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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITIONS REPORTS PURSUANT TO SECTIONS
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
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Commission File Number 0-26481
FINANCIAL INSTITUTIONS, INC.
(Exact Name of Registrant as specified in its charter)
NEW YORK 16-0816610
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(State of Incorporation) (I.R.S. Employer Identification Number)
220 Liberty Street Warsaw, NY 14569
----------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number Including Area Code:
(585) 786-1100
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant to Section 12(g) of the Act: Title of Class:
COMMON STOCK, PAR VALUE $.01 PER SHARE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file 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. [ ]
As of March 1, 2002 there were issued and outstanding, exclusive of treasury
shares, 11,009,761 shares of the Registrant's Common Stock.
The aggregate market value of the 7,760,764 shares of voting stock held by
non-affiliates of the Registrant was $219,397,000, as computed by reference to
the last sales price on March 1, 2002, 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 believed by the
Registrant to be beneficial owners of more than 5% of its outstanding stock have
been deemed to be affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's proxy statement filed with the Securities and
Exchange Commission in connection with the 2002 Annual Meeting of Shareholders
is incorporated by reference in Part III of this Annual Report on Form 10-K.
FINANCIAL INSTITUTIONS, INC.
2001 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
Item 1. Business of the Company 3
Item 2. Properties 18
Item 3. Legal Proceedings 19
Item 4. Submission of Matters for a Vote by
Security Holders 19
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters 19
Item 6. Selected Financial Data Management Discussion 20
Item 7. and Analysis of Financial Condition
and Results of Operations 21
Item 7A. Quantitative and Qualitative Disclosure
About Market Risk 36
Item 8. Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 68
PART III
Item 10. Directors and Executive Officers of
the Registrant 68
Item 11. Executive Compensation 68
Item 12. Security Ownership of Certain Beneficial
Owners and Management 68
Item 13. Certain Relationships and Related Transactions 68
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K 69
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PART I
ITEM I. BUSINESS OF THE COMPANY
GENERAL
Financial Institutions, Inc. (the "Company" or "FII") is a financial holding
company headquartered in Warsaw, New York, which is located 45 miles southwest
of Rochester and 45 miles southeast of Buffalo. The Company operates a
super-community bank holding company - a bank holding company that owns multiple
community banks that are separately managed. The Company owns five commercial
banks that provide consumer, commercial and agricultural banking services in
Western and Central New York State: Wyoming County Bank ("WCB"), The National
Bank of Geneva ("NBG"), The Pavilion State Bank ("PSB"), First Tier Bank & Trust
("FTB") and Bath National Bank ("BNB"), collectively referred to as the "Banks".
The Company was formed in 1931 to facilitate the management of three of these
banks that had been primarily owned by the Humphrey family during the late 1800s
and early 1900s. In recent years, the Company has grown through a combination of
internal growth, the opening of new branch offices and acquisitions. The Company
became qualified in May 2000 as a financial holding company (see
Gramm-Leach-Bliley Act discussion beginning on page 14), and has since
incorporated two financial services subsidiaries into its operations: Burke
Group, Inc. ("BGI") and The FI Group, Inc. ("FIGI"), collectively referred to as
the "Financial Services Group". BGI is an employee benefits and compensation
consulting firm acquired by the Company in October 2001. FIGI is a brokerage
subsidiary that commenced operations as a start-up company in March 2000. In
February 2001, the Company formed FISI Statutory Trust I ("FISI"), to
accommodate the private placement of $16.2 million in capital securities, the
proceeds of which were utilized to partially fund the acquisition of Bath
National Corporation ("BNC"). The capital securities are identified on the
balance sheet as guaranteed preferred beneficial interests in corporation's
junior subordinated debentures.
As a super-community bank holding company, the Company's strategy has been to
manage its bank subsidiaries on a decentralized basis. This strategy provides
the Banks the flexibility to efficiently serve their markets and respond to
local customer needs. While generally operating on a decentralized basis, the
Company has consolidated selected lines of business, operations and support
functions in order to achieve economies of scale, greater efficiency and
operational consistency. By increasing the use of existing technology and by
further centralizing back-office operations, management believes substantial
additional growth can be accomplished without incurring proportionately greater
operational costs.
The relative sizes and profitability of the Company's operating subsidiaries as
of and for the year ended December 31, 2001, are depicted in the following
table:
Percent Percent
Subsidiary Assets of Total Net Income of Total
------------------------------------------------------------------------------------------------
(Dollars in thousands)
Wyoming County Bank $ 551,346 31% $ 8,424 40%
The National Bank of Geneva 546,539 30 8,322 39
Bath National Bank 362,645 20 1,142 * 5
The Pavilion State Bank 177,000 10 2,674 13
First Tier Bank & Trust 161,763 9 1,827 9
Parent, non-bank subsidiaries
and eliminations, net (4,997) - (1,176) (6)
------------ ------ ---------- --------
Total $ 1,794,296 100 $ 21,213 100
========= ====== ====== =======
* From date of acquisition (May 1, 2001)
MERGERS AND ACQUISITIONS
On May 1, 2001, FII acquired all of the common stock of Bath National
Corporation ("BNC"), and its wholly-owned subsidiary bank, Bath National Bank.
BNB is a full service community bank headquartered in Bath, New York, which has
9 branch locations in Steuben, Yates, Ontario and Schuyler Counties. The
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Company paid $48.00 per share in cash for each of the outstanding shares of BNC
common stock with an aggregate purchase price of approximately $62.6 million.
The acquisition was accounted for under the purchase method of accounting, and
accordingly, the excess of the purchase price over the fair value of
identifiable tangible and intangible assets acquired, less liabilities assumed,
has been recorded as goodwill. Goodwill recognized with respect to the merger
was approximately $37.2 million. Goodwill was amortized in 2001 using the
straight-line method over 15 years, since the transaction was consummated prior
to June 30, 2001, the effective date of SFAS No. 142. However, in accordance
with SFAS No. 142, the Company ceased goodwill amortization on January 1, 2002
and will evaluate goodwill for impairment annually. The results of operations
for BNB are included in the income statement from the date of acquisition (May
1, 2001) to the end of the period.
On October 22, 2001, the Company acquired the Burke Group, Inc. ("BGI"), an
employee benefits administration and compensation consulting firm, with offices
in Honeoye Falls and Syracuse, New York. BGI's expertise includes design and
consulting for retirement and employee welfare plans, administrative services
for defined contribution and benefit plans, actuarial services and post
employment benefits. Under the terms of the agreement, BGI shareholders received
primarily common stock as consideration for their ownership in BGI. The
acquisition was accounted for under the purchase method of accounting, and
accordingly, the excess of the purchase price over the fair value of
identifiable assets acquired, less liabilities assumed, has been recorded as
goodwill, after recognizing an intangible asset separate from goodwill in
accordance with SFAS No. 141. Goodwill recognized with respect to the merger was
approximately $1.3 million. In accordance with SFAS No. 142, the Company is not
required to amortize goodwill on this acquisition, but evaluates goodwill for
impairment on an annual basis. The Company also recorded a $500,000 intangible
asset which is being amortized using the straight-line method over five years.
The results of operations for BGI are included in the income statement from the
date of acquisition (October 22, 2001) to the end of the period.
In July 2001, the FASB issued SFAS Nos. 141, "Business Combinations" and 142,
"Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business
combinations be accounted for under the purchase method, use of the
pooling-of-interests method is no longer permitted for business combinations
initiated after June 30, 2001. SFAS No. 142 requires that goodwill (including
goodwill reported in prior acquisitions) no longer be amortized to earnings, but
instead be reviewed for impairment annually, with impairment losses charged to
earnings when they occur. The Company is required to adopt SFAS No. 142
effective January 1, 2002. The results of operations for year ended December 31,
2001 include goodwill amortization from the BNB acquisition of $1,653,000. The
amortization of goodwill ceased effective January 1, 2002.
On January 11, 2002, FII reached a definitive agreement to acquire all of the
outstanding stock of the Bank of Avoca ("BOA"). BOA is a retail oriented
institution with its main office located in Avoca, New York, as well as, a
branch located in Cohocton, New York. Total assets of BOA approximated $17.9
million as of December 31, 2001. FII will fund the transaction using $1.5
million in FII stock, based on the average sales price of FII stock for the 30
trading days immediately prior to the closing date. The acquisition which is
subject to approval by BOA shareholders and by various regulatory agencies, will
be accounted for using the purchase method of accounting and is currently
scheduled to be completed in the second quarter of 2002. Subsequently, BOA will
merge with and into BNB.
FORWARD LOOKING STATEMENTS
This Report 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. When used in this
report, or in the documents incorporated by reference herein, the words
"anticipate", "believe", "estimate", "expect", "intend", "may", and similar
expressions identify such forward-looking statements. Actual results,
performance or achievements could differ materially from those contemplated,
expressed or implied by the forward-looking statements contained herein. These
forward-looking statements are based on the current expectations of the Company
or the Company's management and are subject to a number of risks and
uncertainties, including but not limited to, economic, competitive, regulatory,
and other factors affecting the Company's operations, markets, products and
services, as well as expansion
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strategies and other factors discussed elsewhere in this report filed by the
Company with the Securities and Exchange Commission. Many of these factors are
beyond the Company's control.
MARKET AREA AND COMPETITION
The Company operates 41 branches and has 55 ATMs in twelve contiguous counties
of Western and Central New York State: Allegany, Cattaraugus, Erie, Genesee,
Livingston, Monroe, Ontario, Schuyler, Seneca, Steuben, Wyoming and Yates
Counties.
The Company's market area is geographically and economically diversified in that
it serves both rural markets and, increasingly, the larger more affluent markets
of suburban Rochester and suburban Buffalo. Rochester and Buffalo are the two
largest cities in New York State outside of New York City, with combined
metropolitan area populations of over two million people. The Company
anticipates increasing its presence in the markets around these two cities.
The Company faces significant competition in both making loans and attracting
deposits, as Western and Central New York have a high density of financial
institutions. The Company's competition for loans comes principally from
commercial banks, savings banks, savings and loan associations, mortgage banking
companies, credit unions, insurance companies and other financial service
companies. Its most direct competition for deposits has historically come from
savings and loan associations, savings banks, commercial banks and credit
unions. The Company faces additional competition for deposits from
non-depository competitors such as the mutual fund industry, securities and
brokerage firms and insurance companies.
LENDING ACTIVITIES
General. The Company, through its banking subsidiaries, offers a broad range of
loans including commercial and agricultural working capital and revolving lines
of credit, commercial and agricultural mortgages, equipment loans, crop and
livestock loans, residential mortgage loans and home equity lines of credit,
home improvement loans, student loans, automobile loans, personal loans and
credit cards. The Company sells most of its newly originated fixed rate
residential mortgage loans in the secondary market. Under the Company's
decentralized management philosophy, each of the banks determines individually
which loans are sold and which are retained for the portfolio. The Company
retains the servicing rights on most mortgage loans it sells and realizes
monthly service fee income.
Underwriting Standards. The Company's loan policy establishes the general
parameters of the types of loans that are desirable, emphasizing cash flow and
collateral coverage. Under the decentralized management structure, credit
decisions are made at the subsidiary bank level by officers who generally have
had long personal experience with most of their commercial and many of their
individual borrowers, helping to ensure thorough underwriting and sound credit
decisions. Each subsidiary bank approves its own loan policy that must comply
with the Company's overall loan policy. These policies establish the lending
authority of individual loan officers as well as the loan authority of the
banks' loan committees. The subsidiary bank CEO and Senior Loan Administrator
each have loan authority up to $250,000 while other lending authorities are
$100,000 or less. The CEO and Senior Loan Administrator can approve up to
$500,000 jointly. Each bank subsidiary has a loan committee, which includes
outside members of the subsidiary bank's Board of Directors, with the authority
to approve loans up to the subsidiaries legal lending limit. To assure the
maximum salability of the residential loan products for possible resale into the
secondary mortgage markets, the Company has formally adopted the underwriting,
appraisal, and servicing guidelines of the Federal Home Loan Mortgage
Corporation ("Freddie Mac") as part of its standard loan policy and procedures
manual.
Commercial Loans. The Company, through its banking subsidiaries,
originates commercial loans in its primary market areas and underwrites them
based on the borrower's ability to service the loan from operating income. The
Company, through its banking subsidiaries, offers a broad range of commercial
lending products, including term loans and lines of credit. Short- and
medium-term commercial loans, primarily collateralized, are made available to
businesses for working capital (including inventory and receivables), business
expansion (including acquisition of real estate, expansion and improvements) and
the purchase of equipment. As a general practice, a collateral lien is placed on
any available real estate,
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equipment or other assets owned by the borrower and a personal guarantee of the
borrower is obtained. At December 31, 2001, $45.8 million, or 19.7%, of the
aggregate commercial loan portfolio was at fixed rates while $186.6 million, or
80.3%, was at variable rates. The Company also utilizes government loan
guarantee programs offered by the Small Business Administration (or "SBA") and
Rural Economic and Community Development (or "RECD") when appropriate. See
"Government Guarantee Programs" below.
Commercial Real Estate Loans. In addition to commercial loans secured
by real estate, the Company, through its banking subsidiaries, makes commercial
real estate loans to finance the purchase of real property which generally
consists of real estate with completed structures. Commercial real estate loans
are secured by first liens on the real estate, typically have variable interest
rates and are amortized over a 10 to 20 year period. The underwriting analysis
includes credit verification, appraisals and a review of the borrower's
financial condition. At December 31, 2001, $48.0 million, or 17.5%, of the
aggregate commercial real estate loan portfolio was at fixed rates while $226.7
million, or 82.5%, was at variable rates.
Agricultural Loans. Agricultural loans are offered for short-term crop
production, farm equipment and livestock financing and agricultural real estate
financing, including term loans and lines of credit. Short- and medium-term
agricultural loans, primarily collateralized, are made available for working
capital (crops and livestock), business expansion (including acquisition of real
estate, expansion and improvement) and the purchase of equipment. The Banks also
closely monitor commodity prices and inventory build-up in various commodity
categories to better anticipate price changes in key agricultural products that
could adversely affect the borrowers' ability to repay their loans. At December
31, 2001, $18.8 million, or 10.1%, of the agricultural loan portfolio was at
fixed rates while $167.8 million, or 89.9%, was at variable rates. The Banks
utilize government loan guarantee programs offered by the SBA and the Farm
Service Agency (or "FSA") of the United States Department of Agriculture where
available and appropriate. See "Government Guarantee Programs" below.
Residential Real Estate Loans. The Banks originate fixed and variable
rate one-to-four family residential real estate loans collateralized by
owner-occupied properties located in its market areas. A variety of real estate
loan products which generally are amortized over five to 30 years are offered.
Loans collateralized by one-to-four family residential real estate generally
have been originated in amounts of no more than 80% of appraised value or have
mortgage insurance. Mortgage title insurance and hazard insurance is normally
required. The Company sells most newly originated fixed rate one-to-four family
residential mortgages to Freddie Mac and retains the rights to service the
mortgages. At December 31, 2001, the servicing portfolio totaled $246.0 million
in residential mortgages, all of which have been sold to Freddie Mac. At
December 31, 2001, $163.9 million, or 68.3%, of residential real estate loans
retained in portfolio was at fixed rates while $76.2 million, or 31.7%, was at
variable rates.
Consumer and Home Equity Loans. The Banks originate direct and indirect
credit automobile loans, recreational vehicle loans, boat loans, home
improvement loans, fixed and open-ended home equity loans, personal loans
(collateralized and uncollateralized), student loans and deposit account
collateralized loans. Visa cards that provide consumer credit lines are also
issued. The terms of these loans typically range from 12 to 120 months and vary
based upon the nature of the collateral and the size of loan. The majority of
the consumer lending program is underwritten on a secured basis using the
customer's home or the financed automobile, mobile home, boat or recreational
vehicle as collateral. At December 31, 2001, $175.2 million, or 75.5%, of
aggregate consumer and home equity loans was at fixed rates while $57.0 million,
or 24.5%, was at variable rates.
Government Guarantee Programs. The Banks participate in government loan
guarantee programs offered by the SBA, RECD and FSA. At December 31, 2001, the
Banks had loans with an aggregate principal balance of $39.4 million that were
covered by guarantees under these programs. The guarantees only cover a certain
percentage of these loans. By participating in these programs, the Banks are
able to broaden their base of borrowers while minimizing credit risk.
Delinquencies and Nonperforming Assets. The Banks have several procedures in
place to assist in maintaining the overall quality of the Company's loan
portfolio. Specific underwriting guidelines have
6
been established to be followed by the lending officers. The Company monitors
each bank subsidiary's delinquency levels on a monthly basis for any adverse
trends.
Classification of Assets. Through the loan review process, the Banks maintain
internally classified loan lists which, along with delinquency reporting, helps
management assess the overall quality of the loan portfolio and the adequacy of
the allowance for loan losses. Loans classified as "substandard" are those loans
with clear and defined weaknesses such as a higher leveraged position,
unfavorable financial ratios, uncertain repayment sources or poor financial
condition, which may jeopardize recoverability of the debt. Loans classified as
"doubtful" are those loans which have characteristics similar to substandard
accounts but with an increased risk that a loss may occur, or at least a portion
of the loan may require a charge-off if liquidated at present. Loans classified
as "loss" are those loans which are in the process of being charged-off.
A loan is generally placed on nonaccrual status and ceases accruing interest
when the payment of principal or interest is delinquent for 90 days, or earlier
in some cases, unless the loan is in the process of collection and the
underlying collateral further supports the carrying value of the loan.
Allowance for Loan Losses. The allowance for loan losses is established through
charges to earnings in the form of a provision for loan losses. The allowance
reflects management's estimate of the amount of reasonably foreseeable losses,
based on the following factors:
o the amount of historical charge-off experience;
o the evaluation of the loan portfolio by the loan review function;
o levels and trends in delinquencies and non-accruals;
o trends in volume and terms;
o effects of changes in lending policy;
o experience, ability and depth of management;
o national and local economic trends and conditions; and
o concentration of credit.
Charge-offs occur when loans are deemed to be uncollectible.
Management presents a quarterly review of the allowance for loan losses to each
subsidiary bank's Board of Directors as well as to the Company's Board of
Directors, indicating any change in the allowance since the last review and any
recommendations as to adjustments in the allowance.
In order to determine the adequacy of the allowance for loan losses, the risk
classification and delinquency status of loans and other factors are considered,
such as collateral value, government guarantees, portfolio composition, trends
in economic conditions and the financial strength of borrowers. Specific
allowances for loans which have been individually evaluated for impairment are
established when required. An allowance is also established for groups of loans
with similar risk characteristics, based upon average historical charge-off
experience taking into account levels and trends in delinquencies, loan volumes,
economic and industry trends and concentrations of credit.
INVESTMENT ACTIVITIES
General. The Company's investment securities policy is contained within the
overall Asset-Liability Management and Investment Policy. This policy dictates
that investment decisions will be made based on the safety of the investment,
liquidity requirements, potential returns, cash flow targets, need for
collateral and desired risk parameters. In pursuing these objectives, the
Company considers the ability of
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an investment to provide earnings consistent with factors of quality, maturity,
marketability and risk diversification. The Board of each subsidiary bank adopts
an asset/liability policy containing an investment securities policy within the
parameters of the Company's overall asset/liability policy. The FII Treasurer,
guided by the separate ALCO Committees of each subsidiary bank, is responsible
for securities portfolio decisions within the established policies.
The Company's investment securities strategy centers on providing liquidity to
meet loan demand and redeeming liabilities, meeting pledging requirements,
managing overall interest rate risk and maximizing portfolio yield. Subsidiary
bank policies generally limit security purchases to the following:
o U.S. treasury securities;
o U.S. government agency and government sponsored agency
securities;
o mortgage-backed pass-through securities and collateralized
mortgage obligations ("CMOs") issued by the Federal National
Mortgage
Association ("FNMA"), the Government National Mortgage
Association ("GNMA") and Freddie Mac ("FHLMC");
o investment grade municipal securities, including tax, revenue
and bond anticipation notes and general obligation and revenue
notes and bonds;
o certain creditworthy un-rated securities issued by
municipalities; and
o investment grade corporate debt.
The Company currently does not participate in hedging programs, interest rate
swaps, or other activities involving the use of off-balance sheet derivative
financial instruments. Statement of Financial Accounting Standards (SFAS) No.
133, "Accounting for Derivative Instruments and Hedging Activities," requires
recognition of derivatives as either assets or liabilities, with the instruments
measured at fair value. The accounting for gains and losses resulting from
changes in fair value of the derivative instrument depends on the intended use
of the derivative and the type of risk being hedged. The Company adopted SFAS
No. 133 on January 1, 2001. The adoption of this statement did not have a
material effect on the Company's financial position or results of operations.
Additionally, the Company's investment policy limits investments in corporate
bonds to no more than 10% of total investments and to bonds rated at the time of
purchase as Baa or better by Moody's Investor Services, Inc. or BBB or better by
Standard & Poor's Ratings Services.
SOURCES OF FUNDS
General. Deposits and borrowed funds, primarily Federal Home Loan Bank ("FHLB")
advances and sweep 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 provide additional sources of funds.
Deposits. The Company, through its banking subsidiaries, offers a variety of
deposit account products with a range of interest rates and terms. The deposit
accounts consist of savings, interest-bearing checking accounts, checking
accounts, money market accounts, savings, club accounts and certificates of
deposit. The Company offers certificates of deposit with balances in excess of
$100,000 at preferential rates (jumbo certificates) to local municipalities,
businesses, and individuals as well as Individual Retirement Accounts ("IRAs")
and other qualified plan accounts. To enhance its deposit product offerings, the
Company provides commercial checking accounts for small to moderately-sized
commercial businesses, as well as a low-cost checking account service for
low-income customers.
The flow of deposits is influenced significantly by general economic conditions,
changes in money market rates, prevailing interest rates and competition. The
Banks' deposits are obtained predominantly from the areas in which the Banks'
branch offices are located. The Banks rely primarily on competitive pricing of
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their deposit products, customer service and long-standing relationships with
customers to attract and retain these deposits.
Borrowed Funds. Borrowings consist primarily of advances entered into with the
FHLB and repurchase agreements. The Company anticipates the continued use of
borrowings as a source of funding loan growth.
Guaranteed Preferred Beneficial Interests in Corporation's Junior Subordinated
Debentures. The Company formed a trust in February 2001 to accommodate the
private placement of $16.2 million in capital securities, the proceeds of which
were utilized to partially fund the acquisition of BNC.
SUPERVISION AND REGULATION
The supervision and regulation of bank holding companies and their subsidiaries
is intended primarily for the protection of depositors, the deposit insurance
funds regulated by the FDIC and the banking system as a whole, and not for the
protection of shareholders or creditors of bank holding companies. The various
bank regulatory agencies have broad enforcement power over bank holding
companies and banks, including the power to impose substantial fines,
operational restrictions and other penalties for violations of laws and
regulations.
The following description summarizes some of the laws to which the Company and
its subsidiaries are subject. References to applicable statutes and regulations
are brief summaries and do not claim to be complete. They are qualified in their
entirety by reference to such statutes and regulations. Management believes the
Company is in compliance in all material respects with these laws and
regulations. Changes in the laws, regulations or policies that impact the
Company cannot necessarily be predicted, but they may have a material effect on
the business and earnings of the Company.
THE COMPANY
The Company is a bank holding company registered under the Bank Holding Company
Act of 1956, as amended, and is subject to supervision, regulation and
examination by the Federal Reserve Board. The Bank Holding Company Act and other
federal laws subject bank holding companies to particular restrictions on the
types of activities in which they may engage, and to a range of supervisory
requirements and activities, including regulatory enforcement actions for
violations of laws and regulations.
Regulatory Restrictions on Dividends; Source of Strength. It is the policy of
the Federal Reserve Board that bank holding companies should pay cash dividends
on common stock only out of income available over the past year, and only if
prospective earnings retention is consistent with the holding company's expected
future needs and financial condition. The policy provides that bank holding
companies should not maintain a level of cash dividends that undermines the bank
holding company's ability to serve as a source of strength to its banking
subsidiaries.
Under Federal Reserve Board policy, a bank holding company is expected to act as
a source of financial strength to each of its banking subsidiaries and commit
resources to their support. Such support may be required at times when, absent
this Federal Reserve Board policy, a holding company may not be inclined to
provide it. As discussed below, a bank holding company in certain circumstances
could be required to guarantee the capital plan of an undercapitalized banking
subsidiary.
Safe and Sound Banking Practices. Bank holding companies are not permitted to
engage in unsafe and unsound banking practices. The Federal Reserve Board's
Regulation Y, for example, generally requires a holding company to give the
Federal Reserve Board prior notice of any redemption or repurchase of its own
equity securities, if the consideration to be paid, together with the
consideration paid for any repurchases or redemptions in the preceding year, is
equal to 10% or more of the company's consolidated net worth. The Federal
Reserve Board may oppose the transaction if it believes that the transaction
would constitute an unsafe or unsound practice or would violate any law or
regulation.
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Depending upon the circumstances, the Federal Reserve Board could take the
position that paying a dividend would constitute an unsafe or unsound banking
practice.
The Federal Reserve Board has broad authority to prohibit activities of bank
holding companies and their non-banking subsidiaries which represent unsafe and
unsound banking practices or which constitute violations of laws or regulations,
and can assess civil money penalties for certain activities conducted on a
knowing and reckless basis, if those activities caused a substantial loss to a
depository institution. The penalties can be as high as $1,000,000 for each day
the activity continues.
Anti-Tying Restrictions. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates.
Capital Adequacy Requirements. The Federal Reserve Board has adopted a system
using risk-based capital guidelines to evaluate the capital adequacy of bank
holding companies. Under the guidelines, specific categories of assets are
assigned different risk weights, based generally on the perceived credit risk of
the asset. These risk weights are multiplied by corresponding asset balances to
determine a "risk-weighted" asset base. The guidelines require a minimum total
risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist
of Tier 1 capital elements). Total capital is the sum of Tier 1 and Tier 2
capital. As of December 31, 2001, the Company's ratio of Tier 1 capital to total
risk-weighted assets was 9.81% and the ratio of total capital to total
risk-weighted assets was 11.37%. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Financial Condition-Capital
Resources."
In addition to the risk-based capital guidelines, the Federal Reserve Board uses
a leverage ratio as an additional tool to evaluate the capital adequacy of bank
holding companies. The leverage ratio is a company's Tier 1 capital divided by
three-month average consolidated assets. Certain highly-rated bank holding
companies may maintain a minimum leverage ratio of 3.0%, but other bank holding
companies may be required to maintain a leverage ratio of up to 200 basis points
above the regulatory minimum. As of December 31, 2001, the Company's leverage
ratio was 7.02%.
The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
Federal Reserve Board guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets.
Imposition of Liability for Undercapitalized Subsidiaries. Bank regulators are
required to take "prompt corrective action" to resolve problems associated with
insured depository institutions whose capital declines below certain levels. In
the event an institution becomes "undercapitalized," it must submit a capital
restoration plan. The capital restoration plan will not be accepted by the
regulators unless each company having control of the undercapitalized
institution guarantees the subsidiary's compliance with the capital restoration
plan up to a certain specified amount. Any such guarantee from a depository
institution's holding company is entitled to a priority of payment in
bankruptcy.
The aggregate liability of the holding company of an undercapitalized bank is
limited to the lesser of 5% of the institution's assets at the time it became
undercapitalized or the amount necessary to cause the institution to be
"adequately capitalized." The bank regulators have greater power in situations
where an institution becomes "significantly" or "critically" undercapitalized or
fails to submit a capital restoration plan. For example, a bank holding company
controlling such an institution can be required to obtain prior Federal Reserve
Board approval of proposed dividends, or might be required to consent to a
consolidation or to divest the troubled institution or other affiliates.
10
Acquisitions by Bank Holding Companies. The Bank Holding Company Act requires
every bank holding company to obtain the prior approval of the Federal Reserve
Board before it may acquire all or substantially all of the assets of any bank,
or ownership or control of any voting shares of any bank, if after such
acquisition it would own or control, directly or indirectly, more than 5% of the
voting shares of such bank. In approving bank acquisitions by bank holding
companies, the Federal Reserve Board is required to consider the financial and
managerial resources and future prospects of the bank holding company and the
banks concerned, the convenience and needs of the communities to be served, and
various competitive factors.
Control Acquisitions. The Change in Bank Control Act prohibits a person or group
of persons from acquiring "control" of a bank holding company unless the Federal
Reserve Board has been notified and has not objected to the transaction. Under a
rebuttable presumption established by the Federal Reserve Board, the acquisition
of 10% of more of a class of voting stock of a bank holding company with a class
of securities registered under Section 12 of the Exchange Act, would, under the
circumstances set forth in the presumption, constitute acquisition of control of
the Company.
In addition, any entity is required to obtain the approval of the Federal
Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the
case of an acquirer that is a bank holding company) or more of the Company's
outstanding common stock, or otherwise obtaining control or a "controlling
influence" over the Company.
THE BANKS
Wyoming County Bank ("WCB"), Pavilion State Bank ("PSB") and First Tier Bank &
Trust ("FTB") are New York State-chartered banks. National Bank of Geneva
("NBG") and Bath National Bank ("BNB") are national banks chartered by the
Office of the Comptroller of Currency. All of the deposits of the five
subsidiary banks are insured by the FDIC through the Bank Insurance Fund. FTB is
a member of the Federal Reserve System. The Banks are subject to supervision and
regulation that subject them to special restrictions, requirements, potential
enforcement actions and periodic examination by the FDIC, the Federal Reserve
Board and the New York State Banking Department (in the case of the
state-chartered banks) and the Office of the Comptroller of Currency (in the
case of the national banks). Because the Federal Reserve Board regulates the
bank holding company parent of the Banks, the Federal Reserve Board also has
supervisory authority which directly affects the banks.
Restrictions on Transactions with Affiliates and Insiders. Transactions between
the holding company and its subsidiaries, including the Banks, are subject to
Section 23A of the Federal Reserve Act. In general, Section 23A imposes limits
on the amount of such transactions, and also requires certain levels of
collateral for loans to affiliated parties. It also limits the amount of
advances to third parties which are collateralized by the securities or
obligations of the Company or its subsidiaries.
Affiliate transactions are also subject to Section 23B of the Federal Reserve
Act which generally requires that certain transactions between the holding
company and its affiliates be on terms substantially the same, or at least as
favorable to the banks, as those prevailing at the time for comparable
transactions with or involving other nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O apply to all
insured institutions and their subsidiaries and holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such a loan can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the FDIC may determine
that a lesser amount is appropriate. Insiders are subject to enforcement actions
for knowingly accepting loans in violation of applicable restrictions.
Restrictions on Distribution of Subsidiary Bank Dividends and Assets. Dividends
paid by the Banks have provided a substantial part of the Company's operating
funds and, for the foreseeable future, it is
11
anticipated that dividends paid by the Banks will continue to be its principal
source of operating funds. Capital adequacy requirements serve to limit the
amount of dividends that may be paid by the subsidiaries. Under federal law, the
subsidiaries cannot pay a dividend if, after paying the dividend, a particular
subsidiary will be "undercapitalized." The FDIC may declare a dividend payment
to be unsafe and unsound even though the bank would continue to meet its capital
requirements after the dividend.
Because the Company is a legal entity separate and distinct from its
subsidiaries, the Company's right to participate in the distribution of assets
of any subsidiary upon the subsidiary's liquidation or reorganization will be
subject to the prior claims of the subsidiary's creditors. In the event of a
liquidation or other resolution of an insured depository institution, the claims
of depositors and other general or subordinated creditors are entitled to a
priority of payment over the claims of holders of any obligation of the
institution to its shareholders, including any depository bank holding company
(such as the Company) or any shareholder or creditor thereof.
Examinations. The New York State Banking Department (in the case of WCB, PSB and
FTB), the Office of the Comptroller of the Currency (in the case of NBG and
BNB), the Federal Reserve Board and the FDIC periodically examine and evaluate
the Banks. Based upon such examinations, the appropriate regulator may revalue
the assets of the institution and require that it establish specific reserves to
compensate for the difference between what the regulator determines the value to
be and the book value of such assets.
Audit Reports. Insured institutions with total assets of $500 million or more at
the beginning of a fiscal year must submit annual audit reports prepared by
independent auditors to federal and state regulators. In some instances, the
audit report of the institution's holding company can be used to satisfy this
requirement. Auditors must receive examination reports, supervisory agreements
and reports of enforcement actions. In addition, financial statements prepared
in accordance with generally accepted accounting principles, management's
certifications concerning responsibility for the financial statements, internal
controls and compliance with legal requirements designated by the FDIC, and an
attestation by the auditor regarding the statements of management relating to
the internal controls must be submitted. The FDIC Improvement Act of 1991
requires that independent audit committees be formed, consisting of outside
directors only. The committees of institutions with assets of more than $3
million must include members with experience in banking or financial management,
must have access to outside counsel and must not include representatives of
large customers.
Capital Adequacy Requirements. The FDIC has adopted regulations establishing
minimum requirements for the capital adequacy of insured institutions. The FDIC
may establish higher minimum requirements if, for example, a bank has previously
received special attention or has a high susceptibility to interest rate risk.
The FDIC's risk-based capital guidelines generally require state banks to have a
minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and a
ratio of total capital to total risk-weighted assets of 8.0%. The capital
categories have the same definitions for the Company. As of December 31, 2001,
the ratio of Tier 1 capital to total risk-weighted assets for the Banks was
8.95% for WCB, 9.24% for NBG, 14.18% for BNB, 9.14% for PSB and 8.94% for FTB,
and the ratio of total capital to total risk-weighted assets was 10.21% for WCB,
10.50% for NBG, 15.43% for BNB, 10.40% for PSB and 10.20% for FTB. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
The FDIC's leverage guidelines require state banks to maintain Tier 1 capital of
no less than 4.0% of average total assets, except in the case of certain highly
rated banks for which the requirement is 3.0% of average total assets. As of
December 31, 2001, the ratio of Tier 1 capital to average total assets (leverage
ratio) was 6.56% for WCB, 6.96% for NBG, 8.43% for BNB, 7.02% for PSB and 6.08%
for FTB. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
12
Corrective Measures for Capital Deficiencies. The federal banking regulators are
required to take "prompt corrective action" with respect to capital-deficient
institutions. Agency regulations define, for each capital category, the levels
at which institutions are "well-capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." A "well-capitalized" bank has a total risk-based capital
ratio of 10.0% or higher; a Tier 1 risk-based capital ratio of 6.0% or higher; a
leverage ratio of 5.0% or higher; and is not subject to any written agreement,
order or directive requiring it to maintain a specific capital level for any
capital measure. An "adequately capitalized" bank has a total risk-based capital
ratio of 8.0% or higher; a Tier 1 risk-based capital ratio of 4.0% or higher; a
leverage ratio of 4.0% or higher (3.0% or higher if the bank was rated a
composite 1 in its most recent examination report and is not experiencing
significant growth); and does not meet the criteria for a well-capitalized bank.
A bank is "undercapitalized" if it fails to meet any one of the ratios required
to be adequately capitalized.
In addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations contain broad restrictions on certain
activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from paying
management fees to control persons if the institution would be undercapitalized
after any such distribution or payment.
As an institution's capital decreases, the FDIC's enforcement powers become more
severe. A significantly undercapitalized institution is subject to mandated
capital raising activities, restrictions on interest rates paid and transactions
with affiliates, removal of management and other restrictions. The FDIC has only
very limited discretion in dealing with a critically undercapitalized
institution and is virtually required to appoint a receiver or conservator.
Banks with risk-based capital and leverage ratios below the required minimums
may also be subject to certain administrative actions, including the termination
of deposit insurance upon notice and hearing, or a temporary suspension of
insurance without a hearing in the event the institution has no tangible
capital.
Deposit Insurance Assessments. The bank subsidiaries must pay assessments to the
FDIC for federal deposit insurance protection. The FDIC has adopted a risk-based
assessment system as required by the FDIC Improvement Act. Under this system,
FDIC-insured depository institutions pay insurance premiums at rates based on
their risk classification. Institutions assigned to higher risk classifications
(that is, institutions that pose a greater risk of loss to their respective
deposit insurance funds) pay assessments at higher rates than institutions that
pose a lower risk. An institution's risk classification is assigned based on its
capital levels and the level of supervisory concern the institution poses to the
regulators. In addition, the FDIC can impose special assessments in certain
instances.
The FDIC maintains a process for raising or lowering all rates for insured
institutions semi-annually if conditions warrant a change. Under this system,
the FDIC has the flexibility to adjust the assessment rate schedule twice a year
without seeking prior public comment, but only within a range of five cents per
$100 above or below the premium schedule adopted. Changes in the rate schedule
outside the five cent range above or below the current schedule can be made by
the FDIC only after a full rulemaking with opportunity for public comment.
The Deposit Insurance Fund Act of 1996 contained a comprehensive approach to
recapitalizing the Savings Association Insurance Fund and to assuring the
payment of the Financing Corporation's bond obligations. Under this law, banks
insured under the Bank Insurance Fund are required to pay a portion of the
interest due on bonds that were issued by the Financing Corporation in 1987 to
help shore up the ailing Federal Savings and Loan Insurance Corporation.
Enforcement Powers. The FDIC and the other federal banking agencies have broad
enforcement powers, including the power to terminate deposit insurance, impose
substantial fines and other civil and criminal penalties and appoint a
conservator or receiver. Failure to comply with applicable laws, regulations and
supervisory agreements could subject the Company or its banking subsidiaries, as
well
13
as the officers, directors and other institution-affiliated parties of these
organizations, to administrative sanctions and potentially substantial civil
money penalties.
Brokered Deposit Restrictions. Adequately capitalized institutions cannot
accept, renew or roll over brokered deposits except with a waiver from the FDIC,
and are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew or roll over
brokered deposits.
Cross-Guarantee Provisions. The Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") contains a "cross-guarantee" provision which
generally makes commonly controlled insured depository institutions liable to
the FDIC for any losses incurred in connection with the failure of a commonly
controlled depository institution.
Community Reinvestment Act. The Community Reinvestment Act of 1977 ("CRA") and
the regulations issued thereunder are intended to encourage banks to help meet
the credit needs of their service area, including low and moderate income
neighborhoods, consistent with the safe and sound operations of the banks. These
regulations also provide for regulatory assessment of a bank's record in meeting
the needs of its service area when considering applications regarding
establishing branches, mergers or other bank or branch acquisitions. FIRREA
requires federal banking agencies to make public a rating of a bank's
performance under the CRA. In the case of a bank holding company, the CRA
performance record of the banks involved in the transaction are reviewed in
connection with the filing of an application to acquire ownership or control of
shares or assets of a bank or to merge with any other bank holding company. An
unsatisfactory record can substantially delay or block the transaction.
Consumer Laws and Regulations. In addition to the laws and regulations discussed
herein, the subsidiary banks are also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include, among others, the Truth in Lending Act, the Truth in Savings Act, the
Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal
Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act
and the Real Estate Settlement Procedures Act. These laws and regulations
mandate certain disclosure requirements and regulate the manner in which
financial institutions must deal with customers when taking deposits or making
loans to such customers. The Banks must comply with the applicable provisions of
these consumer protection laws and regulations as part of their ongoing customer
relations.
CHANGING REGULATORY STRUCTURE
GRAMM LEACH-BLILEY ACT
The Gramm-Leach-Bliley Act ("Gramm-Leach") was signed into law on November 12,
1999. Gramm-Leach permits, subject to certain conditions, combinations among
banks, securities firms and insurance companies beginning March 11, 2000. Under
Gramm-Leach, bank holding companies are permitted to offer their customers
virtually any type of financial service including banking, securities
underwriting, insurance (both underwriting and agency), and merchant banking. In
order to engage in these additional financial activities, a bank holding company
must qualify and register with the Board of Governors of the Federal Reserve
System as a "financial holding company" by demonstrating that each of its bank
subsidiaries is "well capitalized," "well managed," and has at least a
"satisfactory" rating under the CRA. On May 12, 2000 the Company received
approval from the Federal Reserve Bank of New York to become a financial holding
company. Gramm-Leach establishes that the federal banking agencies will regulate
the banking activities of financial holding companies and banks' financial
subsidiaries, the U.S. Securities and Exchange Commission will regulate their
securities activities and state insurance regulators will regulate their
insurance activities. Gramm-Leach also provides new protections against the
transfer and use by financial institutions of consumers' nonpublic, personal
information.
The major provisions of Gramm-Leach are:
14
Financial Holding Companies and Financial Activities. Title I establishes a
comprehensive framework to permit affiliations among commercial banks, insurance
companies, securities firms, and other financial service providers by revising
and expanding the Bank Holding Company Act framework to permit a holding company
system to engage in a full range of financial activities through qualification
as a new entity known as a financial holding company. A bank holding company
that qualifies as a financial holding company can expand into a wide variety of
services that are financial in nature, provided that its subsidiary depository
institutions are well-managed, well-capitalized and have received at least a
"satisfactory" rating on their last CRA examination. Services that have been
deemed to be financial in nature include securities underwriting, dealing and
market making, sponsoring mutual funds and investment companies, insurance
underwriting and agency activities and merchant banking.
Title I also required the FDIC to adopt regulations implementing Section 121 of
Title I, regarding permissible activities and investments of insured state
banks. Final regulations adopted by the FDIC in January 2001, in the form of
amendments to Part 362 of the FDIC rules and regulations, provide the framework
for subsidiaries of state nonmember banks to engage in financial activities that
Gramm-Leach permits national banks to conduct through a financial subsidiary.
The regulations require that prior to commencing such financial activities, a
state nonmember bank must notify the FDIC of its intent to do so, and must
certify that it is well-managed and that it and all of its subsidiary insured
depository institutions are well-capitalized after deducting its investment in
the new subsidiary. Furthermore, the regulations require that the notifying bank
must, and must continue to, (i) disclose the capital deduction in published
financial statements, and (ii) comply with sections 23A and 23B of the Federal
Reserve Act and (iii) comply with all required financial and operational
safeguards.
Activities permissible for financial subsidiaries of national banks, and,
pursuant to Section 362 of the FDIC rules and regulations, also permissible for
financial subsidiaries of state nonmember banks, include, but are not limited
to, the following: (a) Lending, exchanging, transferring, investing for others,
or safeguarding money or securities; (b) Insuring, guaranteeing, or indemnifying
against loss, harm, damage, illness, disability, or death, or providing and
issuing annuities, and acting as principal, agent, or broker for purposes of the
foregoing, in any State; (c) Providing financial, investment, or economic
advisory services, including advising an investment company; (d) Issuing or
selling instruments representing interests in pools of assets permissible for a
bank to hold directly; and (e) Underwriting, dealing in, or making a market in
securities.
Securities Activities. Title II narrows the exemptions from the securities laws
previously enjoyed by banks, requires the Federal Reserve Board and the SEC to
work together to draft rules governing certain securities activities of banks
and creates a new, voluntary investment bank holding company.
Insurance Activities. Title III restates the proposition that the states are the
functional regulators for all insurance activities, including the insurance
activities of federally-chartered banks, and bars the states from prohibiting
insurance activities by depository institutions. The law encourages the states
to develop uniform or reciprocal rules for the licensing of insurance agents.
Privacy. Under Title V, federal banking regulators were required to adopt rules
that have limited the ability of banks and other financial institutions to
disclose non-public information about consumers to nonaffiliated third parties.
These limitations require disclosure of privacy policies to consumers and, in
some circumstances, allow consumers to prevent disclosure of certain personal
information to a nonaffiliated third party. Federal banking regulators issued
final rules on May 10, 2000 to implement the privacy provisions of Title V.
Under the rules, financial institutions must provide:
- initial notices to customers about their privacy policies, describing
the conditions under which they may disclose nonpublic personal
information to nonaffiliated third parties and affiliates;
- annual notices of their privacy policies to current customers; and
- a reasonable method for customers to "opt out" of disclosures to
nonaffiliated third parties.
15
Compliance with the rules is mandatory after July 1, 2001. The Company and the
banks were in full compliance with the rules as of or prior to their respective
effective dates.
Safeguarding Confidential Customer Information. Under Title V, federal banking
regulators are required to adopt rules requiring financial institutions to
implement a program to protect confidential customer information. In January
2000, the federal banking agencies adopted guidelines requiring financial
institutions to establish an information security program to:
- identify and assess the risks that may threaten customer information;
- develop a written plan containing policies and procedures to manage and
control these risks;
- implement and test the plan; and
- adjust the plan on a continuing basis to account for changes in
technology, the sensitivity of customer information and internal or
external threats to information security.
The Banks approved security programs appropriate to their size and complexity
and the nature and scope of their operations prior to the July 1, 2001 effective
date of the regulatory guidelines, and are implementating the programs on an
ongoing basis.
Community Reinvestment Act Sunshine Requirements. In February 2001, the federal
banking agencies adopted final regulations implementing Section 711 of Title
VII, the CRA Sunshine Requirements. The regulations require nongovernmental
entities or persons and insured depository institutions and affiliates that are
parties to written agreements made in connection with the fulfillment of the
institution's CRA obligations to make available to the public and the federal
banking agencies a copy of each agreement. The regulations impose annual
reporting requirements concerning the disbursement, receipt and use of funds or
other resources under these agreements. The effective date of the regulations
was April 1, 2001. Neither the Company nor the banks is a party to any agreement
that would be the subject of reporting pursuant to the CRA Sunshine
Requirements.
The Company continues to evaluate the strategic opportunities presented by the
broad powers granted to bank holding companies that elect to be treated as
financial holding companies. In the event that the Company determines that
access to the broader powers of a financial holding company is in the best
interests of the Company, its shareholders and the banks, the Company will file
the appropriate election with the Federal Reserve Board.
The Company and the Banks intend to comply with all provisions of Gramm-Leach
and all implementing regulations as they become effective.
USA PATRIOT ACT
As part of the Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001 ("USA Patriot Act"),
signed into law on October 26, 2001, Congress adopted the International Money
Laundering Abatement and Financial Anti-Terrorism Act of 2001 ("IMLAFATA").
IMLAFATA authorizes the Secretary of the Treasury, in consultation with the
heads of other government agencies, to adopt special measures applicable to
banks, bank holding companies, or other financial institutions. These measures
may include enhanced recordkeeping and reporting requirements for certain
financial transactions that are of primary money laundering concern, due
diligence requirements concerning the beneficial ownership of certain types of
accounts, and restrictions or prohibitions on certain types of accounts with
foreign financial institutions. Covered financial institutions also are barred
from dealing with foreign "shell" banks. In addition, IMLAFATA expands the
circumstances under which funds in a bank account may be forfeited and requires
covered financial institutions to respond under certain circumstances to
requests for information from federal banking agencies within 120 hours.
16
Treasury regulations implementing the due diligence requirements must be issued
no later than April 24, 2002. Whether or not regulations are adopted, the law
becomes effective July 23, 2002. Additional regulations are to be adopted during
2002 to implement minimum standards to verify customer identity, to encourage
cooperation among financial institutions, federal banking agencies, and law
enforcement authorities regarding possible money laundering or terrorist
activities, to prohibit the anonymous use of "concentration accounts," and to
require all covered financial institutions to have in place a Bank Secrecy Act
compliance program. IMLAFATA also amends the Bank Holding Company Act and the
Bank Merger Act to require the federal banking agencies to consider the
effectiveness of a financial institution's anti-money laundering activities when
reviewing an application under these acts.
The Banks have in place a Bank Secrecy Act compliance program, and it engages in
very few transactions of any kind with foreign financial institutions or foreign
persons.
EXPANDING ENFORCEMENT AUTHORITY
The Federal Reserve Board, the Office of the Comptroller of Currency, the New
York State Superintendent of Banks and the FDIC possess extensive authority to
police unsafe or unsound practices and violations of applicable laws and
regulations by depository institutions and their holding companies. For example,
the FDIC may terminate the deposit insurance of any institution which it
determines has engaged in an unsafe or unsound practice. The agencies can also
assess civil money penalties, issue cease and desist or removal orders, seek
injunctions, and publicly disclose such actions.
EFFECT ON ECONOMIC ENVIRONMENT
The policies of regulatory authorities, including the monetary policy of the
Federal Reserve Board, have a significant effect on the operating results of
bank holding companies and their subsidiaries. Among the means available to the
Federal Reserve Board to affect the money supply are open market operations in
U.S. Government securities, changes in the discount rate on member bank
borrowings and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth and
distribution of bank loans, investments and deposits, and their use may affect
interest rates charged on loans or paid for deposits. Federal Reserve Board
monetary policies have materially affected the operating results of commercial
banks in the past and are expected to continue to do so in the future.
17
ITEM 2. PROPERTIES
The Company conducts business through its corporate office, full service bank
offices and branches. The Company's headquarters and operations center is
located in Warsaw, New York. This facility is leased for a nominal rent from the
Wyoming County Industrial Development Agency for local tax reasons and the
Company has the right to purchase it for nominal consideration beginning in
November, 2006. The following table lists the properties of each of the
subsidiary banks:
TYPE OF LEASED OR EXPIRATION
LOCATION FACILITY OWNED OF LEASE
-------- -------- ----- --------
WYOMING COUNTY BANK
Warsaw............................. Main Office Own --
Mount Morris....................... Branch Own --
Lakeville.......................... Branch Own --
Attica............................. Branch Own --
North Java......................... Branch Own --
Wyoming............................ Branch Own --
North Warsaw....................... Branch Own --
Strykersville...................... Branch Own --
Yorkshire.......................... Branch Lease April 2002
Geneseo............................ Branch Own --
Dansville.......................... Branch Lease December 2006
Honeoye Falls...................... Branch Lease April 2008
Williamsville...................... Branch Lease May 2003
THE NATIONAL BANK OF GENEVA
Geneva............................. Main Office Own --
Geneva............................. Drive-up Branch Own --
Geneva (Plaza)..................... Branch Ground Lease December 2006
Canandaigua........................ Branch Own --
Waterloo........................... Branch Own --
Penn Yan........................... Branch Own --
Ovid............................... Branch Own --
BATH NATIONAL BANK
Bath............................... Main Office Own --
Bath............................... Drive-up Branch Own --
Hammondsport....................... Branch Own --
Wayland............................ Branch Own --
Dundee............................. Branch Own --
Hornell............................ Branch Own --
Watkins Glen....................... Branch Lease October 2002
Naples............................. Branch Own --
Erwin.............................. Branch Lease August 2004
THE PAVILION STATE BANK
Pavilion........................... Main Office Own --
Caledonia.......................... Branch Lease April 2006
LeRoy.............................. Branch Own --
Batavia............................ Branch Lease October 2011
Batavia (In-Store)................. Branch Lease August 2008
North Chili........................ Branch Lease July 2015
FIRST TIER BANK & TRUST
Salamanca.......................... Main Office Own --
Ellicottville...................... Branch Own --
Allegany........................... Branch Own --
Olean.............................. Branch Own --
Olean.............................. Drive-up Branch Own --
Cuba............................... Branch Lease November 2007
18
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company and its subsidiaries are parties to or otherwise
involved in legal proceedings arising in the normal course of business.
Management does not believe that there is any pending or threatened proceeding
against the Company or its subsidiaries which, if determined adversely, would
have a material effect on the Company's business, results of operations or
financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the year ended December
31, 2001 to a vote of security holders.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is traded under the symbol of FISI on the Nasdaq
National Market. At March 1, 2002, the Company had 11,009,761 shares of common
stock outstanding (exclusive of treasury shares) and had approximately 1,900
shareholders of record.
The high and low prices listed below represent actual sales transactions as
reported by Nasdaq.
Sales Price Cash Dividends
High Low Close Declared
-----------------------------------------------------
2001
First Quarter $ 20.000 $ 13.000 $ 19.625 $ 0.11
Second Quarter 24.250 18.000 22.400 0.12
Third Quarter 26.650 21.000 23.440 0.12
Fourth Quarter 24.850 17.100 23.400 0.13
2000
First Quarter 13.250 10.375 11.750 0.10
Second Quarter 15.000 11.938 14.000 0.10
Third Quarter 15.438 12.375 14.875 0.11
Fourth Quarter 15.375 13.375 13.609 0.11
19
ITEM 6. SELECTED FINANCIAL DATA
(Dollars in thousands) December 31
-------------------------------------------------------------------------------
2001 2000 1999 1998 1997
-------------------------------------------------------------------------------
SELECTED FINANCIAL CONDITION DATA
Total assets $1,794,296 $1,289,327 $1,136,460 $976,185 $880,512
Loans, net 1,146,976 873,262 752,324 645,857 594,332
Securities available for sale 428,423 257,823 197,134 154,171 107,492
Securities held to maturity 61,281 76,947 81,356 91,016 99,084
Deposits 1,433,658 1,078,111 949,531 850,455 767,726
Borrowed funds 190,389 62,384 56,336 13,862 12,066
Shareholders' equity 149,187 131,618 117,539 96,578 86,843
(Dollars in thousands) For the years ended December 31
-------------------------------------------------------------------------------
2001 2000 1999 1998 1997
-------------------------------------------------------------------------------
SELECTED OPERATIONS DATA
Interest income $114,468 $96,467 $78,692 $72,660 $66,972
Interest expense 49,694 43,605 31,883 30,958 27,851
--------------- ---------------- --------------- -------------- ---------------
Net interest income 64,774 52,862 46,809 41,702 39,121
Provision for loan losses 4,958 4,211 3,062 2,732 2,829
--------------- ---------------- --------------- -------------- ---------------
Net interest income after
provision for loan loss 59,816 48,651 43,747 38,970 36,292
Noninterest income 15,782 9,409 8,055 6,591 5,929
Noninterest expense 43,352 30,156 27,032 24,602 22,084
--------------- ---------------- --------------- -------------- ---------------
Income before income taxes 32,246 27,904 24,770 20,959 20,137
Income taxes 11,033 9,804 8,813 7,354 7,295
--------------- ---------------- --------------- -------------- ---------------
Net income $21,213 $18,100 $15,957 $13,605 $12,842
=============== ================ =============== ============== ===============
At or for the years ended December 31
-----------------------------------------------------------
2001 2000 1999 1998 1997
-----------------------------------------------------------
PER COMMON SHARE DATA
Net income - diluted $1.77 $1.51 $1.38 $1.22 $1.14
Cash dividends declared 0.48 0.42 0.31 0.26 0.22
Book value 11.93 10.36 9.05 7.94 6.94
Market value 23.40 13.61 12.12 - -
At or for the years ended December 31
-----------------------------------------------------------
2001 2000 1999 1998 1997
-----------------------------------------------------------
SELECTED FINANCIAL RATIOS AND OTHER DATA
Performance Ratios:
Return on common equity 15.84% 15.78% 16.16% 16.28% 17.62%
Return on assets 1.34 1.51 1.54 1.48 1.54
Common dividend payout 26.77 27.81 22.54 21.43 19.28
Net interest rate spread 3.96 3.98 4.19 4.24 4.43
Net interest margin (2) 4.62 4.87 5.00 5.06 5.21
Efficiency ratio 48.49 45.19 45.55 46.64 45.22
Noninterest income to average total assets (3) 0.96 0.76 0.75 0.69 0.69
Noninterest expenses to average total assets 2.73 2.52 2.61 2.68 2.65
Average interest-earning assets to average interest
bearing liabilities 119.67 123.25 124.86 123.05 121.91
Asset Quality Ratios:
Non-performing loans to total loans 0.86% 0.80% 0.75% 0.93% 1.24%
Non-performing assets to total loans and other real 0.94 0.91 0.88 1.24 1.62
estate
Allowance for loan losses to non-performing loans 190.32 195.06 198.83 156.86 108.95
Allowance for loan losses to total loans 1.64 1.56 1.50 1.46 1.35
Net charge-offs during the period to average loans
outstanding during the year 0.23 0.21 0.17 0.21 0.32
Capital ratios:
Equity to total assets 8.31% 10.21% 10.34% 9.89% 9.86%
Average common equity to average assets 7.84 8.78 8.63 8.09 7.70
Other Data:
Number of full-service offices 41 32 29 28 27
Loans serviced for others (in millions) $302.3 $205.2 $200.2 $177.8 $153.2
Full time equivalent employees 608 441 411 384 383
(1) Averages presented are daily averages.
(2) Net interest income divided by average interest earning assets. A tax-equivalent adjustment to interest
earned from tax-exempt securities has been computed using a federal tax rate of 35%.
(3) Noninterest income excludes net gain (loss) on sale of securities available for sale.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Net income in 2001 was $21.2 million, or 17% more than the $18.1 million earned
in 2000. In 1999, net income was $16.0 million. Diluted earnings per share for
the year ended December 31, 2001 was $1.77, compared to $1.51 in 2000 and $1.38
in 1999. The return on average common equity in 2001 was 15.84%, compared to
15.78% in 2000 and 16.16% in 1999. The return on average assets in 2001 was
1.34%, compared to 1.51% in 2000 and 1.54% in 1999.
On May 1, 2001, FII acquired all of the common stock of Bath National
Corporation ("BNC"), and its wholly-owned subsidiary bank, Bath National Bank.
BNB is a full service community bank headquartered in Bath, New York, which has
9 branch locations in Steuben, Yates, Ontario and Schuyler Counties. The Company
paid $48.00 per share in cash for each of the outstanding shares of BNC common
stock with an aggregate purchase price of approximately $62.6 million. The
acquisition was accounted for under the purchase method of accounting. The
results of operations for BNB are included in the income statement from the date
of acquisition (May 1, 2001) to the end of the period.
On October 22, 2001, the Company acquired the Burke Group, Inc. ("BGI"), an
employee benefits administration and compensation consulting firm, with offices
in Honeoye Falls and Syracuse, New York. BGI's expertise includes design and
consulting for retirement and employee welfare plans, administrative services
for defined contribution and benefit plans, actuarial services and post
employment benefits. Under the terms of the agreement, BGI shareholders received
primarily common stock as consideration for their ownership in BGI. The
acquisition was accounted for under the purchase method of accounting. The
results of operations for BGI are included in the income statement from the date
of acquisition (October 22, 2001) to the end of the period.
The strong performance in 2001 can be attributed to a combination of continued
focus on basic banking principles, expansion of product lines and geographic
presence and the realization of immediate benefits from recent acquisitions.
Each of the subsidiary banks performed very well during the year, including BNB.
Acquired in the second quarter of 2001, BNB was efficiently integrated and
immediately contributed to consolidated results. The Company continued to
penetrate its existing market areas in addition to expanding further in the
suburban Buffalo and Rochester markets. Effective interest margin management,
despite a declining rate environment and a lagging economy, and solid balance
sheet growth were the primary drivers of our results. FII also experienced
continued growth of fee-based services. The Company anticipates further
expansion of the financial services businesses in the coming years as a result
of the fourth quarter acquisition of BGI, the largest independent retirement
plan consulting company in Western and Central New York. The BGI acquisition
enables FII to further diversify its revenue stream and better leverage the
trust and brokerage businesses for future growth.
21
LENDING ACTIVITIES
Set forth below is selected information concerning the composition of the
Company's loan portfolio.
At December 31
-------------------------------------------------------------------------
(Dollars in thousands) 2001 2000 1999 1998 1997
-------------------------------------------------------------------------
Commercial $ 232,379 $ 169,832 $ 140,376 $ 117,750 $ 105,811
Commercial real estate 274,702 166,041 137,648 106,897 99,218
Agricultural 186,623 165,367 151,534 123,754 107,546
Residential real estate 240,141 201,160 189,149 181,828 170,396
Consumer and home equity 232,205 184,745 145,038 125,198 119,506
-------- -------- -------- -------- -------
Total loans, gross 1,166,050 887,145 763,745 655,427 602,477
Allowance for loan losses (19,074) (13,883) (11,421) (9,570) (8,145)
------------ ---------- ---------- ---------- --------
Total loans, net $ 1,146,976 $ 873,262 $ 752,324 $ 645,857 $ 594,332
============ ========== ========== ========== ==========
Total loans increased to $1.2 billion at December 31, 2001 from $887.1 million
at December 31, 2000, an increase of $279.0 million or 31.4%. The acquisition of
BNB accounted for $189.5 million of the loan growth with the balance of $89.5
million generated principally from continued expansion of the commercial loan
portfolio. Commercial loans increased $62.6 million ($40.5 million from the BNB
acquisition) or 36.8%, while commercial real estate loans increased by $108.7
million ($56.9 million from the BNB acquisition) or 65.4%. At December 31, 2001,
commercial loans totaled $232.4 million, representing 19.9% of total loans, and
commercial real estate loans totaled $274.7 million, representing 23.60% of
total loans. The significant increase in commercial loans and commercial real
estate loans reflect the Banks' business development efforts.
At December 31, 2001, agricultural loans, which include agricultural real estate
loans, represented 16.0% of the total loan portfolio. During 2001, agricultural
loans increased by $21.2 million ($7.2 million from the BNB acquisition), or
12.9%, to $186.6 million.
As of December 31, 2001, residential real estate loans grew by $39.0 million
($50.5 million from the BNB acquisition) or 19.4% from December 31, 2000, and
totaled $240.1 million or 20.6% of total loans. Considering BNB residential real
estate loans acquired amounted to $50.5 million, the residential real estate
portfolio decreased $11.5 million in 2001. This decrease is a reflection of the
Company's trend towards selling residential real estate mortgages, which is
evidenced by the increase in the sold and serviced residential real estate loan
portfolio during 2001. During 2001 and 2000, the Company sold loans totaling
$117,446,000 and $25,880,000, respectively.
The Company also offers a broad range of consumer loan products. Consumer and
home equity loans grew by $47.5 million ($34.4 million from the BNB acquisition)
or 25.7%, in 2001 and ended the year at $232.2 million, representing 19.9% of
the total loan portfolio.
Total loans increased to $887.1 million at December 31, 2000 from $763.7 million
at December 31, 1999, an increase of $123.4 million or 16.2%. Commercial loans
increased $29.4 million or 20.9%, while commercial real estate loans increased
by $28.4 million or 20.6%. At December 31, 2000, commercial loans totaled $169.8
million, representing 19.1% of total loans, and commercial real estate loans
totaled $166.0 million, representing 18.7% of total loans.
At December 31, 2000, agricultural loans, which include agricultural real estate
loans, represented 18.7% of the total loan portfolio. During 2000, agricultural
loans increased by $13.9 million, or 9.2%, to $165.4 million. As of December 31,
2000, residential real estate loans had grown by $12.1 million or 6.4% from
December 31, 1999, and totaled $201.2 million or 22.7% of the total loan
portfolio. The growth in the portfolio resulted from the Banks' business
development efforts and broad line of variable and fixed-rate mortgage products.
Consumer and home equity loans grew by $39.7 million, or 27.4%, in 2000 and
ended the year at $184.7 million, representing 20.8% of the total loan
portfolio. The majority of the increase in consumer loans was from an expanded
indirect lending program.
22
NONACCRUING LOANS AND NONPERFORMING ASSETS
Nonperforming assets increased $3.0 million to $11.0 million at December 31,
2001 compared to the prior year. The increase in nonperforming assets relates
directly to nonperforming assets acquired with BNB. However, given the
continuing growth of the loan portfolio, the Company's ratio of nonperforming
loans to total loans of 0.86% at December 31, 2001, increased slightly from the
ratio of 0.80% at December 31, 2000. The overall level of nonperforming assets
as a percentage of total loans and other real estate was 0.94% at December 31,
2001, comparable to 0.91% at December 31, 2000.
The following table sets forth information regarding nonaccruing loans and other
nonperforming assets.
At December 31
-------------------------------------------------------------
(Dollars in thousands) 2001 2000 1999 1998 1997
-------------------------------------------------------------
Nonaccruing loans (1)
Commercial $ 2,623 $ 1,044 $ 1,159 $ 1,250 $ 970
Commercial real estate 3,344 1,619 1,373 995 1,648
Agricultural 1,529 2,881 1,455 2,340 2,669
Residential real estate 921 835 413 733 1,325
Consumer and home equity 541 217 375 423 431
-------- --------- --------- --------- ---------
Total nonaccruing loans 8,958 6,596 4,775 5,741 7,043
Accruing loans 90 days or more delinquent 1,064 521 969 360 433
-------- --------- --------- --------- ---------
Total nonperforming loans 10,022 7,117 5,744 6,101 7,476
Other real estate owned 947 932 969 2,084 2,309
-------- --------- --------- --------- ---------
Total nonperforming assets $ 10,969 $ 8,049 $ 6,713 $ 8,185 $ 9,785
======= ======== ======== ======== ========
Total nonperforming loans to total loans 0.86% 0.80% 0.75% 0.93% 1.24%
Total nonperforming assets to total loans
and other real estate 0.94% 0.91% 0.88% 1.24% 1.62%
(1) Loans are placed on nonaccrual 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.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents the estimated amount of credit losses
inherent in the Banks' loan portfolios. The Company performs periodic,
systematic reviews of its Banks' portfolios to identify these inherent losses,
and to assess the overall probability of collection of these portfolios. These
reviews result in the identification and quantification of loss factors, which
are used in determining the amount of the allowance for loan losses. In
addition, the Company periodically evaluates prevailing economic and business
conditions, industry concentrations, changes in the size and characteristics of
the portfolio and other pertinent factors. The allowance for loan losses is
allocated to cover the estimated losses inherent in each loan category based on
the results of this detailed review. The process used by the Company to
determine the appropriate overall allowance for loan losses is based on this
analysis, taking into consideration management's judgment. Allowance methodology
is reviewed on a periodic basis and modified as appropriate. Based on this
analysis, the Company believes that the allowance for loan losses is fairly
stated at December 31, 2001.
At December 31, 2001, the Company's allowance for loan losses totaled $19.1
million, an increase of $5.2 million over the previous year end. The allowance
as a percentage of total loans was 1.64% at December 31, 2001, compared to 1.56%
in 2000. The allowance as a percentage of total nonperforming loans was 190.32%
at December 31, 2001, compared to 195.06% at December 31, 2000.
23
The following table sets forth an analysis of the activity in the allowance for
loan losses for the periods indicated.
Years Ended December 31
-------------------------------------------------------------
(Dollars in thousands) 2001 2000 1999 1998 1997
-------------------------------------------------------------
Balance at beginning of year $ 13,883 $ 11,421 $ 9,570 $ 8,145 $ 7,129
Addition as a result of BNB acquisition 2,686 - - - -
Charge-offs:
Commercial 1,003 466 312 263 500
Commercial real estate 394 629 139 687 746
Agricultural 58 85 12 19 -
Residential real estate 178 113 461 215 131
Consumer and home equity 1,319 905 663 488 620
------- -------- -------- -------- --------
Total charge-offs 2,952 2,198 1,587 1,672 1,997
Recoveries:
Commercial 58 206 88 106 12
Commercial real estate 23 22 23 84 18
Agricultural - 1 - - 1
Residential real estate 19 5 163 42 26
Consumer and home equity 399 215 102 133 127
------- -------- -------- ---------- --------
Total recoveries 499 449 376 365 184
Net charge-offs 2,453 1,749 1,211 1,307 1,813
Provision for loan losses 4,958 4,211 3,062 2,732 2,829
------- -------- -------- ---------- --------
Balance at end of year $ 19,074 $ 13,883 $ 11,421 $ 9,570 $ 8,145
========= ========== ========== ========= =========
Ratio of net charge-offs during the year to
average loans outstanding during the year 0.23% 0.21% 0.17% 0.21% 0.32%
Ratio of allowance for loan losses to total loans 1.64% 1.56% 1.50% 1.46% 1.35%
Ratio of allowance for loan losses to
nonperforming loans 190.32% 195.06% 198.83% 156.86% 108.95%
The following table summarizes the loan delinquencies (excluding nonaccrual) in
the loan portfolio as of December 31, 2001:
60-89 90 Days
(Dollars in thousands) Days or More
---- -------
Commercial $ 446 $ 275
Commercial real estate 674 160
Agricultural - -
Residential real estate 677 357
Consumer and home equity 891 272
-------- -------
Total $ 2,688 $ 1,064
======== =======
24
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
The following table sets forth the allocation of the allowance for loan losses
by loan category at the dates indicated. The allocation is made for analytical
purposes and is not necessarily indicative of the categories in which actual
losses may occur. The total allowance is available to absorb losses from any
segment of the loan portfolio.
At December 31
-----------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
-----------------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
of of Loans of of Loans of of Loans of of Loans of of Loans
Allowance in Each Allowance in Each Allowance in Each Allowance in Each Allowance in Each
for Category for Category for Category for Category for Category
Loan to Total Loan to Total Loan to Total Loan to Total Loan to Total
(Dollars in thousands) Losses Loans Losses Loans Losses Loans Losses Loans Losses Loans
---------------------------------------------------------------------------------------------------------
Commercial $ 5,358 19.9% $ 3,402 19.1% $ 2,314 18.4% $ 3,227 17.9% $ 2,406 17.6%
Commercial real estate 3,877 23.6 2,094 18.7 2,181 18.0 1,734 16.3 1,237 16.5
Agricultural 2,586 16.0 2,464 18.7 1,591 19.8 1,288 18.9 1,377 17.8
Residential real estate 1,957 20.6 1,259 22.7 952 24.8 1,489 27.8 1,328 28.3
Consumer and home equity 3,413 19.9 2,449 20.8 1,792 19.0 1,643 19.1 1,490 19.8
Unallocated 1,883 - 2,215 - 2,591 - 189 - 307 -
-------- --- ------- --- ------ --- -------- ---- -------- ---
Total $ 19,074 100% $ 13,883 100% $ 11,421 100% $ 9,570 100% $ 8,145 100%
======== === ======= === ======= === ======== === ======== ===
LOAN MATURITY AND REPRICING SCHEDULE
The following table sets forth certain information as of December 31, 2001,
regarding the amount of loans maturing or repricing in the 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 are included in the period in which the final contractual repayment is
due.
At December 31, 2001
---------------------------------------------------------------
One
Within Through After
One Five Five
(Dollars in thousands) Year Years Years Total
------------- ----------- ----------- ------------
Commercial $ 98,986 $ 89,678 $ 43,715 $ 232,379
Commercial real estate 9,134 36,115 229,453 274,702
Agricultural 42,296 50,964 93,363 186,623
Residential real estate 10,168 22,024 207,949 240,141
Consumer and home equity 14,241 138,407 79,557 232,205
------------- ----------- ----------- ------------
Total loans $ 174,825 $ 337,188 $ 654,037 $ 1,166,050
============= =========== =========== ============
Loans maturing after one year:
With a predetermined interest rate $ 216,874 $ 200,068
With a floating or adjustable rate 120,314 453,969
INVESTING ACTIVITIES
U.S. Treasury and Agency Securities. At December 31, 2001, the U.S. Treasury and
Agency securities portfolio totaled $185.4 million ($15.5 million acquired from
BNB at acquisition), of which $183.5 million was classified as available for
sale. The portfolio consisted of $10.8 million in U. S. Treasury securities and
$174.6 million in U. S. federal agency securities. The U. S. federal agency
security portfolio consists almost exclusively of callable securities. These
callable securities provide higher yields than similar securities without call
features. At December 31, 2000, the U. S. Treasury and Agency securities
portfolio totaled $171.2 million of which $169.2 million was classified as
available for sale.
25
State and Municipal Obligations. At December 31, 2001, the portfolio of state
and municipal obligations totaled $202.6 million ($40.2 million acquired in the
BNB acquisition), of which $143.2 million was classified as available for sale.
At that date $59.4 million was classified as held to maturity, with a fair value
of $60.3 million. At December 31, 2000, the portfolio of state and municipal
obligations totaled $123.9 million, of which $48.9 million was classified as
available for sale. At that date, $75.0 million was classified as held to
maturity, with a fair value of $74.9 million. Over the past two years, more
favorable yields on new purchases of these securities, when compared to other
taxable investment alternatives, has led to significant growth in this
portfolio. The increase is also reflective of the growth in public deposits and
the use of these securities to collateralize those deposits.
Mortgage-Backed Securities. At December 31, 2001, the Company had $90.0 million
($23.0 million acquired from BNB at acquisition) in mortgage-backed securities,
all classified as available for sale. At December 31, 2000, the Company had
$29.1 million in mortgage-backed securities, all classified as available for
sale. The significant increase in mortgage-backed securities in 2001 relates to
more favorable yields on new purchases of this class of securities.
Corporate Bonds. The corporate bond portfolio at December 31, 2001 totaled $7.9
million ($3.1 million acquired in the BNB acquisition), all of which was
classified as available for sale. The portfolio was purchased to further
diversify the investment portfolio and increase investment yield. The Company's
investment policy limits investments in corporate bonds to no more than 10% of
total investments and to bonds rated at inception as Baa or better by Moody's
Investors Service, Inc. or BBB or better by Standard & Poor's Ratings Services.
The corporate bond portfolio at December 31, 2000 totaled $9.3 million, all of
which was classified as available for sale.
Equity Securities. At December 31, 2001, equity securities totaled $3.8 million,
all of which was classified as available for sale. Included in the portfolio is
$3.0 million of FHLMC preferred stock. At December 31, 2000, equity securities
totaled $1.2 million, all of which was classified as available for sale.
SECURITY YIELDS AND MATURITIES SCHEDULE
The following table sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of the Company's debt
securities portfolio as of December 31, 2001. No tax equivalent adjustments were
made to the weighted average yields.
December 31, 2001
---------------------------------------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years After Ten Years Total
---------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average Amortized Average Amortized Average
(Dollars in thousands) Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield
---------------------------------------------------------------------------------------------------------
Available for Sale:
US Treasury and Agency $18,361 4.45% $ 49,274 5.91% $ 100,961 5.80% $ 14,216 6.24% $ 182,812 5.73%
Mortgage-backed securities 686 5.89 19,948 6.07 34,944 5.51 33,818 5.59 89,396 5.66
State and municipal
obligations 8,339 4.50 78,753 4.39 48,822 4.40 5,723 4.95 141,637 4.42
Corporate bonds -- -- 3,509 6.61 749 6.22 3,566 8.18 7,824 7.27
-------------------------------------------------------------------------------------------------
Total debt securities
available for sale $27,386 4.50% $ 151,484 5.16% $ 185,476 5.38% $ 57,323 5.85% $ 421,669 5.31%
=================================================================================================
Held to Maturity:
US Treasury and Agency $ 1,950 6.23% $ -- -% $ -- -% $ -- -% $1,950 6.23%
State and municipal
obligations 29,086 3.87 27,438 4.46 2,162 5.33 645 5.94 59,331 4.22
-------------------------------------------------------------------------------------------------
Total debt securities
held to maturity $31,036 4.02% $ 27,438 4.46% $ 2,162 5.33% $ 645 5.94% $ 61,281 4.28%
=================================================================================================
26
FUNDING ACTIVITIES
BORROWINGS
The following table sets forth certain information as to the Company's
short-term borrowings for the periods indicated. Short-term borrowings mature in
less than one year.
As of and for the year ended December 31
--------------------------------------------
(Dollars in thousands) 2001 2000 1999
--------- --------- ---------
Federal funds purchased and securities
sold under repurchase agreements $ 60,957 $ 15,950 $ 4,596
FHLB advances 42,135 30,953 41,500
Other short-term borrowings 678 - -
-------- ------- --------
Total short-term borrowings $ 103,770 $ 46,903 $ 46,096
========= ========= ========
Average rate at year-end 2.12% 5.75% 5.77%
Average rate during period 3.95% 5.96% 5.02%
The Company had $40.5 million of remaining credit available under lines of
credit with the FHLB at December 31, 2001, which are collateralized by FHLB
stock and real estate mortgage loans. The Company also had $41.0 million of
remaining credit available under unsecured lines of credit with various banks at
December 31, 2001. During 2001, the Company also obtained lines of credit with
Farmer Mac permitting borrowings to a maximum of $50.0 million. However, no
advances were outstanding against those lines at December 31, 2001.
Long-term borrowings are summarized as follows:
As of and for the year ended December 31
--------------------------------------------
(Dollars in thousands) 2001 2000 1999
--------- --------- ---------
FHLB advances $ 65,154 $ 15,382 $ 8,421
10% Notes - - 1,698
Other 5,265 99 121
-------- ------- --------
Total long-term borrowings $ 70,419 $ 15,481 $ 10,240
========= ========= =========
At December 31, 2001 and 2000, long-term borrowings primarily include FHLB
advances with maturities of more than 1 year. The advances mature on various
dates ranging from 2003 through 2011 and bear interest at a fixed weighted
average rate of 5.05% as of December 31, 2001. The Company's FHLB advances
include $20.0 million in fixed-rate callable borrowings, which can be called by
the FHLB on the first anniversary of the borrowing, and quarterly thereafter.
Other long-term borrowings consist primarily of a $5.0 million advance on a
credit agreement with a bank, which was executed to aid in funding the
acquisition of BNB. The credit agreement requires monthly payments of interest
only, at a variable interest rate of 1.50% plus LIBOR, with 5.02% being the rate
in effect at December 31, 2001. The credit agreement expires April 2003.
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN CORPORATIONS JUNIOR SUBORDINATED
DEBENTURES On February 22, 2001, the Company established FISI Statutory Trust I
(the "Trust"), which is a statutory business trust formed under Connecticut law,
upon filing a certificate of trust with the Connecticut Secretary of State. The
Trust exists for the exclusive purposes of (i) issuing and selling 30 year
guaranteed preferred beneficial interests in the Corporation's junior
subordinated debentures ("capital securities") in the aggregate amount of $16.2
million at a fixed rate of 10.20%, (ii) using the proceeds from the sale of the
capital securities to acquire the junior subordinated debentures issued by the
Company and (iii) engaging in only those other activities necessary, advisable
or incidental thereto. The junior subordinated debentures are the sole assets of
the Trust and, accordingly, payments under the corporation obligated junior
debentures are the sole revenue of the Trust. All of the common securities of
27
the Trust are owned by the Company. The Company used the net proceeds from the
sale of the capital securities to partially fund the BNB acquisition. As of
December 31, 2001, all but $3.8 million of the capital securities qualified as
Tier I capital under regulatory definitions. The Company's primary source of
funds to pay interest on the debentures owed to the Trust are current dividends
from its subsidiary banks. Accordingly, the Company's ability to service the
debentures is dependent upon the continued ability of the subsidiary banks to
pay dividends to the Company. Since the capital securities are classified as
debt for financial statement purposes, the tax-deductible expense associated
with the capital securities is recorded as interest expense in the consolidated
statements of income. The Company incurred $487,000 in costs to issue the
securities and the costs are being amortized over 20 years using the
straight-line method.
DEPOSITS
The Banks offer a broad array of core deposit products including checking
accounts, interest-bearing transaction accounts, savings and money market
accounts and certificates of deposit under $100,000. These core deposits totaled
$1,199.2 million or 83.6% of total deposits of $1,433.7 million at December 31,
2001. The core deposit base consists almost exclusively of in-market accounts.
Core deposits are supplemented with certificates of deposit over $100,000, which
amounted to $234.5 million as of December 31, 2001, largely from in-market
municipal, business and individual customers. As of December 31, 2001, brokered
certificates of deposit included in certificates of deposit over $100,000
totaled $45.0 million.
Total deposits at December 31, 2000 amounted to $1,078.1 million, an increase of
$128.6 million or 13.5% from $949.5 million at December 31, 1999. Core deposit
products were $784.3 million or 72.7% of total deposits at December 31, 2000.
Certificates of deposit over $100,000 totaled $293.8 million at December 31,
2000, which included $15.0 million in brokered certificates of deposit.
The daily average balances, percentage composition and weighted average rates
paid on deposits for each of the years ended December 31, 2001, 2000 and 1999
are presented below:
For the year ended December 31
-----------------------------------------------------------------------------------
2001 2000 1999
-----------------------------------------------------------------------------------
Percent Percent Percent
Of Total Weighted Of Total Weighted Of Total Weighted
Average Average Average Average Average Average Average Average Average
(Dollars in thousands) Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
-----------------------------------------------------------------------------------
Interest-bearing checking $ 172,022 13.2% 1.23% $ 113,344 11.4% 1.36% $ 105,076 11.8% 1.34%
Savings and money market 253,128 19.4 2.07 193,027 19.3 2.66 183,800 20.7 2.43
Certificates of deposit
under $100,000 376,256 28.9 5.36 294,926 29.5 5.63 280,953 31.6 5.22
Certificates of deposit
over $100,000 319,974 24.6 4.97 260,757 26.1 6.32 190,942 21.5 5.18
Non-interest bearing accounts 181,831 13.9 - 136,614 13.7 - 127,899 14.4 -
-----------------------------------------------------------------------------------
Total average deposits $1,303,211 100.0% 3.33% $ 998,668 100.0% 3.98% $ 888,670 100.0% 3.78%
===================================================================================
The following table indicates the amount of the Company's certificates of
deposit by time remaining until maturity as of December 31, 2001:
At December 31, 2001
--------------------------------------------------------------------------------------------
3 Months Over 3 To Over 6 To Over 12
Or Less 6 Months 12 Months Months Total
---------------------------------------------------------------------
(Dollars in thousands)
Certificates of deposit
less than $100,000 $ 112,087 $ 99,973 $ 111,322 $ 78,634 $ 402,016
Certificates of deposit
Of $100,000 or more 101,703 33,955 68,695 30,098 234,451
---------- ---------- ---------- ---------- ----------
Total certificates of deposit $ 213,790 $ 133,928 $ 180,017 $ 108,732 $ 636,467
============ ============ ========== ========== ==========
28
NET INCOME ANALYSIS
AVERAGE BALANCE SHEET
The following table sets forth certain information relating to the Company's
consolidated statements of financial condition and reflects the average yields
earned on interest-earning assets, as well as the average rates paid on
interest-bearing liabilities for the years indicated. Such yields and rates were
derived by dividing interest income or expense by the average balances of
interest-earning assets or interest-bearing liabilities, respectively, for the
years shown. Tax equivalent adjustments have been made. All average balances are
average daily balances. Nonaccruing loans are included in the yield calculations
in this table.
Year ended December 31
-------------------------------------------------------------------------------------------
2001 2000 1999
----------------------------- ------------------------------ ------------------------------
Average Interest Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/Yield/
(Dollars in thousands) Balance Paid Rate Balance Paid Rate Balance Paid Rate
----------------------------- ------------------------------ ------------------------------
Interest-earning assets:
Federal funds sold and
interest bearing deposits $ 8,634 $ 358 4.15% $ 3,039 $ 184 6.05% $ 8,529 $ 428 5.02%
Investment securities (1) 421,945 26,567 6.30 308,643 20,324 6.58 274,290 17,203 6.27
Loans (2) 1,056,720 91,482 8.66 825,953 78,538 9.51 700,062 63,417 9.06
--------- -------- ------- --------- --------- ------ --------- ---------- ------
Total interest-earning assets 1,487,299 118,407 7.96 1,137,635 99,046 8.70 982,881 81,048 8.24
Allowance for loan losses (16,825) (12,509) (10,261)
Other non-interest earning assets 117,698 72,390 63,841
-------- --------- ---------
Total assets $1,588,172 $1,197,516 $1,036,461
========= ========= =========
Interest-bearing liabilities:
Savings and money market $ 253,128 $ 5,244 2.07% $ 193,027 $ 5,135 2.66% $ 183,800 $ 4,461 2.43%
Interest-bearing checking 172,022 2,110 1.23 113,344 1,537 1.36 105,076 1,408 1.34
Certificates of deposit 696,230 36,060 5.18 555,683 33,086 5.95 471,895 24,551 5.20
Borrowed funds 107,530 4,840 4.50 60,978 3,847 6.31 26,398 1,463 5.54
Guaranteed preferred beneficial
interests in corporations junior
subordinated debentures 13,892 1,440 10.37 - - - - - -
-------- -------- ------- --------- --------- ------ --------- ---------- ------
Total interest-bearing
liabilities 1,242,802 49,694 4.00 923,032 43,605 4.72 787,169 31,883 4.05
-------- -------- ------- --------- --------- ------ --------- ---------- ------
Non-interest bearing
demand deposits 181,831 136,614 127,899
Other non-interest-bearing
liabilities 21,318 14,906 14,091
--------- -------- -------
Total liabilities 1,445,951 1,074,552 929,159
Stockholders' equity (3) 142,221 122,964 107,302
-------- --------- ---------
Total liabilities and
stockholders' equity $1,588,172 $1,197,516 $1,036,461
========== ========== ==========
Net interest income $ 68,713 $ 55,441 $ 49,165
======= ======== =========
Net interest rate spread 3.96% 3.98% 4.19%
======= ====== ======
Net earning assets $ 244,497 $ 214,603 $ 195,712
======== ========= ========
Net interest income as a percentage
of average interest-earning assets 4.62% 4.87% 5.00%
========== =========== =====
Ratio of average interest-earning assets
to average interest-bearing liabilities 119.67% 123.25% 124.86%
====== ====== ======
(1) Amounts shown are amortized cost for held to maturity securities and fair value for available for sale securities. In order
to make pre-tax income and resultant yields on tax-exempt securities comparable to those on taxable securities and loans,
a tax-equivalent adjustment to interest earned from tax-exempt securities has been computed using a federal tax
rate of 35%.
(2) Net of deferred loan fees and costs, and loan discounts and premiums.
(3) Includes unrealized gains/(losses) on securities available for sale.
29
NET INTEREST INCOME
Net interest income, the principal source of the Company's earnings, was $64.8
million in 2001, an $11.9 million or 22.5% increase over 2000. The significant
increase relates primarily to the acquisition of BNB, as net interest income for
BNB during 2001 amounted to $8.2 million. Average earning assets increased 30.7%
to $1,487.3 million for the year ended December 31, 2001. The growth in earning
assets was partially offset by a 25 basis point decline in net interest margin.
Net interest income was $52.9 million in 2000 compared with $47.0 million in
1999, an increase of 12.6%. Average earning assets grew by $154.7 million in
2000, or 15.7% over 1999, which offset the effects of a 13 basis point decline
in the net interest margin. Net interest margin, on a tax-equivalent basis, was
4.62% for 2001, 4.87% for 2000 and 5.00% for 1999.
The decline in net interest margin in 2001 can be attributed to a number of
factors which include: the declining rate environment, increased competitive
rate pressures for additional loan assets and the continuing shift in the mix of
funding sources. The yield on interest-earning assets declined 74 basis points
to 7.96% in 2001, from 8.70% in 2000, after increasing from 8.24% in 1999.
Similarly, the cost of interest-bearing liabilities decreased 72 basis points to
4.00% in 2001 from 4.72% in 2000, after increasing from 4.05% in 1999.
RATE/VOLUME ANALYSIS
The following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to: (i) changes attributable to changes in volume (changes in volume
multiplied by current year rate); (ii) changes attributable to changes in rate
(changes in rate multiplied by prior volume); and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
Year ended December 31
------------------------------------------------------------------------
2001 vs 2000 2000 vs 1999
------------------------------------------------------------------------
Increase/(Decrease) Total Increase/(Decrease) Total
Due To Increase/ Due To Increase/
(Dollars in thousands) Volume Rate (Decrease) Volume Rate (Decrease)
------------------------------------------------------------------------
Interest-earning assets:
Federal funds sold and
Interest - bearing deposits $ 232 $ (58) $ 174 $ (331) $ 87 $ (244)
Investment securities 7,110 (867) 6,243 2,254 867 3,121
Loans 20,007 (7,063) 12,944 12,060 3,061 15,121
---------- -------- ---------- ---------- ------- ----------
Total interest-earning assets 27,349 (7,988) 19,361 13,983 4,015 17,998
========== ======== ========== ========== ======= ==========
Interest-bearing liabilities:
Savings and money market 721 (148) 573 239 435 674
Interest-bearing checking 1,431 (1,322) 109 108 21 129
Certificates of deposit 7,329 (4,355) 2,974 4,959 3,576 8,535
Borrowed funds 2,108 (1,115) 993 2,181 203 2,384
Guaranteed preferred beneficial
interests in corporation's junior
subordinated debentures 1,440 - 1,440 - - -
---------- -------- ---------- ---------- ------- ----------
Total interest-bearing liabilities 13,029 (6,940) 6,089 7,487 4,235 11,722
========== ========- ========== ========== ======= ==========
Net interest income $ 14,320 $ (1,048) $ 13,272 $ 6,496 $ (220) $ 6,276
========== ======== ========== ========= ======= ==========
30
PROVISION FOR LOAN LOSSES
The provision for loan losses represents management's estimate of the expense
necessary to maintain the allowance for loan losses at an adequate level for
losses inherent in the portfolio. The provision for loan losses was $5.0 million
in 2001, compared to $4.2 million in 2000 and $3.1 million in 1999. The
allowance for loan losses increased due to allowance acquired in the BNB
acquisition, as well as the significant growth in commercial, commercial real
estate, and consumer loans. Also, the Company provided for the additional
exposure in the portfolio related to the softening of the economy throughout the
year. Nonperforming loans were $10.0 million at December 31, 2001, representing
0.86% of total loans outstanding at year-end. Nonperforming loans at year-end
2000 were $7.1 million, representing 0.80% of total loans outstanding. In 2001
net loan charge-offs were $2.5 million or 0.23% of average loans, compared to
net loan charge-offs of $1.7 million or 0.21% of average loans for 2000. The
ratio of the allowance for loan losses to nonperforming loans at December 31,
2001 was 190.32%, down slightly from 195.06% at December 31, 2000. The ratio of
allowance for loan losses to total loans improved to 1.64% at December 31 ,2001
in comparison to 1.56% at December 31, 2000.
NONINTEREST INCOME
The following table presents the major categories of noninterest income during
the years indicated:
Year Ended December 31
--------------------------------------------
(Dollars in thousands) 2001 2000 1999
---- ---- ----
Service charges on deposits.......................... $ 7,653 $ 5,003 $ 4,289
Financial services group fees and commissions........ 2,690 1,151 945
Mortgage banking activities.......................... 2,190 1,536 1,343
Gain on sale or call of securities................... 531 27 71
Other................................................ 2,718 1,692 1,407
--------- -------- ---------
Total noninterest income........................... $ 15,782 $ 9,409 $ 8,055
========= ========= =========
Noninterest income increased 67.7% to $15.8 million in 2001 compared to $9.4
million in 2000. This increase is partially attributed to $2.9 million in
noninterest income generated by the acquired companies, BNB and BGI. Service
charges on deposit accounts increased significantly in 2001, which reflects the
benefit of the continuing growth in core deposits and the related fee-based
products and services. The increase in mortgage banking activities results from
the increase in the gain on sale of residential mortgage loans and an increase
in the serviced loan portfolio. The increase in financial services group fees
and commissions reflects the ongoing expansion of the financial services line of
business. FIGI, the Company's brokerage subsidiary, commenced operations in
March 2000, enabling FII to retain a higher portion of commissions on mutual
fund sales. Also, BGI was acquired during October 2001 and contributed to the
increase. FII has focused on growing fee income, in particular from the
financial services group, thus the integration of BGI with the Company's
existing businesses is expected to further enhance FII's ability to generate fee
income. The increase in gain on the sale or call of securities during 2001
reflects gains recorded as a result of callable agency bonds, which were
acquired at a discount, being called due to the declining interest rate
environment in 2001.
Noninterest income increased 16.8% to $9.4 million in 2000 compared to $8.1
million in 1999. The increase primarily falls out from the increase in service
charges on deposit accounts, which increased $714,000, or 16.6%, to $5.0 million
in 2000 from $4.3 million in 1999, a reflection of core deposit growth.
31
NONINTEREST EXPENSE
The following table presents the major categories of noninterest expense during
the years indicated:
Year Ended December 31
--------------------------------------------
(Dollars in thousands) 2001 2000 1999
---- ---- ----
Salaries and employee benefits....................... $ 22,958 $ 16,803 $ 14,801
Occupancy and equipment.............................. 6,050 4,614 4,491
Supplies and postage................................. 1,959 1,500 1,403
Amortization of goodwill and other intangible assets. 2,381 737 839
Professional fees.................................... 1,293 826 618
Advertising.......................................... 839 637 574
Other real estate.................................... 255 126 259
Other expense........................................ 7,617 4,913 4,047
--------- -------- ---------
Total noninterest expense.......................... $ 43,352 $ 30,156 $ 27,032
========= ========= =========
Noninterest expense increased 43.7% to $43.4 million in 2001 compared to $30.2
million in 2000. This increase is partially attributed to $6.2 million in
noninterest expense from the acquired companies, BNB and BGI. The Company's
largest component of noninterest expense, salaries and employee benefits,
increased 36.6% and 13.5% in the years 2001 and 2000, respectively, a reflection
of staffing additions from BNB and other additions necessary to support the
Company's growth. The increase also results from overhead coupled with
integrating the newly acquired companies, expenditures associated with
maintaining the Company's investment in technology and costs connected with
opening new branch offices. In addition, goodwill amortization expense
recognized on the BNB acquisition amounted to $1.7 million in 2001. The
amortization of goodwill ceased on January 1, 2002 with the adoption of SFAS No.
142. Even with these expenditures, the Company's efficiency ratio, which
measures the amount of overhead required to produce a dollar of revenue,
remained at a relatively low level. For the years ended December 31, 2001, 2000
and 1999 the efficiency ratio was 48.5%, 45.2% and 45.6%, respectively.
Noninterest expense increased 11.6% in 2000 and 9.9% in 1999 primarily from
investments in human resources, facilities and technology. During these years,
the Company added features to technological capabilities including: internet
banking, check imaging and upgrades to overall data processing capabilities.
INCOME TAX EXPENSE
The provision for income taxes provides for Federal and New York State income
taxes, which amounted to $11.0 million, $9.8 million and $8.8 million for the
years ended December 31, 2001, 2000 and 1999, respectively. The increasing trend
corresponds to increased levels of taxable income. The effective tax rate for
2001 was 34.2%, compared to 35.1% in 2000 and 35.6% in 1999. The decrease in the
effective tax rate from 2001 to 2000 was primarily attributable to an increase
in holdings of tax exempt securities, which was partially offset by
non-deductible goodwill amortization expense resulting from the BNB acquisition.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS Nos. 141, "Business Combinations" and 142,
"Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business
combinations be accounted for under the purchase method, use of the
pooling-of-interests method is no longer permitted for business combinations
initiated after June 30, 2001. SFAS No. 142 requires that goodwill (including
goodwill reported in prior acquisitions) no longer be amortized to earnings, but
instead be reviewed for impairment annually, with impairment losses charged to
earnings when they occur. The Company is required to adopt SFAS No. 142
effective January 1, 2002. The results of operations for year ended December 31,
2001 include goodwill amortization from the BNB acquisition of $1,653,000. The
amortization of goodwill ceased effective January 1, 2002.
32
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
The objective of maintaining adequate liquidity is to assure the ability of the
Company and its subsidiaries to meet their financial obligations. These
obligations include the withdrawal of deposits on demand or at their contractual
maturity, the repayment of borrowings as they mature, the ability to fund new
and existing loan commitments and the ability to take advantage of new business
opportunities. The Company and its subsidiaries achieve liquidity by maintaining
a strong base of core customer funds, maturing short-term assets, the ability to
sell securities, lines of credit, and access to capital markets.
Liquidity at the subsidiary bank level is managed through the monitoring of
anticipated changes in loans, core deposits, and wholesale funds. The strength
of the subsidiary bank's liquidity position is a result of its base of core
customer deposits. These core deposits are supplemented by wholesale funding
sources which include credit lines with the other banking institutions, the
FHLB, Farmer Mac, and the Federal Reserve Bank.
The primary source of liquidity for the parent company is dividends from
subsidiaries, lines of credit, and access to capital markets. Dividends from
subsidiaries are limited by various regulatory requirements related to capital
adequacy and earnings trends. The Company's subsidiaries rely on cash flows from
operations, core deposits, borrowings, short-term liquid assets, and, in the
case of non-banking subsidiaries, funds from the parent company.
Total deposits at December 31, 2001 were $1,434 million an increase of $356
million from $1,078 million at December 31, 2000. At the time of acquisition,
total deposits of BNB were $232 million. The remaining growth of $124 million
was the result of gaining greater market share in the Company's existing
markets. Maintenance and growth in the Company's deposits is dependent upon
overall economic conditions and the Company's deposit product features, price,
and service profile relative to competitors.
Total borrowings and trust preferred securities were $190 million, at December
31, 2001, an increase of $128 million from $62 million at December 31, 2000. At
the time of acquisition, total borrowings of BNB were $36 million. Total
short-term borrowing were $104 million at December 31, 2001 compared to $47
million at December 31, 2000, while total long-term borrowings were $70 million
at December 31, 2001 compared to $15 million at December 31, 2000. The Company
formed a trust in February 2001 to accommodate the private placement of $16.2
million in trust preferred securities, the proceeds of which were utilized to
partially fund the acquisition of BNB.
Short-term borrowings consist principally of federal funds purchased, securities
sold under repurchase agreements, and FHLB advances. Lines of credit extended to
the Company in the form of federal funds by other banking institutions are
principally dependent upon the financial strength of the Company, generally as
measured by earnings performance and capital levels. FHLB lines are dependent
upon the Company's membership in the FHLB System and the strength of its capital
position with advances required to be collateralized with available eligible
loans or securities. Securities sold under repurchase agreements are dependent
upon the availability of unpledged securities and the offering to customers of
competitive terms and pricing. Long-term borrowings consist principally of
advances from the FHLB.
At December 31, 2001, the Company had remaining credit available of $40.5
million under lines of credit with the FHLB and $41.0 million with various
banking institutions. During 2001, the Company also obtained lines of credit
with Farmer Mac permitting borrowings to a maximum of $50.0 million to be
secured by eligible loan collateral. No advances were outstanding against the
Farmer Mac line at December 31, 2001.
The Company's cash and cash equivalents were $53 million at December 31, 2001,
an increase of $23 million from the balance of $30 million at December 31, 2000.
The company generated $209 million in net cash from financing activities and $28
million in net cash from operating activities that collectively was utilized in
providing $214 million to investing activities, with the balance of $23 million
increasing the
33
Company's cash and cash equivalents. The principal sources of cash from
financing activities were $124 million from net increase in deposits, $75
million from net increase in borrowings, and $16 million from the issuance of
guaranteed preferred beneficial interests in Corporation's junior subordinated
debentures, partially offset by $7 million in dividend payments. The principal
source of net cash from operating activities is the Company's net income of $21
million supplemented by non-cash earnings charges of $6 million from
depreciation and amortization expense and $5 million for provision for loan
losses. The Company utilized its cash in the following investing activities: $70
million in the net acquisition of securities, $90 million in the net origination
of loans, $4 million in the net acquisition of premises and equipment, and $49
million in the acquisition of BNC and BGI. An additional source of liquidity to
the Company is provided from its ability to limit its investing activities
and/or dispose of its securities and loans. Additional liquidity can be provided
to the Company through limiting the growth in loans by offering terms and
pricing that would not be competitive. Securities available for sale and newly
originated loans could be sold to provide additional liquidity. The fair value
of assets being sold is dependent upon market conditions at the time of sale and
potentially could adversely affect the Company's earnings.
In the normal course of business the Company has outstanding commitments to
extend credit which are not reflected in the Company's consolidated financial
statements. The commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. At December 31, 2001
letters of credit totaling $9 million and unused loan commitments of $266
million were contractually available. Comparable amounts for these commitments
at December 31, 2000 were $7 million and $183 million, respectively. The total
commitment amounts do not necessarily represent future cash requirements as many
of the commitments are expected to expire without funding.
CAPITAL RESOURCES
The Company's total shareholders' equity consists of common equity and perpetual
preferred stock. The Company's equity changes from the issuance of new shares,
the purchase of existing shares, from retained earnings, and from accumulated
other comprehensive income. Retained earnings are affected by net income and
dividends paid on common and preferred stock. Accumulated other comprehensive
income is affected by the fair value of securities available for sale. The
following table summarizes the changes in the Company's shareholders' equity for
the years ended December 31, 2001, 2000, and 1999:
Change in
Accumulated Change in
Total Other Total
Net Dividends Retained Shares Shares Comprehensive Shareholders'
(Dollars in thousands) Income Declared Earnings Issued Purchased Income Equity
------ -------- -------- ------ --------- ------ ------
2001 $21,213 $(6,775) $14,438 $827 $(16) $2,320 $17,569
2000 18,100 (6,113) 11,987 29 (454) 2,517 14,079
1999 15,957 (4,763) 11,194 13,623 (54) (3,802) 20,961
For 2001 the Company's total equity increased $17.6 million, principally from an
increase in retained earnings of $14.4 million. The increase in retained
earnings is the result of $21.2 million in net income net of the payout of $6.8
million or 31.9% of those earnings in dividends to common and preferred
shareholders. For 2000 the Company's total equity increased $14.1 million,
principally from retained earnings of $12.0 million. The increase in retained
earnings is the result of $18.1 million in net income and net of the payout of
$6.1 million or 33.8% of those earnings in dividends to common and preferred
shareholders. For 1999 total equity increased $21.0 million from two principal
sources: $13.6 million from the sale of 1,103,333 shares of the common stock and
$11.2 million from retained earnings. The increase in retained earnings is the
result of $16.0 million in net income and the payout of $4.8 million, or 29.8%,
of those earnings in dividends to common and preferred shareholders.
34
The Federal Reserve Board has adopted a system using risk-based capital
guidelines to evaluate the capital adequacy of bank holding companies. The
guidelines require a minimum total risk-based capital ratio of 8.0%. Leverage
ratio is also utilized in assessing capital adequacy with a minimum requirement
that can range from 3.0% to 5.0%. The following table reflects the changes in
the components of those ratios:
(Dollars in thousands) 2001 2000 1999
----------- ----------- -----------
Total shareholders' equity $ 149,187 $ 131,618 $ 117,539
Less: Unrealized gains/(losses) 2,176 (144) (2,661)
Goodwill and other intangible assets 39,166 2,381 3,118
Disallowed mortgage servicing asset 90 - -
Plus: Minority interests in consolidated subsidiaries 475 458 475
Qualifying trust preferred securities 12,408 - -
----------- ----------- -----------
Total Tier 1 capital $ 120,638 $ 129,839 $ 117,557
=========== =========== ===========
Adjusted average assets $ 1,718,034 $ 1,273,657 $ 1,088,404
Tier 1 leverage ratio 7.02% 10.19% 10.80%
Total Tier 1 capital $ 120,638 $ 129,839 $ 117,557
Plus: Qualifying allowance for loan losses 15,417 11,607 9,855
Qualifying trust preferred securities 3,792 - -
----------- ----------- -----------
Total risk-based capital $ 139,847 $ 141,446 $ 127,412
=========== =========== ===========
Net risk-weighted assets $ 1,229,811 $ 926,291 $ 786,840
Total risk-based capital ratio 11.37% 15.27% 16.19%
The Company's Tier 1 leverage ratio was 7.02% at December 31, 2001 and is
well-above minimum regulatory capital requirements. The ratio declined from
10.19% at December 31, 2000, principally as a result of the acquisition BNB.
Total Tier 1 capital of $120.6 million at December 31, 2001 declined $9.3
million from $129.8 million at December 31, 2000. The decrease in Tier 1 capital
directly relates to the recording of $37.2 million in goodwill for the BNB
acquisition that was partially offset by retained earnings of $14.4 million in
2001 and the issuance of $16.2 million in trust preferred securities in February
2001 of which $12.4 million qualified as Tier 1 capital. Also contributing to
the decline in the leverage ratio was an increase of $444.4 million in adjusted
average assets to $1,718.0 million at December 31, 2001. The increase in
adjusted average assets relates to BNB, which had $289 million in total assets
at the time of acquisition.
The Company's total risk-weighted capital ratio was 11.37% at December 31, 2001
and is well-above minimum regulatory capital requirements. The ratio declined
from 15.27% at December 31, 2000, which is principally a result of the BNB
acquisition. Total risk-based capital was $139.9 million at December 31, 2001 a
decline of $1.5 million from $141.4 million at December 31, 2000. The decline is
attributed to a $9.3 million decrease in Tier 1 capital which was partially
offset by a $3.8 million increase in qualifying allowance for loan losses, and
$3.8 million in trust preferred securities that did not qualify for Tier 1
capital treatment.
35
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
The principal objective of the Company's interest rate risk management is to
evaluate the interest rate risk inherent in certain assets and liabilities,
determine the appropriate level of risk to the Company given its business
strategy, operating environment, capital and liquidity requirements and
performance objectives, and manage the risk consistent with the guidelines
approved by the Company's Board of Directors. The Company's senior management is
responsible for reviewing with the Board its activities and strategies, the
effect of those strategies on the net interest margin, the fair value of the
portfolio and the effect that changes in interest rates will have on the
portfolio and exposure limits. Senior Management develops an Asset-Liability
Policy that meets strategic objectives and regularly reviews the activities of
the subsidiary banks. Each subsidiary bank board adopts an Asset-Liability
Policy within the parameters of the overall FII Asset-Liability Policy and
utilizes an asset/liability committee comprised of senior management of the bank
under the direction of the bank's board.
The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are "interest rate sensitive" and by
monitoring the Company's interest rate sensitivity "gap." An asset or liability
is said to be interest rate sensitive within a specific time period if it will
mature or re-price within that time period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets maturing
or re-pricing within a specific time period and the amount of interest-bearing
liabilities maturing or re-pricing within that same time period. A gap is
considered positive when the amount of interest rate sensitive assets exceeds
the amount of interest rate sensitive liabilities. A gap is considered negative
when the amount of interest rate sensitive liabilities exceeds the amount of
interest rate sensitive assets. At December 31, 2001, the one-year gap position,
the difference between the amount of interest-earning assets maturing or
re-pricing within one year and interest-bearing liabilities maturing or
re-pricing within one year, was $168.7 million, or 9.4% of total assets.
Accordingly, over the one-year period following December 31, 2001, the Company
will have $168.7 million more in liabilities re-pricing than assets. Generally
if rate-sensitive assets re-price sooner than rate-sensitive liabilities,
earnings will be positively impacted in a rising rate environment. Conversely,
in a declining rate environment, earnings will generally be negatively impacted.
If rate-sensitive liabilities re-price sooner than rate-sensitive assets then
generally earnings will be negatively impacted in a rising rate environment.
Conversely, in a declining rate environment earnings will generally be
positively impacted. Management believes that the negative gap position at
December 31, 2001 will not have a material adverse effect on the Company's
operating results.
GAP ANALYSIS
The following table (the "Gap Table") sets forth the amounts of interest-earning
assets and interest-bearing liabilities outstanding at December 31, 2001 which
management anticipates, based upon certain assumptions, to re-price or mature in
each of the future time periods shown. Except as stated below, the amount of
assets and liabilities shown which re-price or mature during a particular period
were determined in accordance with the earlier of the re-pricing date or the
contractual maturity of the asset or liability. The table sets forth an
approximation of the projected re-pricing of assets and liabilities at December
31, 2001, on the basis of contractual maturities, anticipated prepayments and
scheduled rate adjustments within the selected time intervals. All non-maturity
deposits (demand deposits and savings deposits) were assumed to become rate
sensitive over time, with 1%, 3%, 4%, 15%, 14% and 63% of such deposits assumed
to re-price in the periods of less than 30 days, 31 to 180 days, 181 to 365
days, 1 to 3 years, 3 to 5 years and more than 5 years, respectively. Prepayment
and re-pricing rates can have a significant impact on the estimated gap. While
management believes the assumptions used in modeling the Gap are reasonable,
there can be no assurances.
36
Gap Table
December 31, 2001
---------------------------------------------------------------------------------------
Volumes Subject to Repricing Within
---------------------------------------------------------------------------------------
0-30 31-180 181-365 1-3 3-5 >5 Non-
(Dollars in thousands) days days days years years years Sensitive Total
---------------------------------------------------------------------------------------
Interest-earning assets:
Federal funds sold and
and interest-bearing
deposits $1,000 $ - $ 180 $ - $ - $ - $ - $ 1,180
Investment
securities (1) 21,733 68,549 68,363 131,637 45,048 154,374 - 489,704
Loans (2) 50,185 156,400 119,009 264,440 179,791 393,978 2,247 1,166,050
--------- ------- ------- ------- ------- ------- ------ ---------
Total interest-earning
assets 72,918 224,949 187,552 396,077 224,839 548,352 2,247 1,656,934
--------- ------- ------- ------- ------- ------- ------ ---------
Interest-bearing liabilities:
Interest-bearing checking,
savings and money
market deposits 3,465 17,324 20,788 83,154 83,153 364,679 - 572,563
Certificates of deposit 138,836 229,034 172,835 83,705 12,016 41 - 636,467
Borrowed funds (3) 30,990 30,764 10,123 36,134 12,460 69,918 - 190,389
--------- ------- -------- -------- ------ ------ ------ --------
Total interest-bearing
liabilities 173,291 277,122 203,746 202,993 107,629 434,638 - 1,399,419
--------- ------- ------- ------- ------- ------- ------- ---------
Period gap $(100,373) $ (52,173) $ (16,194) $193,084 $117,210 $113,714 $ 2,247 $ 257,515
========= ========= ======== ======== ======== ======== ======= ==========
Cumulative gap $(100,373) $ (152,546) $(168,740) $ 24,344 $141,554 $ 255,268 $257,515 $ -
======== ========== ========= ======== ======== ======== ======== ==========
Period gap to total assets (5.59%) (2.91%) (0.90%) 10.76% 6.53% 6.34% 0.13% 14.35%
========= ========= ========= ======= ======= ======== ======== ==========
Cumulative gap to
total assets (5.59%) (8.50%) (9.40%) 1.36% 7.89% 14.23% 14.35%
========= ========= ======= ======= ====== ======= ======
Cumulative interest-earning assets
to cumulative interest-
bearing liabilities 42.08% 66.13% 74.21% 102.84% 114.67% 118.24% 118.40%
========= ======== ====== ====== ======= ======= ======
(1) Amounts shown include the amortized cost of held to maturity securities and the fair value of
available for sale securities.
(2) Amounts shown include principal balance net of deferred loan fees and costs, unamortized premiums
and discounts.
(3) Amounts shown include guaranteed preferred beneficial interests in Corporation's junior subordinated
debentures.
Certain shortcomings are inherent in the method of analysis presented in the Gap
Table. For example, although certain assets and liabilities may have similar
maturities or periods to repricing, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate loans, have
features which restrict changes in interest rates, both on a short-term basis
and over the life of the asset. Further, in the event of changes in interest
rates, prepayment and early withdrawal levels would likely deviate significantly
from those assumed in calculating the table.
As a result of these shortcomings, the Company directs more attention on
simulation modeling, such as "net interest income at risk" discussed below,
rather than gap analysis. Even though the gap analysis reflects a ratio of
cumulative gap to total assets within acceptable limits, the net interest income
at risk simulation modeling is considered by management to be more informative
in forecasting future income at risk.
37
NET INTEREST INCOME AT RISK ANALYSIS
In addition to the Gap Analysis, management uses a "rate shock" simulation to
measure the rate sensitivity of the balance sheet. Rate shock simulation is a
modeling technique used to estimate the impact of changes in rates on net
interest income and economic value of equity. The following table sets forth the
results of the modeling analysis at December 31, 2001:
Change in Interest
Rates in Basis Points Net Interest Income Economic Value of Equity
---------------------------------- ----------------------------------
(Rate Shock) Amount $ Change % Change Amount $ Change % Change
------------ ------ -------- -------- ------ -------- --------
(Dollars in thousands)
200 $79,677 $3,281 4.29% $311,101 $7,520 2.48%
100 78,266 1,870 2.45% 307,475 3,894 1.28%
Static 76,396 - - 303,581 - -
(100) 74,664 (1,732) (2.27%) 299,504 (4,077) (1.34%)
(200) 73,249 (3,147) (4.12%) 292,693 (10,888) (3.59%)
The Company measures net interest income at risk by estimating the changes in
net interest income resulting from instantaneous and sustained parallel shifts
in interest rates of plus or minus 200 basis points over a period of 12 months.
As of December 31, 2001, a 200 basis point increase in rates would increase net
interest income by $3.3 million, or 4.29%, over the next twelve month period.
Conversely, a 200 basis point decrease in rates would decrease net interest
income by $3.1 million, or 4.12%, over a 12 month period. This simulation is
based on management's assumption as to the effect of interest rate changes on
assets and liabilities and assumes a parallel shift of the yield curve. It also
includes certain assumptions about the future pricing of loans and deposits in
response to changes in interest rates. Further, it assumes that delinquency
rates would not change as a result of changes in interest rates, although there
can be no assurance that this will be the case. While this simulation is a
useful measure as to net interest income at risk due to a change in interest
rates, it is not a forecast of the future results and is based on many
assumptions that, if changed, could cause a different outcome.
38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2001 AND 2000
(Dollars in thousands, except per share amounts) 2001 2000
------------- -------------
ASSETS
Cash, due from banks and interest-bearing deposits $ 52,171 $ 29,226
Federal funds sold 1,000 926
Securities available for sale, at fair value 428,423 257,823
Securities held to maturity (fair value of $62,317 and
$76,884 at December 31, 2001 and 2000, respectively) 61,281 76,947
Loans, net 1,146,976 873,262
Premises and equipment, net 24,467 18,423
Goodwill and other intangible assets 39,166 2,381
Other assets 40,812 30,339
---------- -----------
Total assets $ 1,794,296 $ 1,289,327
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Demand $ 224,628 $ 162,840
Savings, money market and interest-bearing checking 572,563 309,732
Certificates of deposit 636,467 605,539
---------- -----------
Total deposits 1,433,658 1,078,111
Short-term borrowings 103,770 46,903
Long-term borrowings 70,419 15,481
Guaranteed preferred beneficial interests in corporation's
junior subordinated debentures 16,200 -
Accrued expenses and other liabilities 21,062 17,214
---------- -----------
Total liabilities 1,645,109 1,157,709
Shareholders' equity:
3% cumulative preferred stock, $100 par value,
authorized 10,000 shares, issued and outstanding
1,666 shares in 2001 and 1,711 shares in 2000 167 171
8.48% cumulative preferred stock, $100 par value,
authorized 200,000 shares, issued and outstanding
175,855 shares in 2001 and 175,866 shares in 2000 17,585 17,587
Common stock, $ 0.01 par value, authorized 50,000,000
shares, issued 11,303,533 shares in 2001 and 2000 113 113
Additional paid-in capital 17,195 16,472
Retained earnings 112,786 98,348
Accumulated other comprehensive income (loss) 2,176 (144)
Treasury stock, at cost - 282,219 shares in 2001 and
316,812 shares in 2000 (835) (929)
---------- -----------
Total shareholders' equity 149,187 131,618
---------- -----------
Total liabilities and shareholders' equity $ 1,794,296 $ 1,289,327
========== ===========
See accompanying notes to consolidated financial statements.
39
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(Dollars in thousands, except per share amounts) 2001 2000 1999
----------- ----------- -----------
Interest income:
Loans $ 91,482 $ 78,538 $ 63,417
Securities 22,628 17,745 14,847
Other 358 184 428
----------- ----------- -----------
Total interest income 114,468 96,467 78,692
----------- ----------- -----------
Interest expense:
Deposits 43,414 39,758 30,420
Borrowings 4,840 3,847 1,463
Guaranteed preferred beneficial interests in corporation's
junior subordinated debentures 1,440 - -
----------- ----------- -----------
Total interest expense 49,694 43,605 31,883
----------- ----------- -----------
Net interest income 64,774 52,862 46,809
Provision for loan losses 4,958 4,211 3,062
----------- ----------- -----------
Net interest income after provision for loan losses 59,816 48,651 43,747
----------- ----------- -----------
Noninterest income:
Service charges on deposits 7,653 5,003 4,289
Financial services group fees and commissions 2,690 1,151 945
Mortgage banking activities 2,190 1,536 1,343
Gain on sale and call of securities 531 27 71
Other 2,718 1,692 1,407
----------- ----------- -----------
Total noninterest income 15,782 9,409 8,055
----------- ----------- -----------
Noninterest expense:
Salaries and employee benefits 22,958 16,803 14,801
Occupancy and equipment 6,050 4,614 4,491
Supplies and postage 1,959 1,500 1,403
Amortization of goodwill and other intangible assets 2,381 737 839
Other 10,004 6,502 5,498
----------- ----------- -----------
Total noninterest expense 43,352 30,156 27,032
----------- ----------- -----------
Income before income taxes 32,246 27,904 24,770
Income taxes 11,033 9,804 8,813
----------- ----------- -----------
Net income $ 21,213 $ 18,100 $ 15,957
========== ========== ==========
Earnings per common share:
Basic $ 1.79 $ 1.51 $ 1.38
Diluted $ 1.77 $ 1.51 $ 1.38
See accompanying notes to consolidated financial statements.
40
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
Accumulated
Other
3% 8.48% Additional Comprehensive Total
(Dollars in thousands, Preferred Preferred Common Paid in Retained Income Treasury Shareholders'
except per share amounts) Stock Stock Stock Capital Earnings (Loss) Stock Equity
----- ----- ----- ------- -------- ------ ----- ------
Balance December 31, 1998 $ 184 $ 17,673 $ 102 $ 2,837 $ 75,167 $ 1,141 $ (526)$ 96,578
Purchase of 83 shares of 3% preferred
stock (8) - - 4 - - - (4)
Purchase of 378 shares of 8.48% preferred - (37) - (5) - - - (42)
stock
Purchase of 1,000 shares of common stock - - - - - - (8) (8)
Comprehensive income
Net income - - - - 15,957 - - 15,957
Unrealized loss on securities available
for sale (net of tax of ($2,606)) - - - - - (3,759) - (3,759)
Less: Reclassification adjustment
for gains included in net income
(net of tax of $28) - - - - - (43) - (43)
---------
Net unrealized loss on securities
available for sale (net of tax
of ($2,637)) - - - - - - - (3,802)
---------
Total comprehensive income - - - - - - - 12,155
---------
Cash dividends declared:
3% Preferred - $3.00 per share - - - - (5) - - (5)
8.48% Preferred - $8.48 per share - - - - (1,498) - - (1,498)
Common - $0.311 per share - - - - (3,260) - - (3,260)
Issuance of 1,103,133 shares of common stock
through initial public offering, net
of costs - - 11 13,612 - - 13,623
------ ----- ------ ----- ------ ------ ---- --------
Balance - December 31, 1999 $ 176 $ 17,636 $ 113 $16,448 $86,361 $ (2,661) $ (534) $ 117,539
Purchase of 48 shares of 3% preferred
stock (5) - - 3 - - - (2)
Purchase of 490 shares of 8.48%
preferred stock - (49) - (2) - - - (51)
Purchase of 33,300 shares of common stock - - - - - - (401) (401)
Issue 2,288 shares of common
stock-directors plan - - - 23 - - 6 29
Comprehensive income:
Net income - - - - 18,100 - - 18,100
Unrealized gain on securities available
for sale (net of tax of $1,757) - - - - - 2,533 - 2,533
Less: Reclassification adjustment
for gains included in net income
(net of tax of $11) - - - - - (16) -
-------
(16)
Net unrealized gain on securities
available for sale (net of tax
of $1,746) - - - - - - - 2,517
--------
Total comprehensive income - - - - - - - 20,617
--------
Cash dividends declared:
3% Preferred - $3.00 per share - - - - (5) - - (5)
8.48% Preferred - $8.48 per share - - - - (1,491) - - (1,491)
Common - $0.42 per share - - - - (4,617) - - (4,617)
----- ------- ----- ------- ------- ----- ----- ------
Balance - December 31, 2000 $ 171 $ 17,587 $ 113 $ 16,472 $ 98,348 $ (144) $ (929) $ 131,618
Purchase of 45 shares of 3% preferred
stock (4) - - 2 - - - (2)
Purchase of 11 shares of 8.48% preferred
stock - (2) - - - - - (2)
Purchase of 1,000 shares of common stock - - - - - - (12) (12)
Issue 1,141 shares of common
stock-directors plan - - - 23 - - 4 27
Issue 34,452 shares of common
stock -acquisition of Burke Group, Inc. - - - 698 - - 102 800
Comprehensive income:
Net income - - - - 21,213 - - 21,213
Unrealized gain on securities available
for sale (net of tax of $1,803) - - - - - 2,636 - 2,636
Less: Reclassification adjustment
for gains included in net income
(net of tax of $215) - - - - - (316) -
---------
(316)
Net unrealized gain on securities
available for sale (net of tax
of $1,588) - - - - - - - 2,320
---------
Total comprehensive income - - - - - - - 23,533
---------
Cash dividends declared:
3% Preferred - $3.00 per share - - - - (5) - - (5)
8.48% Preferred - $8.48 per share - - - - (1,491) - - (1,491)
Common - $0.48 per share - - - - (5,279) - - (5,279)
----- ------- ---- ------- ------- ------ ----- -------
Balance - December 31, 2001 $ 167 $ 17,585 $ 113 $ 17,195 $112,786 $ 2,176 $ (835) $ 149,187
====== ========= ====== ======== ======== ======== ======= =========
See accompanying notes to consolidated financial statements.
41
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(Dollars in thousands) 2001 2000 1999
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 21,213 $ 18,100 $ 15,957
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 5,984 3,032 3,585
Provision for loan losses 4,958 4,211 3,062
Deferred income tax benefit (112) (965) (692)
Gain on sale and call of securities (531) (27) (71)
Gain on sale of loans (1,513) (382) (151)
Loss (gain) on sale of other assets 131 (88) (70)
Minority interest in net income of subsidiaries 104 90 78
Increase in other assets (1,518) (5,919) (422)
Increase (decrease) in accrued expenses
and other liabilities (625) 3,735 (2,071)
----------- ---------- ----------
Net cash provided by operating activities 28,091 21,787 19,205
Cash flows from investing activities:
Purchase of securities:
Available for sale (377,111) (100,150) (110,571)
Held to maturity (21,933) (21,124) (20,247)
Proceeds from maturity and call of securities:
Available for sale 200,315 28,688 55,990
Held to maturity 37,381 25,248 29,563
Proceeds from sale and call of securities 91,412 14,022 4,585
Increase in loans, net (90,362) (124,767) (109,377)
Proceeds from sales of premises and equipment 174 41 436
Purchase of premises and equipment, net (4,359) (3,234) (1,332)
Payments for purchases of Bath National Corporation
and Burke Group, Inc., net of cash acquired (49,072) - -
---------- ----------- -----------
Net cash used in investing activities (213,555) (181,276) (150,953)
Cash flows from financing activities:
Increase in deposits, net 124,080 128,580 99,076
Increase in short-term borrowings, net 46,497 807 40,734
Proceeds from long-term borrowings 28,912 7,089 1,906
Repayment of long-term borrowings (179) (1,848) (166)
Proceeds from guaranteed preferred beneficial interests in
corporation's junior subordinated debentures, net of costs 15,713 - -
Proceeds from initial public offering, net of costs - - 13,623
Issuance (repurchase) of preferred and common shares, net 11 (425) (54)
Dividends paid (6,551) (5,788) (4,988)
---------- ---------- ----------
Net cash provided by financing activities 208,483 128,415 150,131
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 23,019 (31,074) 18,383
Cash and cash equivalents at the beginning of the year 30,152 61,226 42,843
----------- ----------- -----------
Cash and cash equivalents at the end of the year $ 53,171$ 30,152$ 61,226
=========== =========== ===========
Supplemental disclosure of cash flow information: Cash paid during year for:
Interest $ 46,912$ 40,436$ 32,051
Income taxes 10,793 10,821 9,012
Noncash investing and financing activities:
Fair value of noncash assets acquired in purchase acquisitions $ 282,534 $ - $ -
Fair value of liabilities acquired in purchase acquisitions 271,644 - -
Issuance of common stock for acquisition of Burke Group, Inc. 800 - -
See accompanying notes to consolidated financial statements.
42
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Financial Institutions, Inc. ("FII"), a financial holding company organized
under the laws of New York State, and subsidiaries (the "Company") provide
deposit, lending and other financial services to individuals and businesses in
Central and Western New York State. FII and subsidiaries are each subject to
regulation by certain federal and state agencies.
The consolidated financial statements include the accounts of FII, its five
banking subsidiaries, Wyoming County Bank (99.65% owned) ("WCB"), The National
Bank of Geneva (99.10% owned) ("NBG"), The Pavilion State Bank (100% owned)
("PSB"), First Tier Bank & Trust (100% owned) ("FTB") and the newly acquired
Bath National Bank (100% owned) ("BNB"), collectively referred to as the
"Banks". Also included are the accounts of the Burke Group, Inc. (100% owned)
("BGI") and The FI Group, Inc. (100% owned) ("FIGI"), collectively referred to
as the "Financial Services Group". BGI is an employee benefits and compensation
consulting firm acquired by the Company in October 2001. FIGI is a brokerage
subsidiary that commenced operations in March 2000. In February 2001, the
Company formed FISI Statutory Trust I ("FISI") (100% owned), to accommodate the
private placement of $16.2 million in capital securities, the proceeds of which
were utilized to partially fund the acquisition of BNB. The capital securities
are identified on the balance sheet as guaranteed preferred beneficial interests
in corporation's junior subordinated debentures.
The consolidated financial information included herein combines the results of
operations, the assets, liabilities and shareholders' equity of the Company and
its subsidiaries. All significant inter-company transactions and balances have
been eliminated in consolidation.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and prevailing practices in the banking
industry. In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclose contingent assets and liabilities, and revenues and
expenses for the period. Actual results could differ from those estimates.
Amounts in the prior years' consolidated financial statements are reclassified
when necessary to conform with the current year's presentation.
CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, interest-bearing
deposits and federal funds sold are considered cash equivalents.
SECURITIES
The Company classifies its debt securities as either available for sale or held
to maturity. Debt securities which the Company has the ability and positive
intent to hold to maturity are carried at amortized cost and classified as held
to maturity. Investments in other debt and equity securities are classified as
available for sale and are carried at estimated fair value. Unrealized gains or
losses related to securities available for sale are included in accumulated
other comprehensive income and loss as a component of shareholders' equity, net
of the related deferred income tax effect.
A decline in the fair value of any security below cost that is deemed other than
temporary is charged to income resulting in the establishment of a new cost
basis for the security. Interest income includes interest earned on the
securities adjusted for amortization of premiums and accretion of discounts on
the related securities using the interest method. Realized gains or losses from
the sale of available for sale securities are recognized on the trade date using
the specific identification method.
43
LOANS
Loans are stated at the principal amount outstanding, net of discounts and
deferred loan origination fees and costs which are recorded in interest income
based on the interest method. Mortgage loans held for sale are stated at the
lower of aggregate cost or market value as determined by the current fair value.
Interest income on loans is recognized based on loan principal amounts
outstanding at applicable interest rates. Accrual of interest on loans is
suspended and all unpaid accrued interest is reversed when management believes,
after considering collection efforts and the period of time past due, reasonable
doubt exists with respect to the collectibility of interest. Income is
subsequently recognized to the extent collected, assuming the principal balance
is expected to be recovered.
The Company services residential mortgage loans for other institutions.
Servicing fees are recognized when payments are received. The Company
capitalizes servicing assets when servicing rights are retained after selling
loans to other institutions. Capitalized servicing assets are reported in other
assets and are amortized to noninterest income in proportion to, and over the
period of, the estimated future net servicing income. Servicing assets are
evaluated for impairment based upon the fair value of the rights as compared to
amortized cost. Impairment is determined by stratifying rights by predominant
risk characteristics, such as interest rates and terms, using discounted cash
flows and market-based assumptions. Impairment is recognized through a valuation
allowance, to the extent that fair value is less than the capitalized asset.
Mortgage banking activities consist of fees earned for servicing mortgage loans
sold to third parties, gains (or losses) recognized on sales of mortgages, and
impairment losses recognized on capitalized mortgage servicing assets.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through charges to income and is
maintained at a level which management considers adequate to provide for
probable losses inherent in the portfolio. The adequacy of the allowance is
determined by management's periodic evaluation of the loan portfolio based on
such factors as: current economic conditions; the current financial condition of
the borrowers; the economic environment in which they operate; any delinquency
in payments; and the value of any collateral held. While management uses
available information to recognize losses on loans, future additions to the
allowance 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 Company's allowance for loan losses and may require
additions to the allowance based on their judgments about information available
to them at the time of their examinations.
A loan is considered impaired when, based on current information and events, it
is probable that a creditor will be unable to collect all amounts of principal
and interest under the original terms of the agreement. Accordingly, the Company
measures certain impaired commercial and agricultural loans based on the present
value of future cash flows discounted at the loan's effective interest rate, or
at the loan's observable market price or the fair value of the collateral if the
loan is collateral dependent. The Company has excluded large groups of small
balance, homogeneous loans which include commercial and agricultural loans less
than $250,000, all residential mortgages, home equity and consumer loans that
are collectively evaluated for impairment.
FEDERAL HOME LOAN BANK (FHLB) STOCK
As a member of the FHLB system, the Company is required to maintain a specified
investment in FHLB stock. This non-marketable investment, which is carried at
cost, must be at an amount at least equal to the greater of 5% of the
outstanding advance balance or 1% of the aggregate outstanding residential
mortgage loans held by the Company. Included in other assets is FHLB stock
totaling $5.8 million and $4.0 million, at December 31, 2001 and 2000,
respectively.
44
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation is computed using straight-line and accelerated
methods over estimated useful lives of the assets. Leasehold improvements are
amortized over the shorter of lease terms or the useful lives of the assets.
GOODWILL AND OTHER INTANGIBLE ASSETS
Deposit premiums and goodwill are being amortized on the straight-line method,
over the expected periods to be benefited, which generally range between 5 and
20 years. Intangible assets are periodically reviewed for impairment or when
events or changed circumstances may affect the underlying basis of the assets.
Statement of Financial Accounting Standards (SFAS) No. 142 requires that
goodwill (including goodwill reported in prior acquisitions) no longer be
amortized to earnings, but instead be reviewed for impairment annually, with
impairment losses charged to earnings when they occur. The Company was required
to adopt SFAS No. 142 effective January 1, 2002. Therefore, in accordance with
SFAS No. 142, the Company ceased goodwill amortization on January 1, 2002 and
will evaluate goodwill for impairment annually.
STOCK COMPENSATION
The Company uses a fixed award stock option plan to compensate certain key
members of management of the Company and its subsidiaries. The Company accounts
for issuance of stock options under the intrinsic value-based method of
accounting prescribed by Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees." Under APB No. 25, compensation
expense is recorded on the date the options are granted only if the current
market price of the underlying stock exceeded the exercise price. Statement of
Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation," established accounting and disclosure requirements using a fair
value-based method of accounting for stock-based employee compensation plans. As
allowed under SFAS No. 123, the Company has elected to continue to apply the
intrinsic value-based method of accounting described above and has adopted only
the disclosure requirements of SFAS No. 123.
INCOME TAXES
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and the respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period which includes the
enactment date.
45
EARNINGS PER COMMON SHARE
Basic earnings per share, after giving effect to preferred stock dividends, has
been computed using weighted average common shares outstanding. Diluted earnings
per share reflects the effects, if any, of incremental common shares issuable
upon exercise of dilutive stock options.
Earnings per common share have been computed based on the following:
Years Ended December 31
(Dollars and shares in thousands) 2001 2000 1999
--------- --------- ---------
Net income $ 21,213 $ 18,100 $ 15,957
Less: Preferred stock dividends 1,496 1,496 1,503
--------- --------- ---------
Net income available to common shareholders $ 19,717 $ 16,604 $ 14,454
========= ========= =========
Average number of common shares outstanding
used to calculate basic earnings per
common share 10,994 10,995 10,474
Add: Effect of dilutive options 132 1 -
--------- --------- ---------
Average number of common shares
used to calculate diluted earnings per
common share 11,126 10,996 10,474
========= ========= =========
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company's financial instruments with off-balance sheet risk are commercial
letters of credit and mortgage, commercial and credit card loan commitments.
These financial instruments are reflected in the statement of financial
condition upon funding.
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities," requires recognition of
derivatives as either assets or liabilities, with the instruments measured at
fair value. The accounting for gains and losses resulting from changes in fair
value of the derivative instrument depends on the intended use of the derivative
and the type of risk being hedged. The Company adopted SFAS No. 133 on January
1, 2001, but did not utilize derivatives in 2001. The adoption of this statement
did not have a material effect on the Company's financial position or results of
operations.
FINANCIAL SERVICES GROUP FEES AND COMMISSIONS
Financial services group fees and commissions consist of commissions from sales
of investment products and services to customers, fees and commissions from
trust services provided to customers, and fees and commissions earned from
design, consulting, administrative and actuarial services provided to employee
benefits plans and their sponsors. Fees and commissions are recognized when
earned.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS Nos. 141, "Business Combinations" and 142,
"Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business
combinations be accounted for under the purchase method, use of the
pooling-of-interests method is no longer permitted for business combinations
initiated after June 30, 2001. SFAS No. 142 requires that goodwill (including
goodwill reported in prior acquisitions) no longer be amortized to earnings, but
instead be reviewed for impairment annually, with impairment losses charged to
earnings when they occur. The Company was required to adopt SFAS No. 142
effective January 1, 2002. The results of operations for year ended December 31,
2001 include goodwill amortization from the BNB acquisition of $1,653,000. The
amortization of goodwill ceased effective January 1, 2002.
46
(2) MERGERS AND ACQUISITIONS
On May 1, 2001, FII acquired all of the common stock of Bath National
Corporation ("BNC") , and its wholly-owned subsidiary bank, Bath National Bank.
BNB is a full service community bank headquartered in Bath, New York, which has
9 branch locations in Steuben, Yates, Ontario and Schuyler Counties. The Company
paid $48.00 per share in cash for each of the outstanding shares of BNC common
stock with an aggregate purchase price of approximately $62.6 million. The
acquisition was accounted for under the purchase method of accounting, and
accordingly, the excess of the purchase price over the fair value of
identifiable tangible and intangible assets acquired, less liabilities assumed,
has been recorded as goodwill. Goodwill recognized with respect to the merger
was approximately $37.2 million. Goodwill was amortized in 2001 using the
straight-line method over 15 years, since the transaction was consummated prior
to June 30, 2001, the effective date of SFAS No. 142. However, in accordance
with SFAS No. 142, the Company ceased goodwill amortization on January 1, 2002
and will evaluate goodwill for impairment annually. The results of operations
for BNB are included in the income statement from the date of acquisition (May
1, 2001) to the end of the period.
On October 22, 2001, the Company acquired the Burke Group, Inc. ("BGI"), an
employee benefits administration and compensation consulting firm, with offices
in Honeoye Falls and Syracuse, New York. BGI's expertise includes design and
consulting for retirement and employee welfare plans, administrative services
for defined contribution and benefit plans, actuarial services and post
employment benefits. Under the terms of the agreement, BGI shareholders received
primarily common stock as consideration for their ownership in BGI. The
acquisition was accounted for under the purchase method of accounting, and
accordingly, the excess of the purchase price over the fair value of
identifiable assets acquired, less liabilities assumed, has been recorded as
goodwill, after recognizing an intangible asset separate from goodwill in
accordance with SFAS No. 141. Goodwill recognized with respect to the merger was
approximately $1.3 million. In accordance with SFAS No. 142, the Company is not
required to amortize goodwill on this acquisition, but evaluates goodwill for
impairment on an annual basis. The Company also recorded a $500,000 intangible
asset which is being amortized using the straight-line method over five years.
The results of operations for BGI are included in the income statement from the
date of acquisition (October 22, 2001) to the end of the period.
Goodwill from 2001 acquisitions amounted to $36.8 million as of December 31,
2001. Other intangible assets totaled $2.4 million as of December 31, 2001 and
2000. Goodwill amortization included in the results of operations for the year
ended December 31, 2001 amounted to $1.7 million. Annualized goodwill
amortization for 2001 was $2.5 million. Amortization of other intangible assets
was $728,000 and $737,000 for the years ended December 31, 2001 and 2000,
respectively.
47
The following table presents certain unaudited pro forma information as if the
BNC and BGI acquisitions, which occurred in 2001, had been consummated on
January 1, 2000. This proforma information gives effect to certain adjustments,
including accounting adjustments related to fair value adjustments, amortization
of goodwill 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 BNC and BGI on January 1, 2000.
Pro Forma Pro Forma
(Unaudited) (Unaudited)
Year Ended Year Ended
(Dollars in thousands, except per share) December 31, 2001 December 31, 2000
----------------- -----------------
Net interest income $67,918 $62,097
Provision for loan losses 5,371 9,464
Noninterest income 19,745 14,470
Net income $19,627 $13,806
======== =======
Earnings per share:
Basic $1.65 $1.12
Diluted $1.63 $1.12
On January 11, 2002, FII reached a definitive agreement to acquire all of the
outstanding stock of the Bank of Avoca ("BOA"). BOA is a retail oriented
institution with its main office located in Avoca, New York, as well as, a
branch located in Cohocton, New York. Total assets of BOA approximated $17.9
million as of December 31, 2001. FII will fund the transaction using $1.5
million in FII stock, based on the average sales price of FII stock for the 30
trading days immediately prior to the closing date. The acquisition, which is
subject to approval by BOA shareholders and by various regulatory agencies, will
be accounted for using the purchase method of accounting and is currently
scheduled to be completed in the second quarter of 2002. Subsequently, BOA will
merge with and into BNB.
48
(3) SECURITIES
The aggregate amortized cost and fair value of securities available for sale and
securities held to maturity follow:
December 31, 2001
---------------------------------------------------------
Amortized Gross Unrealized Fair
------------------------------
(Dollars in thousands) Cost Gains Losses Value
----------- ----------- ---------- -----------
Securities Available for Sale:
U.S. Treasury and agency $ 182,812 $ 1,949 $ 1,268 $ 183,493
Mortgage-backed securities 89,396 1,014 416 89,994
State and municipal obligations 141,637 2,220 635 143,222
Corporate bonds 7,824 121 35 7,910
Equity securities 3,082 722 - 3,804
----------- ----------- ---------- -----------
Total securities available for sale $ 424,751 $ 6,026 $ 2,354 $ 428,423
=========== =========== ========== ===========
Securities Held to Maturity:
U.S. Treasury and agency $ 1,950 $ 68 $ - $ 2,018
State and municipal obligations 59,331 981 13 60,299
----------- ----------- ---------- -----------
Total securities held to maturity $ 61,281 $ 1,049 $ 13 $ 62,317
=========== =========== ========== ===========
December 31, 2000
---------------------------------------------------------
Amortized Gross Unrealized Fair
------------------------------
(Dollars in thousands) Cost Gains Losses Value
----------- ----------- ---------- -----------
Securities Available for Sale:
U.S. Treasury and agency $ 170,127 $ 606 $ 1,516 $ 169,217
Mortgage-backed securities 29,019 237 117 29,139
State and municipal obligations 48,512 459 65 48,906
Corporate bonds 9,714 16 384 9,346
Equity securities 695 520 - 1,215
----------- ----------- ---------- -----------
Total securities available for sale $ 258,067 $ 1,838 $ 2,082 $ 257,823
=========== =========== ========== ===========
Securities Held to Maturity:
U.S. Treasury and agency $ 1,950 $ 11 $ - $ 1,961
State and municipal obligations 74,997 253 327 74,923
----------- ----------- ---------- -----------
Total securities held to maturity $ 76,947 $ 264 $ 327 $ 76,884
=========== =========== ========== ===========
The amortized cost and fair value of debt securities by contractual maturity are
as follows:
December 31, 2001
---------------------------------------------------
Available for Sale Held to Maturity
-------------------------- --------------------------
Amortized Fair Amortized Fair
(Dollars in thousands) Cost Value Cost Value
----------- ----------- ---------- -----------
Due in one year or less $ 27,386 $ 27,777 $ 31,036 $ 31,275
Due in one to five years 151,484 154,056 27,438 28,211
Due in five to ten years 185,476 185,180 2,162 2,192
Due after ten years 57,323 57,606 645 639
----------- ----------- ---------- -----------
$ 421,669 $ 424,619 $ 61,281 $ 62,317
=========== =========== ========== ===========
Maturities of mortgage-backed securities are classified in accordance with the
contractual repayment schedules. Expected maturities will differ from contracted
maturities since issuers generally have the right to prepay obligations.
49
Proceeds from the sale and call of securities during 2001 were $91,412,000;
realized gross gains were $617,000 and gross losses were $86,000. Proceeds from
the sale and call of securities available for sale during 2000 were $14,022,000;
realized gross gains were $52,000 and gross losses were $25,000. Proceeds from
the sale and call of securities available for sale during 1999 were $4,585,000;
realized gross gains were $126,000 and gross losses were $55,000. Gains and
losses were computed using the specific identification method. There were no
transfers between held to maturity and available for sale securities in 2001,
2000 or 1999.
Securities held to maturity and available for sale with carrying values of
$340,989,000 and $285,559,000 were pledged as collateral for municipal deposits
and repurchase agreements at December 31, 2001 and 2000, respectively.
(4) LOANS
Loans outstanding at December 31, 2001 and 2000 are summarized as follows:
(Dollars in thousands) 2001 2000
-------------- -----------
Commercial $ 232,379 $ 169,832
Commercial real estate 274,702 166,041
Agricultural 186,623 165,367
Residential real estate 240,141 201,160
Consumer and home equity 232,205 184,745
-------------- -----------
Loans, gross 1,166,050 887,145
Allowance for loan losses (19,074) (13,883)
-------------- -----------
Loans, net $ 1,146,976 $ 873,262
============== ===========
The following table sets forth the changes in the allowance for loan losses for
the years indicated.
Years ended December 31
(Dollars in thousands) 2001 2000 1999
----------- ----------- -----------
Balance at beginning of year $ 13,883 $ 11,421 $ 9,570
Allowance obtained through
BNB acquisition 2,686 - -
Charge-offs:
Commercial 1,003 466 312
Commercial real estate 394 629 139
Agricultural 58 85 12
Residential real estate 178 113 461
Consumer and home equity 1,319 905 663
----------- ----------- -----------
Total charge-offs 2,952 2,198 1,587
Recoveries:
Commercial 58 206 88
Commercial real estate 23 22 23
Agricultural - 1 -
Residential real estate 19 5 163
Consumer and home equity 399 215 102
----------- ----------- -----------
Total recoveries 499 449 376
----------- ----------- -----------
Net charge-offs 2,453 1,749 1,211
Provision for loan losses 4,958 4,211 3,062
----------- ----------- -----------
Balance at end of year $ 19,074 $ 13,883 $ 11,421
=========== =========== ===========
50
The following table sets forth information regarding nonaccruing loans and other
nonperforming assets at December 31, 2001 and 2000:
(Dollars in thousands) 2001 2000
-------------- -------------
Nonaccruing loans $ 8,958 $ 6,596
Accruing loans 90 days or more delinquent 1,064 521
-------------- -------------
Total nonperforming loans 10,022 7,117
Other real estate owned 947 932
-------------- -------------
Total nonperforming assets $ 10,969 $ 8,049
============== =============
The recorded investment in loans that are considered to be impaired totaled
$8,289,000 and $6,113,000 at December 31, 2001 and 2000, respectively. The
allowance for loan losses related to impaired loans amounted to $1,778,000, at
December 31, 2001 and $1,140,000 at December 31, 2000. The average recorded
investment in impaired loans during 2001, 2000 and 1999 was $7,561,000,
$5,329,000 and $3,838,000, respectively. Interest income recognized on impaired
loans, while such loans were impaired, during 2001, 2000 and 1999 was
approximately $392,000, $312,000 and $82,000, respectively.
In the normal course of business there are various outstanding commitments to
extend credit which are not reflected in the accompanying consolidated financial
statements. Loan commitments have off-balance-sheet credit risk until
commitments are fulfilled or expire. The credit risk amounts are equal to the
contractual amounts, assuming that the amounts are ultimately advanced in full
and that the collateral or other security is of no value. The Company's policy
generally requires customers to provide collateral, usually in the form of
customers' operating assets or property, prior to the disbursement of approved
loans. At December 31, 2001, letters of credit totaling $8,602,000 and unused
loan commitments and lines of credit of $265,933,000 were contractually
available. Comparable amounts for these commitments at December 31, 2000 were
$7,018,000 and $182,491,000, respectively. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without funding, the total
commitment amounts do not necessarily represent future cash requirements.
Loans outstanding to certain officers, directors, or companies in which they
have 10% or more beneficial ownership, approximated $25,592,000 and $23,988,000
at December 31, 2001 and 2000, respectively. These loans were made in the
ordinary course of business on substantially the same terms, including interest
rate and collateral, as comparable transactions with other customers, and do not
involve more than a normal risk of collectibility.
As of December 31, 2001, the Company had no significant concentration of credit
risk in the loan portfolio outside of normal geographic concentration pertaining
to the communities that the Company serves. There is no significant exposure to
highly leveraged transactions and there are no foreign credits in the loan
portfolio.
51
Loans serviced for others amounting to $302,258,000 and $205,218,000 at December
31, 2001 and 2000, respectively, are not included in the consolidated statements
of financial condition. The Company had capitalized mortgage servicing rights
related to servicing these loans of $889,000 and $285,000 as of December 31,
2001 and 2000, respectively. Loans held for sale totaled $10,557,000 and
$3,280,000 at December 31, 2001 and 2000, respectively. Proceeds from the sale
of loans were $117,446,000, $25,880,000 and $53,552,000 in 2001, 2000 and 1999,
respectively. Net gain on the sale of loans was $1,513,000, $382,000 and
$151,000 in 2001, 2000 and 1999, respectively. Commitments to sell loans were
$5,828,000 and $847,000 at December 31, 2001 and 2000, respectively. The Company
enters into forward contracts for future delivery of residential mortgage loans
at a specified yield to reduce the interest rate risk associated with fixed rate
residential mortgage loans held for sale and commitments to fund residential
mortgages. Credit risk arises from the possible inability of the other parties
to comply with the contract terms. Substantially all of the Company's contracts
are with government-sponsored enterprises or government agencies (FHLMC and
FHA).
(5) PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 2001 and 2000 follows:
(Dollars in thousands) 2001 2000
-------------- -----------
Land and land improvements $ 2,584 $ 1,975
Buildings and leasehold improvements 21,599 17,034
Furniture, fixtures, equipment and vehicles 16,967 13,488
-------------- -----------
Premises and equipment, gross 41,150 32,497
Accumulated depreciation and amortization (16,683) (14,074)
-------------- -----------
Premises and equipment, net $ 24,467 $ 18,423
============== ===========
Depreciation expense amounted to $2,403,000, $1,866,000 and $2,036,000 for the
years ended December 31, 2001, 2000 and 1999, respectively.
(6) DEPOSITS
Scheduled maturities for certificates of deposit at December 31, 2001 are as
follows:
Mature in year ending December 31,
(Dollars in thousands)
2002 $ 527,735
2003 71,404
2004 12,683
2005 20,641
2006 3,963
Thereafter 41
-------------
$ 636,467
Certificates of deposit greater than $100,000 totaled $234,450,000 and
$293,834,000 at December 31, 2001 and 2000 respectively. Interest expense on
certificates of deposit greater than $100,000 amounted to $15,899,000,
$15,962,000, and $9,895,000 for the years ended December 31, 2001, 2000 and
1999, respectively.
52
(7) BORROWINGS
Short-term borrowings at December 31, 2001 and 2000 are summarized as follows:
(Dollars in thousands) 2001 2000
-------------- -----------
Federal funds purchased and securities
sold under repurchase agreements $ 60,957 $ 15,950
FHLB advances 42,135 30,953
Other 678 -
-------------- -----------
Total short-term borrowings $ 103,770 $ 46,903
============== ===========
Average rate at year-end 2.12% 5.75%
=============== ============
Average rate during period 3.95% 5.96%
=============== ============
The FHLB advances mature in less than one year and carry rates of interest from
1.91% to 5.11%. Advances payable to the FHLB are collateralized by $5.8 million
of FHLB stock and mortgage loans with a carrying value of $157.6 million at
December 31, 2001. At December 31, 2001, the Company had remaining credit
available of $40.5 million under lines of credit with the FHLB. The Company also
had $41.0 million of remaining credit available under unsecured lines of credit
with various banks at December 31, 2001. During 2001, the Company also obtained
lines of credit with Farmer Mac permitting borrowings to a maximum of $50.0
million. However, no advances were outstanding against those lines at December
31, 2001
Short-term FHLB advances as of and for the years ended December 31, 2001, 2000
and 1999 are summarized as follows:
(Dollars in thousands) 2001 2000 1999
------- ------ -------
Weighted average interest rate at year-end 2.49% 6.52% 5.89%
Maximum outstanding at any month-end $ 42,135 $ 60,347 $ 41,500
Average amount outstanding during the year $ 28,551 $ 40,797 $ 7,553
The average amounts outstanding are computed using daily average balances.
Related interest expense for 2001, 2000 and 1999 was $1,346,000, $2,643,000 and
$418,000, respectively.
Federal funds purchased and securities sold under repurchase agreements as of
and for the years ended December 31, 2001, 2000 and 1999 are summarized as
follows:
(Dollars in thousands) 2001 2000 1999
------- ------ -------
Weighted average interest rate at year-end 1.88% 4.26% 4.73%
Maximum outstanding at any month-end $ 65,474 $ 26,135 $ 9,802
Average amount outstanding during the year $ 33,157 $ 7,939 $ 8,762
The average amounts outstanding are computed using daily average balances.
Related interest expense for 2001, 2000 and 1999 was $1,108,000, $400,000 and
$402,000, respectively.
53
At December 31, 2001 and 2000, long-term borrowings primarily include FHLB
advances with maturities of more than 1 year. The advances mature on various
dates ranging from 2001 through 2011 and bear interest at a fixed weighted
average rate of 5.05% as of December 31, 2001. The Company's FHLB advances
include $20.0 million in fixed-rate callable borrowings, which can be called by
the FHLB on the first anniversary of the borrowing, and quarterly thereafter.
Other long-term borrowings consist primarily of a $5.0 million advance on a
credit agreement with a bank, which was executed to aid in funding the
acquisition of BNB. The credit agreement requires monthly payments of interest
only, at a variable interest rate of 1.50% plus LIBOR, with 5.02% being the rate
in effect at December 31, 2001. The credit agreement expires April 2003.
The aggregate maturities of long-term borrowings at December 31, 2001 are as
follows:
Mature in year ending December 31,
(Dollars in thousands)
2003 $ 10,360
2004 18,177
2005 9,679
2006 1,183
2007 1,183
Thereafter 29,837
-------------
$ 70,419
The weighted average interest rate on long-term borrowings at December 31, 2001
and 2000 was 5.06% and 6.41%, respectively. Related interest expense for 2001,
2000 and 1999 was $2,386,000, $804,000 and $643,000, respectively.
(8) GUARANTEED PREFERRED BENEFICIAL INTERESTS IN CORPORATIONS JUNIOR
SUBORDINATED DEBENTURES
On February 22, 2001, the Company established FISI Statutory Trust I (the
"Trust"), which is a statutory business trust formed under Connecticut law, upon
filing a certificate of trust with the Connecticut Secretary of State. The Trust
exists for the exclusive purposes of (i) issuing and selling 30 year guaranteed
preferred beneficial interests in the Corporation's junior subordinated
debentures ("capital securities") in the aggregate amount of $16.2 million at a
fixed rate of 10.20%, (ii) using the proceeds from the sale of the capital
securities to acquire the junior subordinated debentures issued by the Company
and (iii) engaging in only those other activities necessary, advisable or
incidental thereto. The junior subordinated debentures are the sole assets of
the Trust and, accordingly, payments under the corporation obligated junior
debentures are the sole revenue of the Trust. All of the common securities of
the Trust are owned by the Company. The Company used the net proceeds from the
sale of the capital securities to partially fund the BNB acquisition. As of
December 31, 2001, all but $3.8 million of the capital securities qualify as
Tier I capital under regulatory definitions. The Company's primary source of
funds to pay interest on the debentures owed to the Trust are current dividends
from its subsidiary banks. Accordingly, the Company's ability to service the
debentures is dependent upon the continued ability of the subsidiary banks to
pay dividends to the Company. Since the capital securities are classified as
debt for financial statement purposes, the tax-deductible expense associated
with the capital securities is recorded as interest expense in the consolidated
statements of income. The Company incurred $487,000 in costs to issue the
securities and the costs are being amortized over 20 years using the
straight-line method.
54
(9) INCOME TAXES
Total income taxes for the years ended December 31, 2001, 2000 and 1999 were
allocated as follows:
(Dollars in thousands) 2001 2000 1999
----------- ----------- -----------
Income from operations $ 11,033 $ 9,804 $ 8,813
Shareholders' equity, for unrealized gain (loss)
on securities available for sale 1,588 1,746 (2,637)
----------- ----------- -----------
$ 12,621 $ 11,550 $ 6,176
=========== =========== ===========
Income tax expense (benefit) attributable to operations for the years ended
December 31, 2001, 2000 and 1999 consists of:
(Dollars in thousands) 2001 2000 1999
----------- ----------- -----------
Current:
Federal $ 8,676 $ 8,380 $ 7,449
State 2,469 2,389 2,056
----------- ----------- -----------
Total current 11,145 10,769 9,505
Deferred:
Federal (68) (785) (657)
State (44) (180) (35)
----------- ----------- -----------
Total deferred (112) (965) (692)
----------- ----------- -----------
Total income taxes $ 11,033 $ 9,804 $ 8,813
=========== =========== ===========
A reconciliation of the actual and statutory tax rates applicable to income from
operations for the years ended December 31, 2001, 2000 and 1999 differ as
follows:
2001 2000 1999
----------- ----------- -----------
Statutory rate 35.0% 35.0% 35.0%
Increase (decrease) resulting from:
Tax exempt interest income (8.1) (6.0) (5.6)
State taxes, net of federal income tax benefit 4.9 5.1 5.3
Goodwill amortization 1.8 - 0.2
Other 0.6 1.0 0.7
------- --------- --------
Total 34.2% 35.1% 35.6%
55
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities at December 31, 2001 and 2000 are presented
as follows:
(Dollars in thousands) 2001 2000
------------- -------------
Deferred tax assets:
Allowance for loan losses $ 7,165 $ 5,437
Unrealized loss on securities available for sale - 100
Core deposit intangible 773 603
Interest on nonaccrual loans 750 536
Other 395 209
------------- -------------
Total gross deferred tax assets 9,083 6,885
Deferred tax liabilities:
Prepaid pension costs 1,150 1,504
Unrealized gain on securities available for sale 1,488 -
Depreciation of premises and equipment 693 447
Loan servicing assets 354 114
Other 476 239
------------- -------------
Total gross deferred tax liabilities 4,161 2,304
------------- -------------
Net deferred tax asset, at year-end (included in other assets) $ 4,922 $ 4,581
============= =============
Net deferred tax asset, at beginning of year 4,581 5,362
------------- -------------
(Increase) decrease in net deferred tax asset (341) 781
Net deferred tax asset acquired 1,470 -
Initial purchase accounting adjustments, net 347 -
Change in unrealized gain/loss on securities available for sale (1,588) (1,746)
------------- -------------
Deferred tax benefit $ (112) $ (965)
============= =============
Realization of deferred tax assets is dependent upon the generation of future
taxable income or the existence of sufficient taxable income within the
carry-back period. A valuation allowance is provided when it is more likely than
not that some portion of the deferred tax assets will not be realized. In
assessing the need for a valuation allowance, management considers the scheduled
reversal of the deferred tax liabilities, the level of historical taxable income
and projected future taxable income over the periods in which the temporary
differences comprising the deferred tax assets will be deductible. Based on its
assessment, management determined that no valuation allowance is necessary at
December 31, 2001 and 2000.
56
(10) LEASE COMMITMENTS
At December 31, 2001, the Company was obligated under a number of noncancellable
operating leases for land, buildings and equipment. Certain of these leases
provide for escalation clauses and contain renewal options calling for increased
rentals if the lease is renewed. Future minimum lease payments on operating
leases at December 31, 2001 were as follows:
Operating lease payments in year ending December 31,
(Dollars in thousands)
2002 $ 434
2003 397
2004 368
2005 329
2006 271
Thereafter 837
-------------
$ 2,636
(11) RETIREMENT PLANS AND POSTRETIREMENT BENEFITS
DEFINED BENEFIT PLAN
The Company has a defined benefit pension plan covering substantially all
employees. The benefits are based on years of service and the employee's highest
average compensation during five consecutive years of employment. The Company's
funding policy is to contribute annually an actuarially determined amount to
cover current service cost plus amortization of prior service costs.
The following table sets forth the defined benefit pension plan's change in
benefit obligation and change in plan assets for 2001, 2000 and 1999 using the
most recent actuarial data measured at September 30, 2001, 2000 and 1999:
(Dollars in thousands) 2001 2000 1999
----------- ----------- -----------
Change in benefit obligation:
Benefit obligation at beginning of year $ (12,114) $ (11,740) $ (10,947)
Service cost (850) (766) (673)
Additional prior service cost (399) - -
Interest cost (890) (806) (698)
Actuarial gain (loss) 72 603 17
Benefits paid 470 476 459
Plan expenses 103 119 102
----------- ----------- -----------
Benefit obligation at end of year (13,608) (12,114) (11,740)
Change in plan assets:
Fair value of plan assets at beginning of year 17,180 15,706 13,509
Actual (loss) return on plan assets (1,367) 1,588 2,111
Employer contribution - 481 647
Benefits paid (470) (476) (459)
Plan expenses (103) (119) (102)
----------- ----------- -----------
Fair value of plan assets at end of year 15,240 17,180 15,706
----------- ----------- -----------
Funded status 1,632 5,066 3,966
Unamortized net asset at transition (179) (217) (255)
Unrecognized net (gain) loss subsequent to transition 1,292 (1,433) (552)
Unamortized prior service cost 345 (57) (59)
----------- ----------- -----------
Prepaid benefit cost, included in other assets $ 3,090 $ 3,359 $ 3,100
=========== =========== ===========
57
Pension expense consists of the following components for the years ended
December 31, 2001, 2000 and 1999:
(Dollars in thousands) 2001 2000 1999
----------- ----------- -----------
Service cost $ 850 $ 766 $ 673
Interest cost on projected benefit obligation 890 806 698
Expected return on plan assets (1,429) (1,307) (1,121)
Amortization of net transition asset (38) (38) (38)
Amortization of unrecognized prior service cost (3) (3) (3)
----------- ----------- -----------
Net periodic pension expense $ 270 $ 224 $ 209
=========== =========== ===========
Weighted average discount rate 7.50% 7.00% 7.00%
========== =========== ==========
Expected long-term rate of return 8.50% 8.50% 8.50%
========== =========== ==========
Rate of compensation increase 5.00% 5.00% 5.00%
========== =========== ==========
DEFINED CONTRIBUTION PLAN
The Company also sponsors a defined contribution profit sharing (401(k)) plan
covering substantially all employees. The Company matches certain percentages of
each eligible employee's contribution to the plan. Expense for the plan amounted
to $708,000, $524,000 and $480,000, in 2001, 2000 and 1999, respectively.
POSTRETIREMENT BENEFITS
Prior to December 31, 2000, BNB provided health and dental care benefits to
retired employees who met specified age and service requirements through a
postretirement health and dental care plan in which both BNB and the retiree
shared the cost. The plan provided for substantially the same medical insurance
coverage as for active employees until their death and was integrated with
Medicare for those retirees aged 65 or older. In 2000, the plan's eligibility
requirements were amended to curtail eligible benefit payments to only retired
employees and active participants who were fully vested under the Plan. The
accrued liability related to this plan amounted to $741,000 as of December 31,
2001. Expense for the plan amounted to $80,000 in 2001.
(12) STOCK COMPENSATION PLANS
The Company has a Management Stock Incentive Plan and a Directors' Stock
Incentive Plan. Under the plans, the Company may grant stock options to its
directors, directors of its subsidiaries, and key employees to purchase shares
of common stock, shares of restricted stock and stock appreciation rights.
Grants under the plans may be made to up to 10% of the number of shares of
common stock issued, including treasury shares. The exercise price of each
option equals the market price of the Company's stock on the date of the grant.
The maximum term of each option is ten years and the options' generally vest
between three and five years.
The Company applies APB Opinion 25 and related Interpretations in accounting for
the stock option plans. Accordingly, no compensation cost has been recognized.
Had compensation cost for the Company's stock incentive plans been determined
based on the fair value at the grant dates for awards under the plans consistent
with the method prescribed by SFAS No. 123, the Company's net income and
earnings per share would have been adjusted to the following pro forma amounts:
58
(Dollars in thousands, except per share)
For the years ended December 31
------------------------------------------
2001 2000 1999
------------- ------------- ------------
Net income
As reported $ 21,213 $ 18,100 $ 15,957
Pro forma 20,925 17,898 15,868
Earnings per share (basic)
As reported $ 1.79 $ 1.51 $ 1.38
Pro forma 1.77 1.49 1.37
Earnings per share (diluted)
As reported $ 1.77 $ 1.51 $ 1.38
Pro forma 1.75 1.49 1.37
The weighted-average fair value of options granted during the years ended
December 31, 2001, 2000, and 1999 amounted to $5.53, $3.72 and $4.49,
respectively. The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions:
For the years ended December 31
------------------------------------------
2001 2000 1999
------------- ------------- ------------
Dividend yield 2.43% 2.98% 2.16%
Expected life (in years) 10.00 10.00 10.00
Expected volatility 20.00% 20.00% 20.00%
Risk-free interest rate 4.99% 6.17% 6.00%
The activity in the FII stock option plans is summarized below:
Weighted
Stock Average
Options Exercise
Outstanding Price
------------------ -------------
Balance December 31, 1998 $ - $ -
Granted 319,042 14.00
----------- ---------
Balance December 31, 1999 319,042 14.00
Granted 70,638 13.45
Cancelled (5,162) (13.56)
----------- ----------
Balance December 31, 2000 384,518 13.90
Granted 115,637 18.94
Cancelled (3,474) (13.28)
----------- ----------
Balance December 31, 2001 $496,681 $15.08
======== ======
Exercisable at:
December 31, 2001 $153,826 $13.92
December 31, 2000 65,986 14.00
December 31, 1999 - -
A summary of stock options at December 31, 2001 follows:
Outstanding Exercisable
-------------------------------------- ------------------------
Weighted Weighted Weighted
Number Average Average Number Average
Range of of Stock Exercise Life of Stock Exercise
Exercise Price Options Price (in years) Options Price
----------------------- ------------- ----------- ----------- --------- -----------
$11.75 to $14.00 425,928 $ 13.93 7.8 153,826 $ 13.92
$21.35 to $22.99 71,383 21.95 9.5 - -
59
(13) REGULATORY CAPITAL
The Company is subject to various regulatory capital requirements administered
by the Federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory, and possibly additional discretionary, actions
by regulators that, if undertaken, could have a direct material impact on the
Company's financial statements.
For evaluating regulatory capital adequacy, companies are required to determine
capital and assets under regulatory accounting practices. Quantitative measures
established by regulation to ensure capital adequacy require the Company to
maintain minimum amounts and ratios. The leverage ratio requirement is based on
period-end capital to average total assets during the previous three months.
Compliance with risk based capital requirements is determined by dividing
regulatory capital by the sum of a company's weighted asset values. Risk
weightings are established by the regulators for each asset category according
to the perceived degree of risk. As of December 31, 2001 and 2000, the Company
and each subsidiary bank met all capital adequacy requirements to which they are
subject.
As of December 31, 2001, the most recent notification from the Federal Deposit
Insurance Corporation categorized the Company and its subsidiary banks as well
capitalized under the regulatory framework for prompt corrective action. There
are no conditions or events since that notification that management believes
have changed the Company's category.
Payments of dividends by the subsidiary banks to FII are limited or restricted
in certain circumstances under banking regulations. At December 31, 2001, an
aggregate of $6,572,000 was available for payment of dividends by the subsidiary
banks to FII without the approval from the appropriate regulatory authorities.
December 31, 2001
----------------------------------------------------------------------------
Actual Regulatory
Capital Minimum Requirements Well-Capitalized
------------------------ -------------------- -- ----------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Leverage capital (Tier 1) as percent of
three-month average assets:
Company $ 120,638 7.02% $ 68,721 4.00% $ 85,902 5.00%
BNB 27,428 8.43 13,008 4.00 16,260 5.00
FTB 8,951 6.08 5,893 4.00 7,366 5.00
NBG 37,415 6.96 21,506 4.00 26,883 5.00
PSB 12,154 7.02 6,922 4.00 8,652 5.00
WCB 35,437 6.56 21,538 4.00 26,922 5.00
As percent of risk-weighted, period-end assets: Core capital (Tier 1):
Company 120,638 9.81 49,192 4.00 73,789 6.00
BNB 27,428 14.18 7,741 4.00 11,611 6.00
FTB 8,951 8.94 4,003 4.00 6,005 6.00
NBG 37,415 9.24 16,191 4.00 24,287 6.00
PSB 12,154 9.14 5,318 4.00 7,978 6.00
WCB 35,347 8.95 15,792 4.00 23,688 6.00
Total capital (Tiers 1 and 2):
Company 139,847 11.37 98,385 8.00 122,981 10.00
BNB 29,851 15.43 15,481 8.00 19,352 10.00
FTB 10,206 10.20 8,006 8.00 10,008 10.00
NBG 42,487 10.50 32,382 8.00 40,478 10.00
PSB 13,822 10.40 10,637 8.00 13,296 10.00
WCB 40,301 10.21 31,585 8.00 39,481 10.00
60
December 31, 2000
----------------------------------------------------------------------------
Actual Regulatory
Capital Minimum Requirements Well-Capitalized
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Leverage capital (Tier 1) as percent of three-month average assets:
Company $ 129,839 10.19% $ 50,946 4.00% $ 63,683 5.00%
FTB 7,832 5.93 5,279 4.00 6,599 5.00
NBG 38,222 8.02 19,067 4.00 23,384 5.00
PSB 10,854 6.46 6,718 4.00 8,397 5.00
WCB 30,813 6.19 19,918 4.00 24,897 5.00
As percent of risk-weighted, period-end assets: Core capital (Tier 1):
Company 129,839 14.02 37,052 4.00 55,577 6.00
FTB 7,832 9.19 3,410 4.00 5,114 6.00
NBG 38,222 10.32 14,820 4.00 22,230 6.00
PSB 10,854 8.91 4,873 4.00 7,309 6.00
WCB 30,813 8.93 13,805 4.00 20,708 6.00
Total capital (Tiers 1 and 2):
Company 141,446 15.27 74,103 8.00 92,629 10.00
FTB 8,900 10.44 6,819 8.00 8,524 10.00
NBG 42,859 11.57 29,640 8.00 37,050 10.00
PSB 12,381 10.16 9,745 8.00 12,182 10.00
WCB 35,143 10.18 27,610 8.00 34,513 10.00
(14) FAIR VALUE OF FINANCIAL INSTRUMENTS
The "fair value" of a financial instrument is defined as the price a willing
buyer and a willing seller would exchange in other than a distressed sale
situation. The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments at December 31, 2001 and 2000:
2001 2000
--------------------------- ----------------------------
Carrying Fair Carrying Fair
(Dollars in thousands) Amount Value Amount Value
---------- ----------- ------ ----------
Financial Assets
Cash and cash equivalents $ 53,171 $ 53,171 $ 30,152 $ 30,152
Securities 489,704 490,740 334,770 334,707
FHLB and FRB stock 7,732 7,732 4,046 4,046
Loans, net 1,146,976 1,174,381 873,262 897,977
Financial Liabilities
Deposits:
Interest Bearing:
Savings and interest
bearing demand 572,563 572,563 309,732 309,732
Time deposits 636,467 635,425 605,539 606,113
Non-interest bearing 224,628 224,628 162,840 162,840
----------- ----------- ----------- ------------
Total deposits 1,433,658 1,432,616 1,078,111 1,078,685
Borrowings:
Short-term 103,770 103,770 46,903 46,903
Long-term 70,419 74,042 15,481 15,382
Guaranteed preferred beneficial
interests in corporation's junior
subordinated debentures 16,200 17,596 - -
61
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments.
Cash and cash equivalents: The carrying amounts reported in the consolidated
statements of financial condition for cash, due from banks, interest-bearing
deposits and Federal funds sold approximate the fair value of those assets.
Securities: Fair value is based on quoted market prices, where available. Where
quoted market prices are not available, fair value is based on quoted market
prices of comparable instruments.
FHLB and FRB stock: The carrying amounts reported in the consolidated statements
of financial condition for FHLB and FRB stock approximate the fair value of
those assets.
Loans: For variable rate loans that reprice frequently, fair value approximates
carrying amount. The fair value for fixed rate loans is estimated through
discounted cash flow analysis using interest rates currently being offered for
loans with similar terms and credit quality. The fair value of loans held for
sale is based on quoted market prices and investor commitments. For
nonperforming loans, fair value is estimated by discounting expected cash flows
at a rate commensurate with the risk associated with the estimated cash flows.
Deposits: The fair value for savings, money market and non-interest bearing
accounts is equal to the carrying amount because of the customer's ability to
withdraw funds immediately. The fair value of time deposits is estimated using a
discounted cash flow approach that applies prevailing market interest rates for
similar maturity instruments.
Borrowings: Carrying value approximates fair value for short-term borrowings.
The fair value for long-term borrowings is estimated using a discounted cash
flow approach that applies prevailing market interest rates for similar maturity
instruments.
Guaranteed Preferred Beneficial Interests in Corporation's Junior Subordinated
Debentures: The fair value for guaranteed preferred beneficial interests in
corporation's junior subordinated debentures is estimated using a discounted
cash flow approach that applies prevailing market interest rates for similar
maturity instruments.
62
(15) SEGMENT INFORMATION
Reportable segments are comprised of WCB, NBG, BNB, PSB and FTB as the Company
evaluates performance on an individual bank basis. The reportable segment
information as of and for the years ended December 31, 2001, 2000 and 1999
follows:
(Dollars in thousands) 2001 2000 1999
-------------- -------------- ---------------
Net interest income
WCB $ 23,306 $ 21,505 $ 19,332
NBG 20,279 18,230 16,154
BNB 8,184 - -
PSB 8,186 7,203 6,384
FTB 6,041 5,173 4,721
---------- ----------- ---------
Total segment net interest income 65,996 52,111 46,591
Parent, non-bank subsidiaries
and eliminations, net (1,222) 751 218
---------- ----------- ---------
Total net interest income $ 64,774 $ 52,862 $ 46,809
========== ============ =========
Net income
WCB $ 8,424 $ 7,549 $ 6,774
NBG 8,322 7,154 6,093
BNB 1,142 - -
PSB 2,674 2,005 2,039
FTB 1,827 1,523 1,367
---------- ----------- ---------
Total segment net income 22,389 18,231 16,273
Parent, non-bank subsidiaries
and eliminations, net (1,176) (131) (316)
---------- ----------- ---------
Total net income $ 21,213 $ 18,100 $ 15,957
========== =========== =========
Assets
WCB $ 551,346 $ 494,589 $ 452,353
NBG 546,539 488,181 417,120
BNB 362,645 - -
PSB 177,000 171,186 141,363
FTB 161,763 131,638 122,052
---------- ----------- ---------
Total segment assets 1,799,293 1,285,594 1,132,888
Parent, non-bank subsidiaries
and eliminations, net (4,997) 3,733 3,572
---------- ----------- ---------
Total assets $ 1,794,296 $ 1,289,327 $ 1,136,460
=========== ========== ========
63
(16) CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following are the condensed statements of condition of FII as of December
31, 2001 and 2000, and the condensed statements of income and cash flows for the
years ended December 31, 2001, 2000 and 1999:
CONDENSED STATEMENTS OF CONDITION
(Dollars in thousands) 2001 2000
------------- --------------
Assets:
Cash and due from subsidiaries $ 7,186 $ 17,116
Securities available for sale, at fair value 1,333 1,215
Investment in subsidiaries 163,053 89,808
Accrued dividends receivable from subsidiaries - 22,962
Other assets 5,236 4,135
------------- -------------
Total assets $ 176,808 $ 135,236
============= =============
Liabilities and equity:
Due to subsidiaries $ 16,702 $ -
Short-term borrowings 500 -
Long-term borrowings 5,000 -
Other liabilities 5,419 3,618
Shareholders' equity 149,187 131,618
------------- -------------
Total liabilities and equity $ 176,808 $ 135,236
============= =============
CONDENSED STATEMENTS OF INCOME
(Dollars in thousands) 2001 2000 1999
-------------- -------------- --------------
Dividends from subsidiaries $ 16,643 $ 30,115 $ 6,088
Other income 7,577 6,178 5,212
------------- ------------- -------------
Total income 24,220 36,293 11,300
Expenses 9,602 6,190 5,542
------------- ------------- -------------
Income before income taxes and equity
in earnings of subsidiaries 14,618 30,103 5,758
Income tax benefit (expense) 788 (33) 93
------------- ------------- -------------
Income before equity earnings in subsidiaries 15,406 30,070 5,851
Equity in undistributed earnings (dividends in
excess of earnings) of subsidiaries 5,807 (11,970) 10,106
------------- ------------- -------------
Net income $ 21,213 $ 18,100 $ 15,957
============= ============= =============
64
CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands) 2001 2000 1999
-------------- -------------- --------------
Cash flows from operating activities:
Net income $ 21,213 $ 18,100 $ 15,957
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 711 620 842
Dividends in excess of earnings
(equity in undistributed earnings)
of subsidiaries (5,807) 11,970 (10,106)
Deferred income tax (benefit) expense (102) (56) 58
Decrease (increase) in accrued dividends
receivable from subsidiaries 22,962 (22,962) -
Increase in other assets (1,139) (181) (141)
Decrease (increase) in accrued
expense and other liabilities 1,562 230 (78)
------------- ------------- -------------
Net cash provided by
operating activities 39,400 7,721 6,532
------------- ------------- -------------
Cash flows from investing activities:
Equity investment in subsidiaries, net (63,381) - (154)
Purchase of securities available for sale - (140) (520)
Purchase of premises and equipment, net (1,109) (340) (319)
-------------- ------------- -------------
Net cash used in
investing activities (64,490) (480) (993)
------------- ------------- -------------
Cash flows from financing activities:
Proceeds from short-term borrowings 500 - -
Proceeds from long-term borrowings 5,000 - -
Repayment of long-term borrowings - (1,698) (42)
Proceeds from issuance of guaranteed
preferred beneficial interests in
corporation's junior subordinated
debentures 16,200 - -
Issuance (repurchase) of preferred
and common shares, net 11 (425) (54)
Dividends paid (6,551) (5,788) (4,988)
Proceeds from initial public offering,
net of costs - - 13,623
------------- ------------- -------------
Net cash provided by (used in)
financing activities 15,160 (7,911) 8,539
------------- ------------- -------------
Net (decrease) increase in cash and
cash equivalents (9,930) (670) 14,078
Cash and cash equivalents at
beginning of the year 17,116 17,786 3,708
------------- ------------- -------------
Cash and cash equivalents at
end of the year $ 7,186 $ 17,116 $ 17,786
============= ============= =============
65
SUPPLEMENTARY DATA (UNAUDITED)
Quarterly Financial Information
Income Diluted
Net Provision Before Earnings Per
(Dollars in thousands, Interest for Loan Income Net Common
except per share data) Income Losses Taxes Income Share
------ ------ ----- ------ -----
2001
First quarter $ 13,589 $ 811 $ 7,319 $ 4,805 $ 0.40
Second quarter 15,985 1,026 8,002 5,185 0.43
Third quarter 17,138 1,563 8,268 5,360 0.45
Fourth quarter 18,062 1,558 8,657 5,863 0.49
2000
First quarter $ 12,633 $ 835 $ 6,712 $ 4,294 $ 0.36
Second quarter 13,090 1,172 6,960 4,449 0.37
Third quarter 13,418 1,100 7,231 4,665 0.39
Fourth quarter 13,721 1,104 7,001 4,692 0.39
66
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Financial Institutions, Inc.:
We have audited the accompanying consolidated statements of financial condition
of Financial Institutions, Inc. and subsidiaries as of December 31, 2001 and
2000, and the related consolidated statements of income, changes in
shareholders' equity and comprehensive income, and cash flows for each of the
years in the three-year period ended December 31, 2001. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
the significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Financial
Institutions, Inc. and subsidiaries as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.
/s/ KPMG LLP
Buffalo, New York
January 22, 2002
67
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and all of the executive officers of the
Registrant on pages 3, 9, 12 and 13 of the Proxy Statement for its 2002 Annual
Meeting of Shareholders to be filed with the U.S. Securities and Exchange
Commission is incorporated herein by reference thereto.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation on pages 7, 8 and 9 of the
Registrant's Proxy Statement for its 2002 Annual Meeting of Shareholders to be
filed with the U.S. Securities and Exchange Commission is incorporated herein by
reference thereto.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners of the
Company's management on page 4 of the Registrant's Proxy Statement for its 2002
Annual Meeting of Shareholders to be filed with the U.S. Securities and Exchange
Commission is incorporated herein by reference thereto.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions on pages 12
and 13 of the Registrant's Proxy Statement for its 2002 Annual Meeting of
Shareholders to be filed with the U.S. Securities and Exchange Commission is
incorporated herein by reference thereto.
68
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
(1) FINANCIAL STATEMENTS.
The financial statements listed below and the Independent
Auditors' Report are included in this Annual Report on Form 10-K:
Independent Auditors' Report
Consolidated Statements of Financial Condition as of
December 31, 2001 and 2000
Consolidated Statements of Income for the years ended
December 31, 2001, 2000 and 1999
Consolidated Statements of Changes in Shareholders' Equity
and Comprehensive Income for the years ended December 31,
2001, 2000 and 1999
Consolidated Statements of Cash Flows the years ended
December 31, 2001, 2000 and 1999
Notes to Consolidated Financial Statements
(2) SCHEDULES.
All schedules are omitted since the required information is either
not applicable, not required, or is contained in the respective
financial statements or in the notes thereto.
69
(3) EXHIBITS.
The following is a list of all exhibits filed or incorporated by
reference as part of this Registration Statement.
Exhibit No. Description Location
- ------------- -------------------------------------------- -----------------------------------
3.1 Amended and Restated Certificate of Contained in Exhibit 3.1 of the
Incorporation Registrant's Registration Statement
on Form S-1 dated June 25, 1999
(File No. 333-76865)
(The "S-1 Registration Statement")
3.2 Amended and Restated Bylaws Filed Herewith
10.1 1999 Management Stock Incentive Plan Contained in Exhibit 10.1
of the S-1 Registration Statement
10.2 1999 Directors Stock Incentive Plan Contained in Exhibit 10.2
of the S-1 Registration Statement
10.3 Employment Agreement for Filed Herewith
Peter G. Humphrey
10.4 Employment Agreement for Filed Herewith
John R. Koelmel
10.5 Employment Agreement for Filed Herewith
Jon J. Cooper
10.6 Employment Agreement for Filed Herewith
Thomas L. Kime
10.7 Employment Agreement for Filed Herewith
Douglas McCabe
10.8 Employment Agreement for Filed Herewith
Randolph C. Brown
10.9 Employment Agreement for Filed Herewith
Patrick C. Burke
11.1 Statement of Computation of Per Share Earnings Contained in Note 1 of the
Registrant's Consolidated
Financial Statements Under
Item 8 Filed Herewith
21.1 Subsidiaries of Financial Institutions, Inc. Filed Herewith
23.1 Consent of KPMG LLP Filed Herewith
(B) REPORTS ON FORM 8-K
The Company filed no Current Reports on Form 8-K during the quarter
ended December 31, 2001.
70
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FINANCIAL INSTITUTIONS, INC.
Date: March 11, 2002 By: /s/ Peter G. Humphrey
---------------------
Peter G. Humphrey
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signatures Title Date
/s/ Peter G. Humphrey March 11, 2002
- ------------------------------- President, Chief Executive
Peter G. Humphrey Officer (Principal Executive
Officer), Chairman of the
Board and Director
/s/ John R. Koelmel March 11, 2002
- ------------------------------- Senior Vice President
John R. Koelmel and Chief Administrative Officer
/s/ Ronald A. Miller March 11, 2002
- ------------------------------- Senior Vice President
Ronald A. Miller and Chief Financial Officer
(Principal Accounting Officer)
/s/ W.J. Humphrey, Jr. Director March 11, 2002
- -------------------------------
W.J. Humphrey, Jr.
/s/ Jon J. Cooper Director and Senior Vice President March 11, 2002
- -------------------------------
Jon J. Cooper
/s/ Barton P. Dambra Director March 11, 2002
- -------------------------------
Barton P. Dambra
/s/ Samuel M. Gullo Director March 11, 2002
- -------------------------------
Samuel M. Gullo
/s/ Thomas L. Kime Director and Senior Vice President March 11, 2002
- -------------------------------
Thomas L. Kime
/s/ H. Jack South Director March 11, 2002
- -------------------------------
H. Jack South
/s/ John Tyler, Jr. Director March 11, 2002
- -------------------------------
John Tyler, Jr.
/s/ Bryan G. vonHahmann Director March 11, 2002
- -------------------------------
Bryan G. vonHahmann
/s/ James H. Wycoff Director March 11, 2002
- -------------------------------
James H. Wycoff
/s/ Douglas L. McCabe Director and Senior Vice President March 11, 2002
- -------------------------------
Douglas L. McCabe
/s/ Randy C. Brown Director and Senior Vice President March 11, 2002
- -------------------------------
Randy C. Brown