2002. The Company adopted Interpretation No. 45 effective
January 1, 2003, which did not have a material impact on the
Company's consolidated financial statements.
In January 2003, as amended in December 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest
Entities," which clarifies the application of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements." More
specifically, the Interpretation explains how to identify variable
interest entities and how to determine whether or not those entities
should be consolidated. The Interpretation requires the primary
beneficiaries of variable interest entities to consolidate the
variable interest entities if they are subject to a majority of the
risk of loss or are entitled to receive a majority of the residual
returns. It also requires that both the primary beneficiary and all
other enterprises with a significant variable interest in a variable
interest entity make certain disclosures. Interpretation No. 46
applies immediately to variable interest entities created after
January 31, 2003, and to variable interest entities in which an
enterprise obtains an interest after that date. It applies in the
first fiscal period ending after December 15, 2003, to variable
interest entities in which an enterprise holds a variable interest
that it acquired before February 1, 2003. The provisions of this
Interpretation did not have a material impact on the Company's
consolidated financial statements.
(2) Corporate Structure and Stock Offering
FNFG was organized by First Niagara in April 1998 in connection with its
conversion from a New York State chartered mutual savings bank to a New
York State chartered stock savings bank and the reorganization to a
two-tiered mutual holding company. As part of that reorganization, FNFG
sold shares of common stock to eligible depositors of First Niagara and
issued approximately 53% of its shares of common stock to First Niagara
Financial Group, MHC (the "MHC"), a mutual holding company. As a result of
share repurchases subsequent to the reorganization, the MHC's ownership
interest increased to 61% of the issued and outstanding shares of common
stock of FNFG.
On January 17, 2003, the MHC converted from mutual to stock form (the
"Conversion"). In connection with the Conversion, the 61% of outstanding
shares of FNFG common stock owned by the MHC were sold to depositors of
First Niagara and other public investors (the "Offering"). Completion of
the Conversion and Offering resulted in the issuance of 67.4 million
shares of common stock. A total of 41.0 million shares were sold in
subscription, community and syndicated offerings, at $10.00 per share. An
additional 26.4 million shares were issued to the former public
stockholders of FNFG based upon an exchange ratio of 2.58681 new shares
for each share of FNFG held as of the close of business on January 17,
2003. Cash was paid in lieu of the issuance of fractional shares. In
connection with the Conversion, the amount of authorized but unissued
preferred stock was increased from $5.0 million to $50.0 million. The
Conversion was accounted for as reorganization in corporate form with no
change in the historical basis of the Company's assets, liabilities and
equity. All per share data and references to the number of shares
outstanding for purposes of calculating prior year per share amounts have
been adjusted to give recognition to the exchange ratio applied in the
Conversion. Prior year share data within the consolidated statements of
condition and changes in stockholders' equity have not been restated for
the exchange ratio.
54
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Costs related to the Offering, primarily marketing fees paid to the
Company's investment banking firm, professional fees, registration fees,
printing and mailing costs were $19.1 million and accordingly, net
offering proceeds were $390.9 million. As a result of the Conversion and
Offering, FNFG was succeeded by a new, fully public, Delaware corporation
with the same name and the MHC ceased to exist.
(3) Acquisitions and Dispositions of Assets
Acquisition of Finger Lakes Bancorp, Inc.
On January 17, 2003, simultaneously with the Conversion and Offering, the
Company acquired 100% of the outstanding common shares of Finger Lakes
Bancorp, Inc. ("FLBC") the holding company of Savings Bank of the Finger
Lakes ("SBFL"), headquartered in Geneva, New York. Subsequent to the
acquisition, SBFL branch locations were merged into First Niagara's
banking center network. The Company paid $20.00 per share, in a
combination of cash and stock from the Offering. The aggregate purchase
price of $67.3 million included the issuance of 3.4 million shares of FNFG
stock, cash payments totaling $33.2 million and capitalized costs related
to the acquisition, primarily investment banking and professional fees, of
$617 thousand. The value of the shares issued to FLBC shareholders was
based on the Offering price of $10.00 per share. This acquisition was
accounted for under the purchase method of accounting. Accordingly, the
results of operations of FLBC have been included in the consolidated
statement of income from the date of acquisition.
The following table presents unaudited pro forma information as if FLBC
had been consummated on January 1, 2002. Pro forma information for 2003 is
not presented since such pro forma results were not materially different
from actual results. This pro forma information gives effect to certain
adjustments, including accounting adjustments related to fair value
adjustments, amortization of core deposit intangibles and related income
tax effects. The pro forma information does not necessarily reflect the
results of operations that would have occurred had the Company acquired
FLBC on January 1, 2002 (In thousands except per share amounts):
Pro forma
(unaudited)
2002
-----------
Net interest income $101,355
Noninterest income 45,023
Noninterest expense 87,619
Net income 32,271
Basic earnings per share $ 0.48
========
Diluted earnings per share $ 0.47
========
55
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The following table summarizes the purchase price allocation relating to
the acquisition of FLBC. This allocation is based on the estimated fair
values of assets acquired and liabilities assumed at the acquisition date
(in thousands):
January 17,
2003
-----------
Cash and cash equivalents $ 4,873
Securities available for sale 146,147
Loans, net 201,084
Goodwill 28,665
Core deposit intangible 2,578
Other assets 27,625
--------
Total assets acquired 410,972
--------
Deposits 259,520
Borrowings 75,621
Other liabilities 8,499
--------
Total liabilities assumed 343,640
--------
Net assets acquired $ 67,332
========
The core deposit intangible acquired is being amortized over 11 years. The
goodwill was assigned to the Company's banking segment of which none is
deductible for tax purposes.
Sale of NOVA Healthcare Administrators, Inc.
On February 18, 2003, the Company sold its wholly owned third-party
benefit plan administrator subsidiary, NOVA Healthcare Administrators,
Inc. ("NOVA"). NOVA's assets totaled $5.8 million, including goodwill of
$1.0 million and other intangibles of $1.5 million. This sale resulted in
a gain of $208 thousand, net of $1.9 million of income taxes. The Company
has classified the results of operations from NOVA, including the net gain
on sale, as discontinued operations in the consolidated statements of
income for all periods presented.
Acquisition of Insurance Agencies
Effective July 1, 2003, First Niagara Risk Management, Inc. ("FNRM"), the
wholly owned insurance agency of First Niagara, simultaneously acquired
Costello, Dreher, Kaiser Insurance Agency ("Costello") and Loomis & Co.,
Inc. ("Loomis"), two Rochester, New York based insurance agencies.
Following completion of this transaction, the operations of Costello and
Loomis were merged into FNRM. Both acquisitions were accounted for under
the purchase method of accounting. Accordingly, the results of operations
of Costello and Loomis have been included in the consolidated statement of
income from the date of acquisition and as a result, the Company recorded
$4.5 million of goodwill and a $2.7 million customer list intangible
asset. The customer list intangible is being amortized over a weighted
average of 14 years. The goodwill was assigned to the Company's financial
services segment of which $2.2 million is deductible for tax purposes.
Sale of Banking Center
On October 25, 2002, the Company sold its Lacona Banking Center. In
connection with this transaction, $2.3 million of loans and $26.4 million
of deposits were sold, which resulted in a pre-tax gain of $2.4 million.
56
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Subsequent Event - Acquisition of Troy Financial Corporation
On January 16, 2004, FNFG acquired 100% of the outstanding common shares
of Troy Financial Corporation ("TFC"), the holding company of The Troy
Savings Bank ("TSB") and The Troy Commercial Bank ("TCB"), which had
combined assets of approximately $1.2 billion and twenty-one branch
locations. Following completion of the acquisition, TSB branch locations
were merged into First Niagara's banking center network and TCB became a
wholly-owned subsidiary of First Niagara as a New York State chartered
commercial bank. FNFG paid $35.50 per share in a combination of 43% cash
and 57% common stock for all of the outstanding shares and options of TFC.
This acquisition extended the Company's market area to the Albany region
of New York State.
The aggregate purchase price of approximately $356 million included the
issuance of 13.3 million shares of FNFG stock, cash payments totaling
approximately $152 million and capitalized costs related to the
acquisition, primarily investment banking and professional fees, of
approximately $3 million. The value of the shares issued to TFC
shareholders of $15.15 per share was based on the average of the closing
price of FNFG common stock for the five trading days immediately preceding
the receipt of final bank regulatory approval on December 15, 2003. This
acquisition was accounted for under the purchase method of accounting.
Accordingly, the results of operations of TFC will be included in the 2004
consolidated statement of income from the date of acquisition. The
estimated fair values of the assets acquired and liabilities assumed from
TFC as of January 16, 2004, including purchase accounting adjustments,
were $1.4 billion and $1.0 billion, respectively.
(4) Investment Securities
The amortized cost, gross unrealized gains and losses and approximate fair
value of securities available for sale at December 31, 2003 are summarized
as follows (in thousands):
Amortized Unrealized Unrealized Fair
cost gains losses value
--------- ---------- ---------- --------
Debt securities:
U.S. Government agencies $287,604 563 (1,109) 287,058
States and political subdivisions 36,766 1,433 (10) 38,189
Corporate 13,708 46 (144) 13,610
-------- -------- -------- --------
Total debt securities 338,078 2,042 (1,263) 338,857
-------- -------- -------- --------
Mortgage-backed securities:
Federal National Mortgage Association 207,480 934 (1,616) 206,798
Federal Home Loan Mortgage Corporation 121,639 786 (1,206) 121,219
Government National Mortgage Association 9,959 346 (1) 10,304
Collateralized mortgage obligations:
Federal Home Loan Mortgage Corporation 97,419 163 (453) 97,129
Federal National Mortgage Association 43,370 180 (214) 43,336
Government National Mortgage Association 14,722 -- (320) 14,402
Privately issued 6,411 15 (3) 6,423
-------- -------- -------- --------
Total collateralized mortgage obligations 161,922 358 (990) 161,290
-------- -------- -------- --------
Total mortgage-backed securities 501,000 2,424 (3,813) 499,611
-------- -------- -------- --------
Asset-backed securities 2,363 39 -- 2,402
Other 5,009 16 (12) 5,013
-------- -------- -------- --------
Total securities available for sale $846,450 4,521 (5,088) 845,883
======== ======== ======== ========
57
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Management has assessed the 112 securities available for sale in an
unrealized loss position at December 31, 2003 and determined the decline
in fair value below amortized cost to be temporary. In making this
determination management considered the period of time the securities were
in a loss position, the percentage decline in comparison to the securities
amortized cost, the financial condition of the issuer (primarily
government or government agencies) and the Company's ability and intent to
hold these securities until their fair value recovers to their amortized
cost. Management believes the decline in fair value is primarily related
to the historically low interest rate environment and not to the credit
deterioration of the individual issuer.
The following table sets forth certain information regarding the Company's
securities available for sale that were in an unrealized loss position at
December 31, 2003 by the length of time those securities were in a
continuous loss position as follows (in thousands):
Less than 12 months 12 months or longer Total
--------------------- --------------------- ---------------------
Fair Unrealized Fair Unrealized Fair Unrealized
value losses value losses value losses
-------- ---------- -------- ---------- -------- ----------
Debt securities:
U.S. Government agencies $137,306 1,109 -- -- 137,306 1,109
States and political subdivisions 4,856 10 -- -- 4,856 10
Corporate 7,324 111 1,871 33 9,195 144
-------- -------- -------- -------- -------- --------
Total debt securities 149,486 1,230 1,871 33 151,357 1,263
-------- -------- -------- -------- -------- --------
Mortgage-backed securities:
Federal National Mortgage Association 114,061 1,616 -- -- 114,061 1,616
Federal Home Loan Mortgage Corporation 95,664 1,206 -- -- 95,664 1,206
Government National Mortgage Association 111 1 -- -- 111 1
Collateralized mortgage obligations:
Federal Home Loan Mortgage Corporation 59,822 453 -- -- 59,822 453
Federal National Mortgage Association 22,196 214 -- -- 22,196 214
Government National Mortgage Association 14,402 320 -- -- 14,402 320
Privately issued 2,636 2 25 1 2,661 3
-------- -------- -------- -------- -------- --------
Total collateralized mortgage obligations 99,056 989 25 1 99,081 990
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities 308,892 3,812 25 1 308,917 3,813
-------- -------- -------- -------- -------- --------
Other 2,466 12 -- -- 2,466 12
-------- -------- -------- -------- -------- --------
Total investment securities $460,844 5,054 1,896 34 462,740 5,088
======== ======== ======== ======== ======== ========
58
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The amortized cost, gross unrealized gains and losses and approximate fair
value of securities available for sale at December 31, 2002 are summarized
as follows (in thousands):
Amortized Unrealized Unrealized Fair
cost gains losses value
--------- ---------- ---------- --------
Debt securities:
U.S. Government agencies $229,582 1,008 (7) 230,583
States and political subdivisions 32,957 1,609 -- 34,566
Corporate 14,665 137 (239) 14,563
-------- -------- -------- --------
Total debt securities 277,204 2,754 (246) 279,712
-------- -------- -------- --------
Mortgage-backed securities:
Federal National Mortgage Association 12,619 1,171 -- 13,790
Federal Home Loan Mortgage Corporation 51,024 1,936 -- 52,960
Government National Mortgage Association 9,910 659 -- 10,569
Collateralized mortgage obligations:
Federal Home Loan Mortgage Corporation 142,008 529 (182) 142,355
Federal National Mortgage Association 52,611 303 (65) 52,849
Government National Mortgage Association 14,999 32 (6) 15,025
Privately issued 52,543 316 (88) 52,771
-------- -------- -------- --------
Total collateralized mortgage obligations 262,161 1,180 (341) 263,000
-------- -------- -------- --------
Total mortgage-backed securities 335,714 4,946 (341) 340,319
-------- -------- -------- --------
Asset-backed securities 3,776 63 (2) 3,837
Other 8,630 596 (730) 8,496
-------- -------- -------- --------
Total securities available for sale $625,324 8,359 (1,319) 632,364
======== ======== ======== ========
Gross realized gains and losses on securities available for sale are
summarized as follows (in thousands):
2003 2002 2001
------- ------- -------
Gross realized gains $ 1,208 8,924 2,080
Gross realized losses (1,199) (9,968) (2,163)
------- ------- -------
Net realized gains (losses) $ 9 (1,044) (83)
======= ======= =======
Scheduled contractual maturities of certain investment securities owned by
the Company at December 31, 2003 are as follows (in thousands):
Amortized Fair
cost value
--------- --------
Debt securities:
Within one year $117,408 117,736
After one year through five years 198,822 198,586
After five years through ten years 8,224 8,973
After ten years 13,624 13,562
-------- --------
Total debt securities 338,078 338,857
Mortgage-backed securities 501,000 499,611
Asset-backed securities 2,363 2,402
-------- --------
$841,441 840,870
======== ========
59
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
While the contractual maturities of mortgage and asset-backed securities
generally exceed ten years, the effective lives are expected to be
significantly shorter due to prepayments.
At December 31, 2003 and 2002, $276.0 million and $228.7 million,
respectively, of investment securities were pledged to secure borrowings
and lines of credit from the Federal Home Loan Bank ("FHLB") and Federal
Reserve Bank ("FRB"), repurchase agreements and deposits.
At December 31, 2003 and 2002, no investments in securities of a single
non-U.S. Government or government agency issuer exceeded 10% of
stockholders' equity.
Federal funds sold and other short-term investments at December 31, 2003
include $75.0 million of securities purchased under agreements to resell.
The maximum and average amount outstanding under these agreements during
2003 was $125.0 million and $72.5 million, respectively. There were no
such agreements at any month-end during 2002. In connection with these
agreements, the Company accepts investment securities or loans as
collateral, which are maintained at a third-party custodian or with the
counterparty and may not be sold or repledged. The collateral is returned
at the maturity of the investment, which typically is 30 days or less.
(5) Loans
Loans receivable at December 31, 2003 and 2002 consist of the following
(in thousands):
2003 2002
----------- -----------
Real estate:
Residential $ 949,703 933,020
Home equity 179,172 136,986
Commercial and multi-family 653,762 473,493
Commercial construction 86,154 101,633
----------- -----------
Total real estate loans 1,868,791 1,645,132
Commercial business loans 215,000 178,555
Consumer loans 202,371 169,155
----------- -----------
Total loans 2,286,162 1,992,842
Net deferred costs and unearned discounts 8,461 2,591
Allowance for credit losses (25,420) (20,873)
----------- -----------
Total loans, net $ 2,269,203 1,974,560
=========== ===========
Included in commercial business loans are $78.1 million and $41.5 million
of direct financing leases at December 31, 2003 and 2002, respectively.
Under direct financing leases, the Company leases equipment to small
businesses with terms generally ranging from two to five years. The
Company originated $49.6 million, $34.6 million and $16.5 million of
equipment leases during 2003, 2002 and 2001, respectively, of which $1.2
million, $2.6 million and $4.5 million were sold to outside investors,
respectively. The remainder of the leases originated in 2003, 2002 and
2001 were retained by the Company.
60
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Non-accrual loans amounted to $12.3 million, $7.5 million and $11.5
million at December 31, 2003, 2002 and 2001, respectively. Interest income
that would have been recorded if the loans had been performing in
accordance with their original terms amounted to $295 thousand, $182
thousand and $604 thousand in 2003, 2002 and 2001, respectively. At
December 31, 2003 and 2002, the balance of impaired loans amounted to
$10.4 million and $4.2 million, respectively, and $1.7 million and $897
thousand, respectively, was included within the allowance for credit
losses to specifically reserve for losses relating to those loans. Real
estate owned at December 31, 2003 and 2002 was $543 thousand and $1.4
million, respectively.
Residential mortgage loans include loans held for sale of $2.7 million and
$4.3 million at December 31, 2003 and December 31, 2002, respectively.
Loans sold amounted to $56.4 million, $55.5 million and $105.5 million in
2003, 2002 and 2001, respectively. Gains on the sale of loans amounted to
$1.3 million, $1.0 million and $1.4 million in 2003, 2002 and 2001,
respectively, and is included in other noninterest income in the
consolidated statements of income.
Changes in the allowance for credit losses are summarized as follows (in
thousands):
2003 2002 2001
-------- -------- --------
Balance, beginning of year $ 20,873 18,727 17,746
Provision for credit losses 7,929 6,824 4,160
Obtained through acquisitions 2,001 -- --
Charge-offs (6,760) (5,804) (4,071)
Recoveries 1,377 1,126 892
-------- -------- --------
Balance, end of year $ 25,420 20,873 18,727
======== ======== ========
Virtually all of the Company's loans are to customers located in New York
State. The ultimate collectibility of these loans is susceptible to
changes in market conditions in this market area.
Loans due from certain officers and directors of the Company and
affiliates amounted to $1.9 million and $1.5 million at December 31, 2003
and 2002, respectively.
Changes in capitalized mortgage servicing assets, classified within other
assets in the consolidated statements of condition are summarized as
follows (in thousands):
2003 2002 2001
-------- -------- --------
Balance, beginning of year $ 1,408 1,265 519
Originations 538 482 952
Obtained through acquisitions 425 -- --
Amortization (714) (339) (206)
-------- -------- --------
Balance, end of year $ 1,657 1,408 1,265
======== ======== ========
Mortgages serviced for others by the Company amounted to $246.1 million,
$242.9 million and $252.3 million at December 31, 2003, 2002 and 2001,
respectively.
61
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
(6) Premises and Equipment
A summary of premises and equipment at December 31, 2003 and 2002 follows
(in thousands):
2003 2002
-------- --------
Land $ 3,539 3,511
Buildings and improvements 39,456 31,190
Furniture and equipment 44,309 33,670
Property under capital leases 1,365 1,365
-------- --------
88,669 69,736
Accumulated depreciation and amortization (44,975) (29,291)
-------- --------
Premises and equipment, net $ 43,694 40,445
======== ========
Rent expense was $2.1 million, $1.8 million and $1.5 million for 2003,
2002 and 2001, respectively, and is included in occupancy and equipment
expense.
(7) Goodwill and Intangible Assets
The following table sets forth information regarding the Company's
goodwill for 2003 and 2002 (in thousands):
Financial
Banking services Consolidated
segment segment total
-------- --------- ------------
Balances at January 1, 2002 $ 66,875 7,338 74,213
Contingent earn-out -- (112) (112)
-------- -------- --------
Balances at December 31, 2002 66,875 7,226 74,101
Acquired 28,665 4,520 33,185
Sold -- (1,028) (1,028)
Contingent earn-out -- (277) (277)
-------- -------- --------
Balances at December 31, 2003 $ 95,540 10,441 105,981
======== ======== ========
The Company has performed the required annual goodwill impairment tests as
of November 1, 2003 and 2002. Based upon the results of these tests, the
Company has determined that goodwill was not impaired as of those dates.
62
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The following tables set forth information regarding the Company's
amortizing intangible assets at December 31, 2003 and 2002 (in thousands):
2003 2002
-------- --------
Customer lists:
Gross amount $ 10,271 10,113
Accumulated amortization (3,693) (3,721)
-------- --------
Net carrying amount 6,578 6,392
-------- --------
Core deposit intangible asset:
Gross amount 2,578 --
Accumulated amortization (439) --
-------- --------
Net carrying amount 2,139 --
-------- --------
Total amortizing intangible assets, net $ 8,717 6,392
======== ========
Estimated future amortization expense over the next five years for
intangible assets outstanding at December 31, 2003 is as follows:
2004 $1,381
2005 1,276
2006 1,246
2007 1,122
2008 1,038
======
Effective January 1, 2002, in accordance with SFAS No. 142, the Company no
longer amortized goodwill. The following is a reconciliation of reported
net income and earnings per share for the year ended December 31, 2001 to
net income and earnings per share adjusted as if SFAS No. 142 had been
adopted on January 1, 2001 (in thousands except per share amounts):
2001
----------
Net income:
As reported $ 21,220
Add back: Goodwill amortization 4,742
----------
Adjusted net income $ 25,962
==========
Basic earnings per share:
As reported $ 0.33
Add back: Goodwill amortization 0.08
----------
Adjusted basic earnings per share $ 0.41
==========
Diluted earnings per share:
As reported $ 0.33
Add back: Goodwill amortization 0.07
----------
Adjusted diluted earnings per share $ 0.40
==========
63
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
(8) Other Assets
A summary of other assets at December 31, 2003 and 2002 follows (in
thousands):
2003 2002
------- -------
FHLB stock $19,221 20,863
Accrued interest receivable 14,913 12,093
Other receivables and prepaid assets 12,061 7,975
Net deferred tax assets (see note 15) 11,296 9,188
Other 13,519 12,207
------- -------
$71,010 62,326
======= =======
Included in other assets are $4.6 million and $3.6 million of limited
partnership investments at December 31, 2003 and 2002, respectively. These
investments were made primarily for Community Reinvestment Act purposes
and are accounted for using the equity method. At December 31, 2003, the
Company had $1.0 million in outstanding funding commitments to these
partnerships.
(9) Deposits
Deposits consist of the following at December 31, 2003 and 2002 (in
thousands):
2003 2002
-------------------- --------------------
Weighted Weighted
average average
Balance rate Balance rate
-------------------- --------------------
Savings $ 654,320 0.78% 708,846 1.48%
Certificates of deposit, maturing:
Within one year 777,160 2.34 630,587 3.15
After one year, through two years 140,717 3.09 195,372 3.24
After two years, through three years 48,686 4.37 20,499 4.68
After three years, through four years 17,808 3.83 25,231 4.50
After four years, through five years 4,919 3.08 4,906 4.17
After five years 2,255 4.32 2,651 4.72
---------- ----------
991,545 2.58 879,246 3.26
---------- ----------
Checking:
Interest-bearing 538,967 0.80 467,550 1.18
Noninterest-bearing 154,672 -- 134,160 --
---------- ----------
693,639 601,710
---------- ----------
Mortgagors' payments held in escrow 15,712 -- 15,619 2.00
---------- ----------
$2,355,216 1.49% 2,205,421 2.04%
========== ==========
Deposits at December 31, 2002 included approximately $89.2 million of
stock subscription proceeds in connection with the Company's second step
stock offering and $13.0 million from the MHC. Those funds were withdrawn
from their respective deposit accounts and credited to stockholders'
equity upon completion of the Conversion and Offering on January 17, 2003.
64
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Interest expense on deposits is summarized as follows (in thousands):
2003 2002 2001
------- ------- -------
Certificates of deposit $29,232 32,774 47,284
Savings 6,809 12,750 10,919
Interest-bearing checking 4,767 7,791 15,878
Mortgagors' payments
held in escrow -- 296 328
------- ------- -------
$40,808 53,611 74,409
======= ======= =======
Certificates of deposit issued in amounts over $100 thousand amounted to
$198.0 million, $170.0 million and $157.8 million at December 31, 2003,
2002 and 2001, respectively. Interest expense thereon approximated $5.8
million, $6.3 million and $9.3 million in 2003, 2002 and 2001,
respectively. The Federal Deposit Insurance Corporation insures deposit
amounts up to $100 thousand. Interest rates on certificates of deposit
range from 1.00% to 7.70% at December 31, 2003.
(10) Other Borrowed Funds
Information relating to outstanding borrowings at December 31, 2003 and
2002 is summarized as follows (in thousands):
2003 2002
-------- --------
Short-term borrowings:
FHLB advances $ 31,573 48,180
Repurchase agreements 55,575 15,132
Loan payable to First Niagara
Financial Group, MHC -- 6,000
-------- --------
$ 87,148 69,312
======== ========
Long-term borrowings:
FHLB advances $182,928 187,823
Repurchase agreements 187,890 140,000
-------- --------
$370,818 327,823
======== ========
FHLB advances generally bear fixed interest rates ranging from 1.24% to
7.71% and had a weighted average rate of 5.37% at December 31, 2003.
Repurchase agreements generally bear fixed interest rates ranging from
0.80% to 6.75% and had a weighted average rate of 4.58% at December 31,
2003.
Interest expense on borrowings is summarized as follows (in thousands):
2003 2002 2001
------- ------- -------
FHLB advances $11,328 14,081 16,514
Repurchase agreements 10,408 8,256 7,669
Loan payable to First Niagara
Financial Group, MHC -- 153 394
Commercial bank loan -- 6 366
------- ------- -------
$21,736 22,496 24,943
======= ======= =======
65
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The Company has lines of credit with the FHLB, FRB and a commercial bank
that provide a secondary funding source for lending, liquidity and asset
and liability management. At December 31, 2003, the FHLB line of credit
totaled $895.6 million with $214.5 million outstanding. The FRB and
commercial bank lines of credit totaled $36.5 million and $25.0 million,
respectively, with no borrowings outstanding on either line as of December
31, 2003. Approximately $233.7 million of residential mortgage and
multifamily loans were pledged to secure the amount outstanding under the
FHLB line of credit at December 31, 2003. As part of the commercial bank
line of credit agreement, FNFG will pledge shares of First Niagara common
stock equal to two times the borrowings outstanding.
As of December 31, 2003, the Company had entered into repurchase
agreements with the FHLB and various broker-dealers, whereby securities
available for sale with a carrying value of $243.5 million were pledged to
collateralize the borrowings. These are treated as financing transactions
and the obligations to repurchase are reflected as a liability in the
consolidated financial statements. The dollar amount of securities
underlying the agreements are included in securities available for sale in
the consolidated statements of condition. However, the securities are
delivered to the dealer with whom each transaction is executed. The
dealers may sell, loan or otherwise dispose of such securities to other
parties in the normal course of their business, but agree to resell to the
Company the same securities at the maturities of the agreements. The
Company also retains the right of substitution of collateral throughout
the terms of the agreements. At December 31, 2003, there were no amounts
at risk under reverse repurchase agreements with any individual
counterparty or group of related counterparties that exceeded 10% of
stockholders' equity. The amount at risk is equal to the excess of the
carrying value (or market value if greater) of the securities sold under
agreements to repurchase over the amount of the repurchase liability.
The aggregate maturities of long-term borrowings at December 31, 2003 are
as follows (in thousands):
2005 $ 96,239
2006 59,268
2007 39,164
2008 78,160
Thereafter 97,987
--------
$370,818
========
(11) Commitments and Contingent Liabilities
Loan Commitments
In the ordinary course of business, the Company extends commitments to
originate residential mortgages, commercial loans and other consumer
loans. Commitments to extend credit are agreements to lend to a customer
as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since the Company
does not expect all of the commitments to be funded, the total commitment
amounts do not necessarily represent future cash requirements. The Company
evaluates each customer's creditworthiness on a case-by-case basis.
Collateral may be obtained based upon management's assessment of the
customers' creditworthiness. Commitments to extend credit may be written
on a fixed rate basis exposing the Company to interest rate risk given the
possibility that market rates may change between commitment and actual
extension of credit. The Company had outstanding commitments to originate
loans of approximately $115.9 million and $124.6 million at December 31,
2003 and 2002, respectively. Commitments to sell residential mortgages
amounted to $3.8 million and $5.0 million at December 31, 2003 and 2002,
respectively.
66
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The Company extends credit to consumer and commercial customers, up to a
specified amount, through lines of credit. As the borrower is able to draw
on these lines as needed, the funding requirements are generally
unpredictable. Unused lines of credit amounted to $234.3 million and
$167.4 million at December 31, 2003 and 2002, respectively. The Company
also issues standby letters of credit to third parties, which guarantee
payments on behalf of commercial customers in the event the customer fails
to perform under the terms of the contract with the third-party. Standby
letters of credit amounted to $20.4 million and $12.1 million at December
31, 2003 and 2002, respectively. Since a significant portion of unused
commercial lines of credit and the majority of outstanding standby letters
of credit expire without being funded, the Company's expectation is that
its obligation to fund the above commitment amounts is substantially less
than the amounts reported. The credit risk involved in issuing these
commitments is essentially the same as that involved in extending loans to
customers and is limited to the contractual notional amount of those
instruments.
Lease Obligations
Future minimum rental commitments for premises and equipment under
noncancellable operating leases at December 31, 2003 were $2.2 million in
2004; $2.1 million in 2005; $2.0 million in 2006; $1.7 million in 2007;
$1.6 million in 2008; and $7.1 million thereafter through 2021. Real
estate taxes, insurance and maintenance expenses related to these leases
are obligations of the Company.
Liquidation Account
First Niagara established liquidation accounts at the time of its
conversion from a New York State chartered mutual savings bank to a New
York State chartered stock savings bank and the reorganization to a
two-tiered mutual holding company in April 1998 and at the time of its
conversion from a mutual holding company structure to stock form in
January 2003. The liquidation accounts were established in an amount equal
to First Niagara's net worth as of the date of the latest consolidated
statement of financial condition appearing in the final prospectus for
each conversion. In the event of a complete liquidation of First Niagara,
each eligible account holder will be entitled, under New York State Law,
to receive a distribution from the liquidation accounts in an amount equal
to their current adjusted account balance for all such depositors then
holding qualifying deposits in First Niagara. Accordingly, retained
earnings of the Company are deemed to be restricted up to the balances of
the liquidation accounts at December 31, 2003 and 2002. The liquidation
accounts are maintained for the benefit of eligible pre-conversion account
holders who continue to maintain their accounts at First Niagara after the
conversions. Similarly, liquidation accounts are also maintained for
depositors of acquired banks in connection with their conversions. The
liquidation accounts, which are reduced annually to the extent that
eligible account holders have reduced their qualifying deposits as of each
anniversary date, totaled $214.2 million at December 31, 2003 and $38.6
million at December 31, 2002.
Dividends
FNFG's ability to pay dividends to its shareholders is substantially
dependent upon the ability of First Niagara to pay dividends to FNFG. The
payment of dividends by First Niagara is subject to continued compliance
with minimum regulatory capital requirements. In addition, regulatory
approval would be required prior to First Niagara declaring any dividends
in excess of net income for that year plus net income retained in the two
preceding years. First Niagara must file a notice with the Office of
Thrift Supervision ("OTS") at least 30 days before the Board of Directors
declares a dividend or approves a capital distribution. The OTS may
disapprove a notice or application if: First Niagara would be
undercapitalized following the distribution; the proposed capital
distribution raises safety and soundness concerns; or the capital
distribution would violate a prohibition contained in any statute,
regulation or agreement.
67
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
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.
Other
The Company has commitments to invest in certain Community Reinvestment
Act limited partnerships as discussed in note 8. The Company also has
investment securities pledged to secure borrowings, lines of credit,
repurchase agreements and deposits as discussed in note 4.
(12) Capital
OTS regulations require savings institutions to maintain a minimum ratio
of tangible capital to total adjusted assets of 1.5%, a minimum ratio of
Tier 1 (core) capital to total adjusted assets of 4.0%, and a minimum
ratio of total (core and supplementary) capital to risk-weighted assets of
8.0%.
Under its prompt corrective action regulations, the OTS is required to
take certain supervisory actions (and may take additional discretionary
actions) with respect to an undercapitalized institution. Such actions
could have a direct material effect on the institution's financial
statements. The regulations establish a framework for the classification
of savings institutions into five categories -- well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized,
and critically undercapitalized. Generally, an institution is considered
well capitalized if it has a Tier 1 (core) capital ratio of at least 5.0%,
a Tier 1 risk-based capital ratio of at least 6.0%, and a total risk-based
capital ratio of at least 10.0%.
The actual capital amounts and ratios for First Niagara at December 31,
2003 and 2002 are presented in the following table (in thousands):
To be well capitalized
Minimum under prompt corrective
Actual capital adequacy action provisions
------------------- ------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
-------- -------- -------- -------- -------- --------
December 31, 2003:
Tangible capital $411,562 11.87% $ 52,017 1.50% $ N/A N/A%
Tier 1 (core) capital 413,700 11.92 138,797 4.00 173,496 5.00
Tier 1 risk-based capital 413,700 17.94 N/A N/A 138,366 6.00
Total risk-based capital 439,120 19.04 184,488 8.00 230,610 10.00
December 31, 2002:
Tangible capital $186,218 6.54% $ 42,699 1.50% $ N/A N/A%
Tier 1 (core) capital 186,218 6.54 113,863 4.00 142,328 5.00
Tier 1 risk-based capital 186,218 10.27 N/A N/A 108,743 6.00
Total risk-based capital 205,508 11.34 144,990 8.00 181,238 10.00
68
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The following is a reconciliation of stockholders' equity under generally
accepted accounting principles ("GAAP") to regulatory capital for First
Niagara at December 31, 2003 an 2002 (in thousands):
2003 2002
--------- ---------
GAAP stockholders' equity $ 525,846 270,946
Capital adjustments:
Goodwill and other intangible assets (114,698) (80,493)
Qualifying intangible assets 2,139 --
Unrealized losses on equity securities available
for sale (net of tax) -- (408)
Fair value adjustment included in stockholders' equity 340 (3,930)
Disallowed portion of mortgage servicing rights (166) (140)
Minority interest 239 243
--------- ---------
Tier 1 capital 413,700 186,218
Allowable portion of allowance for credit losses 25,420 20,873
Fair value of equity securities -- (1,583)
--------- ---------
Total capital $ 439,120 205,508
========= =========
The foregoing capital ratios are based in part on specific quantitative
measures of assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. Capital amounts and
classifications are also subject to qualitative judgments by the OTS about
capital components, risk weightings and other factors. These capital
requirements apply only to First Niagara, and do not consider additional
capital retained by FNFG.
Management believes that as of December 31, 2003, First Niagara met all
capital adequacy requirements to which it was subject. Further, the most
recent Federal Deposit Insurance Corporation notification categorized
First Niagara as a well-capitalized institution under the prompt
corrective action regulations. Management is unaware of any conditions or
events since the latest notification from federal regulators, including
the acquisition of TFC, that have changed the capital adequacy category of
First Niagara.
In July 2003 the Company received approval from its Board of Directors and
a regulatory non-objection from the OTS to its request to repurchase up to
2.1 million (3%) of its outstanding common stock in order to fund
currently exercisable stock options. The regulatory non-objection was
necessary because the repurchase program will commence less than one year
from the date of the Company's reorganization and second step stock
offering on January 17, 2003. As of December 31, 2003, 110 thousand shares
have been repurchased under this program at an average cost of $14.58 per
share.
(13) Derivative and Hedging Activities
During 1999 and 2000 the Company entered into interest rate swap
agreements to manage the interest rate risk related to its Money Market
Deposit Accounts ("MMDA"). Under the agreements the Company paid an annual
fixed rate of interest and received a floating three-month U.S. Dollar
LIBOR rate over a two-year period. The last of the Company's interest rate
swap agreements expired in December 2002. Since the swap agreements
qualified as cash flow hedges, the Company recognized the portion of the
change in fair value of the interest rate swaps that was considered
effective in hedging cash flows as a direct charge or credit to other
comprehensive income, net of tax, each period. The Company intends to
continue to analyze the future utilization of swap agreements as part of
its overall asset and liability management process.
69
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The following table illustrates the effect of interest rate swaps on other
comprehensive income for 2002 and 2001 (in thousands):
Before-tax Income Net-of-tax
amount taxes amount
---------- ------ ---------
Year ended December 31, 2002:
Net unrealized losses arising during 2002 $(175) 70 (105)
Reclassification adjustment for realized
losses included in net income 518 (207) 311
----- ----- -----
Net gains included in other
comprehensive income $ 343 (137) 206
===== ===== =====
Year ended December 31, 2001:
Net unrealized losses arising during 2001 $(837) 334 (503)
Reclassification adjustment for realized
losses included in net income 652 (260) 392
----- ----- -----
Net losses included in other
comprehensive income $(185) 74 (111)
===== ===== =====
With the adoption of SFAS No. 133 on January 1, 2001 a negative fair value
adjustment of $95 thousand was recorded in other comprehensive income, net
of income taxes of $63 thousand, as a cumulative effect of a change in
accounting principle, as required by the Statement. For 2002, interest
expense on deposits was reduced by $117 thousand for the portion of the
change in fair value of swaps that was determined to be ineffective. For
2001, interest expense on deposits was increased by $117 thousand for the
portion of the change in fair value of swaps that was determined to be
ineffective. Amounts included in other comprehensive income relating to
the unrealized losses on swaps was reclassified to interest expense on
deposit accounts as interest expense on the hedged MMDA accounts increased
or decreased, based upon fluctuations in the U.S. Dollar LIBOR rate.
(14) Stock Based Compensation
The Company has two stock based compensation plans pursuant to which
options may be granted to officers, directors and key employees. The 1999
Stock Option Plan authorizes grants of options to purchase up to 1,390,660
shares of common stock. In 2002, the Board of Directors and stockholders
of FNFG adopted a long-term incentive stock benefit plan. This plan
authorizes the issuance of up to 834,396 shares of common stock pursuant
to grants of stock options, stock appreciation rights, accelerated
ownership option rights or stock awards. During 2003 and 2002, only stock
options were granted under this plan. Under both plans, stock options are
granted with an exercise price equal to the stock's market value on the
date of grant. All options have a 10-year term and become fully vested and
exercisable over a period of 4 to 5 years from the grant date. At December
31, 2003, there were a total of 1.3 million shares available for grant
under these plans. All stock options and restricted stock awards
outstanding and available for grant on January 17, 2003 were adjusted for
the 2.58681 exchange ratio applied in the Conversion. Prior year share and
per share amounts within this note have not been adjusted for this
exchange ratio.
70
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The following is a summary of stock option activity for 2003, 2002 and
2001:
Weighted
Number of average
shares exercise price
--------- --------------
Balance at January 1, 2001 1,239,150 $10.12
Granted 173,375 13.06
Exercised (39,700) 10.22
Forfeited (120,600) 10.23
---------
Balance at December 31, 2001 1,252,225 10.51
Granted 164,868 29.38
Exercised (90,350) 10.43
---------
Balance at December 31, 2002 1,326,743 12.86
January 17, 2003 Conversion 2,105,289 4.97
Granted 667,900 13.73
Exercised (104,823) 4.38
Forfeited (65,858) 7.13
---------
Balance at December 31, 2003 3,929,251 $ 6.44
=========
The following is a summary of stock options outstanding at December 31,
2003, 2002 and 2001:
Weighted Weighted Weighted
average average average
Options exercise remaining Options exercise
Exercise price outstanding price life (years) exercisable price
- ------------------ ----------- --------- ------------ ----------- ---------
December 31, 2003:
$3.49 - $3.65 965,510 $ 3.51 6.44 668,152 $ 3.51
$4.16 - $5.93 1,859,766 $ 4.30 5.74 1,454,209 $ 4.24
$6.52 - $9.80 109,939 $ 8.83 8.26 35,569 $ 8.31
$11.25 - $16.21 994,036 $ 13.03 9.21 151,854 $ 12.06
--------- ---------
Total 3,929,251 $ 6.44 6.86 2,309,784 $ 4.60
========= =========
December 31, 2002:
$9.03 - $12.60 1,135,375 $ 10.41 6.99 544,495 $ 10.37
$13.80 - $16.86 26,500 $ 15.48 8.73 5,125 $ 15.67
$25.35 - $31.54 164,868 $ 29.38 9.62 -- --
--------- ---------
Total 1,326,743 $ 12.86 7.35 549,620 $ 10.42
========= =========
December 31, 2001:
$9.03 - $12.60 1,224,725 $ 10.40 7.97 348,500 $ 10.35
$13.80 - $16.86 27,500 $ 15.47 9.73 -- --
--------- ---------
Total 1,252,225 $ 10.51 8.01 348,500 $ 10.35
========= =========
71
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
During 1999, the Company allocated 556,264 shares for issuance under a
Restricted Stock Plan. The plan grants shares of FNFG's stock to executive
management, members of the Board of Directors and key employees. The
restricted stock generally becomes fully vested over five years from the
grant date. Compensation expense equal to the market value of FNFG's stock
on the grant date is accrued ratably over the service period for shares
granted. At December 31, 2003, there were 358,095 unvested shares
outstanding and 317,856 additional shares available for grant under the
plan. Shares granted under the Restricted Stock Plan during 2003, 2002 and
2001 totaled 97,100, 45,315 and 51,500, respectively, and had a weighted
average market value on the date of grant of $13.49, $26.99 and $13.51,
respectively. Compensation expense related to this plan amounted to $1.4
million, $927 thousand and $648 thousand for 2003, 2002 and 2001,
respectively.
(15) Income Taxes
Total income taxes were allocated as follows (in thousands):
2003 2002 2001
-------- -------- --------
Income from continuing operations $ 18,646 18,752 12,427
Income from discontinued operations 1,868 402 276
Stockholders' equity (1,855) (1,345) (1,403)
======== ======== ========
The components of income taxes attributable to income from continuing and
discontinued operations are as follows (in thousands):
2003 2002 2001
------- ------- -------
Continuing Operations:
Current:
Federal $14,888 16,182 11,157
State 901 1,470 450
------- ------- -------
15,789 17,652 11,607
------- ------- -------
Deferred:
Federal 2,447 (549) 801
State 410 1,649 19
------- ------- -------
2,857 1,100 820
------- ------- -------
Income taxes from continuing
operations 18,646 18,752 12,427
Income taxes from discontinued
operations 1,868 402 276
------- ------- -------
Total income taxes $20,514 19,154 12,703
======= ======= =======
As discussed further in note 3, during 2003 the Company sold its
wholly-owned subsidiary, NOVA, which generated a pre-tax gain of $2.1
million. For income tax purposes, this sale was treated as an asset sale,
which resulted in approximately $1.9 million in federal and state tax
expense.
72
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The Company's effective tax rate for 2003, 2002 and 2001 were 36.2%, 38.3%
and 37.4%, respectively. Income tax expense attributable to income from
continuing operations differs from the expected tax expense (computed by
applying the Federal corporate tax rate of 35% to income before income
taxes) as follows (in thousands):
2003 2002 2001
-------- -------- --------
Expected tax expense from continuing operations $ 19,106 17,206 11,757
Increase (decrease) attributable to:
State income taxes, net of Federal
benefit and deferred state tax 757 820 312
Bank-owned life insurance income (1,202) (930) (877)
Municipal interest (499) (430) (537)
Nondeductible ESOP expense 450 209 102
Amortization of goodwill and intangibles 186 233 1,796
New York State bad debt tax expense
recapture, net of Federal benefit -- 1,784 --
Other (152) (140) (126)
-------- -------- --------
Income taxes from continuing operations $ 18,646 18,752 12,427
======== ======== ========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 2003 and 2002 are presented below (in thousands):
2003 2002
-------- --------
Deferred tax assets:
Financial statement allowance for credit losses $ 10,226 8,328
Net purchase discount on acquired companies 663 1,738
Deferred compensation 2,749 2,144
Post-retirement benefit obligation 1,626 1,403
Unrealized loss on securities available for sale 228 --
Net operating loss carryforwards acquired 1,228 --
Acquired intangibles -- 696
Pension obligation -- 1,135
Other 568 528
-------- --------
Total gross deferred tax assets 17,288 15,972
Valuation allowance -- --
-------- --------
Net deferred tax assets 17,288 15,972
-------- --------
Deferred tax liabilities:
Tax return allowance for credit losses, in excess
of base year amount (1,930) (2,266)
Unrealized gain on securities available for sale -- (2,808)
Excess of tax return depreciation over financial
statement depreciation (1,179) (1,078)
Acquired intangibles (797) --
Pension obligation (1,421) --
Other (665) (632)
-------- --------
Total gross deferred tax liabilities (5,992) (6,784)
-------- --------
Net deferred tax asset $ 11,296 9,188
======== ========
73
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Prior to 2002, First Niagara was subject to special provisions in the New
York State tax law that allowed it to deduct on its tax return bad debt
expenses in excess of those actually incurred based on a specified formula
("excess reserve") as long as First Niagara was able to maintain the
required percentage of qualified assets (primarily residential mortgages
and mortgage-backed securities) to total assets. In 2002, First Niagara
was no longer able to maintain this required percentage of qualified
assets, as prescribed by the tax law, and therefore is required to repay
this excess reserve. Accordingly, the Company recorded a $1.8 million
deferred tax liability for the recapture of this excess reserve in the
second quarter of 2002. It is anticipated that the tax liability will be
repaid over a period of 10 to 15 years.
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, availability of operating loss carrybacks, projected future
taxable income, and tax planning strategies in making this assessment.
Based upon the level of historical taxable income, the opportunity for net
operating loss carrybacks, and projections for future taxable income over
the periods which deferred tax assets are deductible, management believes
it is more likely than not the Company will realize the benefits of these
deductible differences at December 31, 2003.
(16) Earnings Per Share
The computation of basic and diluted earnings per share follows. All
references to the number of shares outstanding for purposes of calculating
prior year per share amounts are restated to give recognition to the
2.58681 exchange ratio applied in the January 17, 2003 Conversion. Amounts
in the table are in thousands except per share amounts.
2003 2002 2001
-------- -------- --------
Net income available to common stockholders $ 36,106 30,795 21,220
======== ======== ========
Weighted average shares outstanding:
Total shares issued 71,069 76,973 76,973
Unallocated ESOP shares (4,050) (2,227) (2,364)
Unvested restricted stock awards (433) (567) (656)
Treasury shares (475) (9,734) (9,986)
-------- -------- --------
Total basic weighted average shares outstanding 66,111 64,445 63,967
Incremental shares from assumed exercise of
stock options 1,436 1,224 569
Incremental shares from assumed vesting of
restricted stock awards 207 214 160
-------- -------- --------
Total diluted weighted average shares outstanding 67,754 65,883 64,696
======== ======== ========
Basic earnings per share $ 0.55 0.48 0.33
======== ======== ========
Diluted earnings per share $ 0.53 0.47 0.33
======== ======== ========
74
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
(17) Benefit Plans
Pension Plans
Information regarding the Company's pension plans at December 31, 2003 and
2002 are as follows (in thousands):
2003 2002
-------- --------
Change in projected benefit obligation:
Projected benefit obligation at beginning of year $ 11,173 11,874
Projected benefit obligation acquired 2,632 --
Service cost 41 288
Interest cost 868 751
Actuarial loss 825 1,290
Benefits paid (476) (331)
Settlements (206) (23)
Plan amendments -- 119
Curtailment -- (2,795)
-------- --------
Projected benefit obligation at end of year 14,857 11,173
-------- --------
Change in fair value of plan assets:
Fair value of plan assets at beginning of year 8,186 9,763
Plan assets acquired 2,412 --
Employer contributions 3,700 --
Actual gain (loss) on plan assets 1,059 (1,223)
Benefits paid (476) (331)
Settlements (206) (23)
-------- --------
Fair value of plan assets at end of year 14,675 8,186
-------- --------
Projected benefit obligation in excess of plan
assets at end of year (182) (2,987)
Unrecognized actuarial loss 4,060 3,587
-------- --------
Prepaid pension costs $ 3,878 600
======== ========
Accumulated benefit obligation $ 14,857 11,173
======== ========
Amounts recognized in the consolidated balance sheet consist of:
Prepaid pension costs $ 3,878 600
Accumulated other comprehensive loss, net of tax (130) (2,156)
On January 17, 2003, in connection with its acquisition of FLBC, the
Company became the sponsor of SBFL's retirement plan, which was frozen on
December 31, 2002. As of October 1, 2003, this plan had an accumulated
benefit obligation of $3.0 million and a fair value of plan assets of $2.5
million. As a result, the Company has recorded a $206 thousand pension
liability and a $216 thousand (gross) additional minimum pension
liability, included as a reduction of stockholders' equity net of taxes of
$86 thousand. During 2003 the Company contributed $3.7 million to its
defined benefit pension plan and does not anticipate making any
contributions in 2004. As of December 31, 2003, the Company has met all
minimum ERISA funding requirements. As of October 1, 2002 the accumulated
benefit obligation of First Niagara's pension plan exceeded the fair value
of its assets and the Company recorded a $3.6 million (gross) additional
minimum pension liability net of taxes of $1.4 million.
75
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Net pension cost is comprised of the following (in thousands):
2003 2002 2001
------ ------ ------
Service cost $ 41 288 676
Interest cost 868 751 739
Expected return on plan assets (873) (892) (1,026)
Amortization of unrecognized gain 217 -- (152)
Amortization of unrecognized
prior service liability -- 58 121
Curtailment credit -- (998) --
------ ------ ------
Net periodic pension cost (gain) $ 253 (793) 358
====== ====== ======
Effective February 1, 2002, the Company froze all benefit accruals and
participation in the First Niagara pension plan. Accordingly, subsequent
to that date, no employees will be permitted to commence participation in
the plan and future salary increases and years of credited service will
not be considered when computing an employee's benefits under the plan. As
a result, the Company recognized a one-time pension curtailment gain of
$998 thousand in 2002.
The principal actuarial assumptions used were as follows:
2003 2002 2001
---- ---- ----
Discount rate 6.00% 6.50% 7.25%
Expected long-term rate of return on plan assets 9.00% 8.50% 9.00%
Assumed rate of future compensation increases N/A N/A 4.50%
==== ==== ====
The expected long-term rate of return on plan assets assumption was
determined based on historical returns earned by equities and fixed income
securities, adjusted to reflect expectations of future returns as applied
to the plan's target allocation of asset classes. Equities and fixed
income securities were assumed to earn a return above the inflation rate
in the ranges of 5% to 9% and 2% to 6%, respectively. The long-term
inflation rate was estimated to be 3%. When these overall return
expectations are applied to the plan's target allocation, the expected
rate of return is determined to be 9.0% which is approximately the
midpoint of the range of expected return.
The weighted average asset allocation of the Company's pension plans at
October 1, 2003 and 2002, the plans measurement date, were as follows (in
thousands):
2003 2002
---- ----
Asset Category:
Equity mutual funds 67% 62%
Bond mutual funds 33% 38%
--- ---
100% 100%
=== ===
76
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The Company's target allocation for investment in equity mutual funds is
60% - 70% with a mix between large cap core and value, small cap and
international companies. The target allocation for bond mutual fund
investments is 30% - 40% with a mix between actively managed and
intermediate bond funds. This allocation is consistent with the Company's
goal of diversifying the pension plans assets in order to preserve capital
while achieving investment results that will contribute to the proper
funding of pension obligations and cash flow requirements. If the plans
are underfunded, the bond fund portion will be temporarily increased to
50% in order to lessen asset value volatility. Asset rebalancing is
performed at least annually, with interim adjustments made when the
investment mix varies by more than 5% from the target.
Other Post-retirement Benefits
A reconciliation of the benefit obligation and accrued benefit cost of the
Company's post-retirement plan at December 31, 2003 and 2002 are as
follows (in thousands):
2003 2002
------- -------
Change in accumulated post-retirement benefit obligation:
Accumulated post-retirement benefit
obligation at beginning of year $ 4,011 3,284
Post-retirement benefit obligation acquired 610 --
Interest cost 277 230
Actuarial loss 408 792
Benefits paid (319) (295)
------- -------
Accumulated post-retirement benefit obligation
at end of year 4,987 4,011
Fair value of plan assets at end of year -- --
------- -------
Post-retirement benefit obligation in excess
of plan assets at end of year (4,987) (4,011)
Unrecognized actuarial loss 1,667 1,313
Unrecognized prior service credit (755) (819)
------- -------
Accrued post-retirement benefit
cost at end of year $(4,075) (3,517)
======= =======
Accumulated post-retirement benefit obligation $ 4,987 4,011
======= =======
The components of net periodic post-retirement benefit cost are as follows
(in thousands):
2003 2002 2001
----- ----- -----
Service cost $ -- -- 47
Interest cost 277 230 208
Amortization of unrecognized loss 53 13 1
Amortization of unrecognized prior service credit (64) (64) (46)
Curtailment credit -- -- (11)
----- ----- -----
Total periodic cost $ 266 179 199
===== ===== =====
77
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
The principal actuarial assumptions used were as follows:
2003 2002 2001
---- ---- ----
Discount rate 6.00% 6.50% 7.25%
Assumed rate of future compensation increase 4.00% 4.00% 4.50%
==== ==== ====
The Company uses an October 1 measurement date for its post-retirement
plan. The assumed health care cost trend rate used in measuring the
accumulated post-retirement benefit obligation was 8.00% for 2004, and
gradually decreased to 4.50% by 2008 and thereafter. This assumption can
have a significant effect on the amounts reported. If the rate were
increased one percent, the accumulated post-retirement benefit obligation
as of December 31, 2003 would have increased by 13.2% and the aggregate of
service and interest cost would have increased by 7.4%. If the rate were
decreased one percent, the accumulated post-retirement benefit obligation
as of December 31, 2003 would have decreased by 11.2% and the aggregate of
service and interest cost would have decreased by 6.3%.
Effective January 19, 2001, the Company modified its post-retirement
health care and life insurance plan. Participation in the plan was closed
to those employees who did not meet the retirement eligibility
requirements as of December 31, 2001. The Company does not anticipate
making any contributions to its post-retirement plan in 2004.
401(k) Plan
All full-time and part-time employees of the Company that meet certain age
and service requirements are eligible to participate in the Company
sponsored 401(k) plan. Under the plan, participants may make
contributions, in the form of salary reductions, up to the maximum
Internal Revenue Code limit. The Company contributes an amount to the plan
equal to 100% of the first 2% of employee contributions plus 75% of
employee contributions between 3% and 6%. The Company's contribution to
these plans amounted to $1.4 million, $1.3 million and $1.2 million for
2003, 2002 and 2001, respectively.
Employee Stock Ownership Plan ("ESOP")
The Company's ESOP plan is accounted for in accordance with Statement of
Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans."
All full-time and part-time employees of the Company that meet certain age
and service requirements are eligible to participate. The ESOP holds
shares of FNFG common stock that were purchased in the 1998 initial public
offering, the January 2003 Offering and in the open market. The 2,050,000
shares purchased in the Offering were purchased at the $10 per share
offering price. All allocated and unallocated shares of FNFG stock held by
the ESOP on January 17, 2003 were adjusted by the 2.58681 exchange ratio
applied in the conversion. The purchased shares were funded by loans in
1998 and 2003 from FNFG payable in equal annual installments over 30 years
bearing a fixed interest rate. Loan payments are funded by cash
contributions from First Niagara and dividends on allocated and
unallocated FNFG stock held by the ESOP. The loan can be prepaid without
penalty. Shares purchased by the ESOP are maintained in a suspense account
and held for allocation among the participants. As annual loan payments
are made, shares are committed to be released and subsequently allocated
to employee accounts. Compensation expense is recognized in an amount
equal to the average market price of the shares to be released during the
respective year. Compensation expense of $2.0 million, $1.1 million and
$803 thousand was recognized for 2003, 2002 and 2001, respectively, in
connection with the 154,499, 45,786 and 56,550 shares allocated to
participants during those respective years. The amount of allocated and
unallocated FNFG shares held by the ESOP were 4,049,658 and 713,245,
respectively, at December 31, 2003 and 832,747 and 225,252, respectively,
at December 31, 2002. The fair value of unallocated ESOP shares was $60.6
million at December 31, 2003 and $21.8 million at December 31, 2002.
78
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Other Plans
The Company also sponsors various non-qualified compensation plans for
officers and employees. Awards are payable if certain earnings and
performance objectives are met. Awards under these plans amounted to $3.7
million, $2.5 million and $2.5 million for 2003, 2002 and 2001,
respectively. The Company also maintains various unfunded supplemental
benefit plans for certain former and present executive officers. The
accrued benefit liability under these plans was $2.4 million and $697
thousand at December 31, 2003 and 2002, respectively.
(18) Fair Value of Financial Instruments
The carrying value and estimated fair value of the Company's financial
instruments at December 31, 2003 and 2002 are as follows (in thousands):
Carrying Estimated fair
value value
---------- --------------
December 31, 2003:
Financial assets:
Cash and cash equivalents $ 174,252 174,252
Securities available for sale 845,883 845,883
Loans, net 2,269,203 2,335,908
Accrued interest receivable 14,913 14,913
FHLB stock 19,221 19,221
Financial liabilities:
Deposits $2,355,216 2,362,520
Borrowings 457,966 485,777
Accrued interest payable 2,372 2,372
December 31, 2002:
Financial assets:
Cash and cash equivalents $ 90,525 90,525
Securities available for sale 632,364 632,364
Loans, net 1,974,560 2,073,157
Accrued interest receivable 12,093 12,093
FHLB stock 20,863 20,863
Financial liabilities:
Deposits $2,205,421 2,212,379
Borrowings 397,135 427,572
Accrued interest payable 2,380 2,380
Fair value estimates are based on existing on and off balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that
are not considered financial instruments. In addition, the tax
ramifications related to the realization of the unrealized gains and
losses can have a significant effect on fair value estimates and have not
been considered in these estimates. Fair value estimates, methods, and
assumptions are set forth below for each type of financial instrument.
79
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial
instruments, including judgments regarding future expected loss
experience, current economic conditions, risk characteristics of various
financial instruments, and other factors. These estimates are subjective
in nature and involve uncertainties and matters of significant judgment
and therefore cannot be determined with precision. Changes in assumptions
could significantly affect the estimates.
Cash and Cash Equivalents
The carrying value approximates the fair value because the instruments
have original maturities of three months or less.
Securities
The carrying value and fair value are estimated based on quoted market
prices.
Loans
Residential revolving home equity and personal and commercial open ended
lines of credit reprice as the prime rate changes. Therefore, the carrying
value of such loans approximates their fair value.
The fair value of fixed-rate performing loans is calculated by discounting
scheduled cash flows through estimated maturity using current origination
rates. The estimate of maturity is based on the contractual cash flows
adjusted for prepayment estimates based on current economic and lending
conditions. Fair value for significant nonaccruing loans is based on
carrying value, which does not exceed recent external appraisals of any
underlying collateral.
Accrued Interest Receivable and Payable
The fair value of accrued interest receivable on loans and investments and
accrued interest payable on deposits and borrowings approximates the
carrying value because all interest is receivable or payable in 90 to 120
days.
FHLB Stock
FHLB stock carrying value approximates fair value.
Deposits
The fair value of deposits with no stated maturity, such as savings, money
market and checking, as well as mortgagors' payments held in escrow, is
equal to the amount payable on demand. The fair value of certificates of
deposit is based on the discounted value of contractual cash flows, using
rates currently offered for deposits of similar remaining maturities.
Borrowings
The fair value of borrowings is calculated by discounting scheduled cash
flows through the estimated maturity using current market rates.
Commitments
The fair value of commitments to extend credit, standby letters of credit
and financial guarantees are not included in the above table as the
carrying value generally approximates fair value. These instruments
generate fees that approximate those currently charged to originate
similar commitments. Additional information about these instruments is
included in note 11.
80
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
(19) Segment Information
The Company has two business segments, banking and financial services. The
financial services segment includes the Company's insurance, investment
advisory and trust operations, which are organized under one Financial
Services Group. The banking segment includes the results of First Niagara
excluding financial services. The results of operations from NOVA, the
third-party benefit plan administrator subsidiary sold in February 2003,
are included as discontinued operations in the financial services segment.
Transactions between the banking and financial services segments are
primarily related to interest income and expense on intercompany deposit
accounts, and are eliminated in consolidation.
Information for the Company's segments at or for the years ended December
31, 2003, 2002 and 2001 is presented in the following table (in
thousands):
Financial
Banking services Consolidated
activities activities Eliminations total
---------- ---------- ------------ ------------
2003
Interest income $ 169,983 86 (110) 169,959
Interest expense 62,629 25 (110) 62,544
---------- ---------- ---------- ----------
Net interest income 107,354 61 -- 107,415
Provision for credit losses 7,929 -- -- 7,929
---------- ---------- ---------- ----------
Net interest income after
provision for credit losses 99,425 61 -- 99,486
Noninterest income 25,070 18,346 (37) 43,379
Amortization of intangibles 439 945 -- 1,384
Other noninterest expense 72,420 14,510 (37) 86,893
---------- ---------- ---------- ----------
Income from continuing operations
before income taxes 51,636 2,952 -- 54,588
Income taxes from continuing
operations 17,432 1,214 -- 18,646
---------- ---------- ---------- ----------
Income from continuing operations 34,204 1,738 -- 35,942
Income from discontinued operations -- 164 -- 164
---------- ---------- ---------- ----------
Net income $ 34,204 1,902 -- 36,106
========== ========== ========== ==========
Total assets $3,578,550 25,128 (14,171) 3,589,507
========== ========== ========== ==========
81
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Financial
Banking services Consolidated
activities activities Eliminations total
---------- ---------- ------------ ------------
2002
Interest income $ 167,637 105 (105) 167,637
Interest expense 76,212 -- (105) 76,107
---------- ---------- ---------- ----------
Net interest income 91,425 105 -- 91,530
Provision for credit losses 6,824 -- -- 6,824
---------- ---------- ---------- ----------
Net interest income after
provision for credit losses 84,601 105 -- 84,706
Noninterest income 25,500 16,372 (85) 41,787
Amortization of intangibles -- 677 -- 677
Other noninterest expense 63,873 12,866 (85) 76,654
---------- ---------- ---------- ----------
Income from continuing operations
before income taxes 46,228 2,934 -- 49,162
Income taxes from continuing
operations 17,236 1,516 -- 18,752
---------- ---------- ---------- ----------
Income from continuing operations 28,992 1,418 -- 30,410
Income from discontinued operations -- 385 -- 385
---------- ---------- ---------- ----------
Net income $ 28,992 1,803 -- 30,795
========== ========== ========== ==========
Total assets $2,914,242 28,726 (8,173) 2,934,795
========== ========== ========== ==========
2001
Interest income $ 178,368 149 (149) 178,368
Interest expense 99,501 -- (149) 99,352
---------- ---------- ---------- ----------
Net interest income 78,867 149 -- 79,016
Provision for credit losses 4,160 -- -- 4,160
---------- ---------- ---------- ----------
Net interest income after
provision for credit losses 74,707 149 -- 74,856
Noninterest income 20,433 14,215 (23) 34,625
Amortization of intangibles 3,787 1,523 -- 5,310
Other noninterest expense 59,668 10,934 (23) 70,579
---------- ---------- ---------- ----------
Income from continuing operations
before income taxes 31,685 1,907 -- 33,592
Income taxes from continuing
operations 11,148 1,279 -- 12,427
---------- ---------- ---------- ----------
Income from continuing operations 20,537 628 -- 21,165
Income from discontinued operations -- 55 -- 55
---------- ---------- ---------- ----------
Net income $ 20,537 683 -- 21,220
========== ========== ========== ==========
Total assets $2,837,552 27,767 (7,373) 2,857,946
========== ========== ========== ==========
82
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
(20) Condensed Parent Company Only Financial Statements
The following condensed statements of condition of FNFG as of December 31,
2003 and 2002 and the related condensed statements of income and cash
flows for 2003, 2002 and 2001 should be read in conjunction with the
consolidated financial statements and related notes (in thousands):
2003 2002
-------- --------
Condensed Statements of Condition
Assets:
Cash and cash equivalents $167,777 3,724
Investment securities available for sale 55 1,915
Loan receivable from ESOP 31,980 12,034
Investment in subsidiaries 525,846 270,946
Other assets 3,217 1,938
-------- --------
Total assets $728,875 290,557
======== ========
Liabilities:
Accounts payable and other liabilities $ 701 861
Short-term loan payable to related parties -- 6,000
Stockholders' equity 728,174 283,696
-------- --------
Total liabilities and stockholders' equity $728,875 290,557
======== ========
2003 2002 2001
-------- -------- --------
Condensed Statements of Income
Interest income $ 2,958 736 1,482
Dividends received from subsidiaries 32,500 10,900 16,000
-------- -------- --------
Total interest income 35,458 11,636 17,482
Interest expense -- 166 924
-------- -------- --------
Net interest income 35,458 11,470 16,558
Net realized (losses) gains on securities
available for sale (79) 397 98
Noninterest expense 2,770 1,817 1,674
-------- -------- --------
Income before income taxes and
undisbursed income of subsidiaries 32,609 10,050 14,982
Income tax benefit (101) (355) (425)
-------- -------- --------
Income before undisbursed
income of subsidiaries 32,710 10,405 15,407
Undisbursed income of subsidiaries 3,396 20,390 5,813
-------- -------- --------
Net income $ 36,106 30,795 21,220
======== ======== ========
83
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Condensed Statements of Cash Flows 2003 2002 2001
---------- ---------- ----------
Cash flows from operating activities:
Net income $ 36,106 30,795 21,220
Adjustments to reconcile net income to
net cash provided by operating activities:
Accrual of fees and discounts, net -- (16) (17)
Undisbursed income of subsidiaries (3,396) (20,390) (5,813)
Net realized losses (gains) on securities
available for sale 79 (397) (98)
Stock based compensation expense 1,501 927 648
Deferred income taxes (130) 36 678
(Increase) decrease in other assets (3,030) (460) 2,711
(Decrease) increase in other liabilities (1,169) 189 (708)
---------- ---------- ----------
Net cash provided by operating
activities 29,961 10,684 18,621
---------- ---------- ----------
Cash flow from investing activities:
Proceeds from sales of securities available for sale 3,543 986 195
Purchases of securities available for sale -- (582) (125)
Principal payments on securities available for sale -- 3,405 2,353
Acquisitions, net of cash acquired (29,299) -- (322)
Repayment of ESOP loan receivable 681 477 477
---------- ---------- ----------
Net cash (used in) provided by
investing activities (25,075) 4,286 2,578
---------- ---------- ----------
Cash flows from financing activities:
Purchase of treasury stock (1,604) -- --
Net proceeds from second step offering 195,454 -- --
Purchase of common stock by ESOP (20,500) -- --
Repayment of short-term borrowings -- (4,500) (10,709)
Proceeds from exercise of stock options 459 942 406
Dividends paid on common stock (14,642) (10,794) (8,983)
---------- ---------- ----------
Net cash provided by (used in) financing
activities 159,167 (14,352) (19,286)
---------- ---------- ----------
Net increase in cash and cash
equivalents 164,053 618 1,913
Cash and cash equivalents at beginning
of year 3,724 3,106 1,193
---------- ---------- ----------
Cash and cash equivalents at end of year $ 167,777 3,724 3,106
========== ========== ==========
84
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's
management, including the Chief Executive Officer and Chief Financial
Officer, the Company has evaluated the effectiveness of the design and
operation of its disclosure controls and procedures (as defined in Rule
13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2003.
Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of that date, the Company's
disclosure controls and procedures are effective to ensure that
information required to be disclosed in the reports that the Company files
or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported, within the time periods specified in
the Securities and Exchange Commission's rules and forms. There has been
no change in the Company's internal control over financial reporting
during the most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal control
over financial reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers of FNFG in the
Proxy Statement for the 2004 Annual Meeting of Stockholders is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation in the Proxy Statement for
the 2004 Annual Meeting of Stockholders is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners of
FNFG management in the Proxy Statement for the 2004 Annual Meeting of
Stockholders is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions in
the Proxy Statement for the 2004 Annual Meeting of Stockholders is
incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding the fees paid to and services provided by KPMG LLP,
the Company's independent auditors' in the Proxy Statement for the 2004
Annual Meeting of Stockholders is incorporated herein by reference.
85
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial statements are filed as part of this Annual Report on Form
10-K. See Part II, Item 8. "Financial Statements and Supplementary
Data."
(b) Reports on Form 8-K
On October 9, 2003, the Company filed a Current Report on Form 8-K
which disclosed third quarter 2003 financial results and provided
earnings guidance for the full year. Such Current Report, as an Item
7 exhibit included the Company's press release dated October 9,
2003.
On December 2, 2003, the Company filed a Current Report on Form 8-K
which disclosed the appointment of Paul J. Kolkmeyer as President
and CEO of both First Niagara and the Company. Such Current Report,
as an Item 7 exhibit included the Company's press release dated
December 2, 2003.
On December 11, 2003, the Company filed a Current Report on Form 8-K
which disclosed that the election period for holders of TFC common
stock in connection with the proposed acquisition of TFC by First
Niagara ended effective 5:00 p.m. EST on December 10, 2003. Such
Current Report, as an Item 7 exhibit included the Company's press
release dated December 10, 2003.
On December 18, 2003, the Company filed a Current Report on Form 8-K
which disclosed the appointment of John R. Koelmel as Executive Vice
President/Chief Financial Officer of both First Niagara and the
Company and announced the election of Paul J. Kolkmeyer to the
Boards of Directors of both the Company and First Niagara. Also on
December 18, 2003, the Company disclosed that it had received TFC
shareholder and all bank regulatory approvals necessary to proceed
with their merger and preliminary election results. Such Current
Report, as an Item 7 exhibit included the Company's press releases
dated December 18, 2003.
86
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(Continued)
(c) Exhibits
The exhibits listed below are filed herewith or are incorporated by
reference to other filings.
Exhibit Index to Form 10-K
--------------------------
Exhibit 3.3 Certificate of Incorporation (1)
Exhibit 3.4 Bylaws (1)
Exhibit 10.1 Form of Employment Agreement with
the Named Executive Officers (2)
Exhibit 10.2 First Niagara Bank Deferred
Compensation Plan (3)
Exhibit 10.3 First Niagara Financial Group,
Inc. 1999 Stock Option Plan (4)
Exhibit 10.4 First Niagara Financial Group,
Inc. 1999 Recognition and
Retention Plan(4)
Exhibit 10.5 First Niagara Financial Group,
Inc. 2002 Long-Term Incentive
Stock Benefit Plan(5)
Exhibit 11 Calculations of Basic Earnings Per
Share and Diluted Earnings Per
Share (See Note 16 to Notes to
Consolidated Financial Statements)
Exhibit 14 Code of Ethics for Senior
Financial Officers
Exhibit 21 Subsidiaries of First Niagara
Financial Group, Inc. (See Part I,
Item 1 of Form 10-K)
Exhibit 23 Consent of Independent Auditors'
Exhibit 31.1 Certification of Chief Executive
Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification of Chief Financial
Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
Exhibit 32 Certification of Chief Executive
Officer and Chief Financial
Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(1) Incorporated by reference to the Company's Registration
Statement on Form S-1, originally filed with the Securities
and Exchange Commission on September 18, 2002.
(2) Incorporated by reference to the Company's Pre-effective
Amendment No. 1 to the Registration Statement on Form S-1,
filed with the Securities and Exchange Commission on November
14, 2002.
(3) Incorporated by reference to the Company's Registration
Statement on Form S-1, originally filed with the Securities
and Exchange Commission on December 22, 1997.
(4) Incorporated by reference to the Company's Proxy Statement for
the 1999 Annual Meeting of Stockholders filed with the
Securities and Exchange Commission on March 31, 1999.
(5) Incorporated by reference to the Company's Proxy Statement for
the 2002 Annual Meeting of Stockholders filed with the
Securities and Exchange Commission on March 27, 2002.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
FIRST NIAGARA FINANCIAL GROUP, INC.
Date: March 12, 2004 By: /s/ Paul J. Kolkmeyer
-------------------------------
Paul J. Kolkmeyer
President and Chief Executive
Officer
87
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/ Paul J. Kolkmeyer President and Chief Executive March 12, 2004
-------------------------- Officer
Paul J. Kolkmeyer
/s/ John R. Koelmel Executive Vice President, Chief March 12, 2004
-------------------------- Financial Officer
John R. Koelmel
/s/ Gordon P. Assad Director March 12, 2004
--------------------------
Gordon P. Assad
/s/ John J. Bisgrove, Jr. Director March 12, 2004
--------------------------
John J. Bisgrove, Jr.
/s/ G. Thomas Bowers Director March 12, 2004
--------------------------
G. Thomas Bowers
/s/ James W. Currie Director March 12, 2004
--------------------------
James W. Currie
/s/ Daniel J. Hogarty, Jr. Vice Chairman March 12, 2004
--------------------------
Daniel J. Hogarty, Jr.
/s/ Daniel W. Judge Director March 12, 2004
--------------------------
Daniel W. Judge
/s/ B. Thomas Mancuso Director March 12, 2004
--------------------------
B. Thomas Mancuso
/s/ James Miklinski Director March 12, 2004
--------------------------
James Miklinski
/s/ Sharon D. Randaccio Director March 12, 2004
--------------------------
Sharon D. Randaccio
/s/ Robert G. Weber Chairman March 12, 2004
--------------------------
Robert G. Weber
/s/ Louise Woerner Director March 12, 2004
--------------------------
Louise Woerner
/s/ David M. Zebro Director March 12, 2004
--------------------------
David M. Zebro
88