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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-23975
FIRST NIAGARA FINANCIAL GROUP, INC.
(exact name of registrant as specified in its charter)
Delaware 16-1545669
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
6950 South Transit Road, P.O. Box 514, Lockport, NY 14095-0514
- --------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(716) 625-7500
--------------
(Registrant's telephone number, including area code)
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 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
The Registrant had 25,978,553 shares of Common Stock, $.01 par value,
outstanding as of August 12, 2002.
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FIRST NIAGARA FINANCIAL GROUP, INC.
FORM 10-Q
For the Quarterly Period Ended June 30, 2002
TABLE OF CONTENTS
Item Number Page Number
- ----------- -----------
PART I - FINANCIAL INFORMATION
1. Financial Statements
Condensed Consolidated Statements of Condition as of
June 30, 2002 (unaudited) and December 31, 2001..................... 3
Condensed Consolidated Statements of Income for the
three and six months ended June 30, 2002 and 2001 (unaudited)....... 4
Condensed Consolidated Statements of Comprehensive Income for the
three and six months ended June 30, 2002 and 2001 (unaudited)....... 5
Condensed Consolidated Statements of Changes in Stockholders' Equity
for the six months ended June 30, 2002 and 2001 (unaudited)......... 6
Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 2002 and 2001 (unaudited)................. 7
Notes to Condensed Consolidated Financial Statements (unaudited)...... 8
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.............................................. 13
3. Quantitative and Qualitative Disclosures about Market Risk............... 23
PART II - OTHER INFORMATION
1. Legal Proceedings........................................................ 24
2. Changes in Securities and Use of Proceeds................................ 24
3. Defaults upon Senior Securities.......................................... 24
4. Submission of Matters to a Vote of Security Holders...................... 24
5. Other Information........................................................ 24
6. Exhibits and Reports on Form 8-K......................................... 25
Signatures.................................................................. 25
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
- --------------------------------------------------------------------------------
First Niagara Financial Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Condition
June 30, December 31,
2002 2001
----------- ---------
(unaudited)
(In thousands except share
and per share amounts)
Assets
Cash and cash equivalents:
Cash and due from banks ................................................. $ 44,368 52,423
Federal funds sold and other short-term investments ..................... 125,177 22,231
----------- ---------
Total cash and cash equivalents ................................ 169,545 74,654
Securities available for sale ............................................. 556,228 693,897
Loans, net ................................................................ 1,910,645 1,853,141
Premises and equipment, net ............................................... 40,556 40,233
Goodwill, net ............................................................. 74,101 74,213
Amortizing intangible assets, net ......................................... 6,675 6,797
Other assets .............................................................. 114,473 115,011
----------- ---------
Total assets .......................................... $ 2,872,223 2,857,946
=========== =========
Liabilities and Stockholders' Equity
Liabilities:
Deposits ................................................................ $ 2,148,274 1,990,830
Short-term borrowings ................................................... 72,633 212,992
Long-term borrowings .................................................... 334,223 346,048
Other liabilities ....................................................... 44,790 47,459
----------- ---------
Total liabilities ..................................... 2,599,920 2,597,329
----------- ---------
Stockholders' equity:
Preferred stock, $.01 par value, 5,000,000 shares
authorized, none issued ............................................... -- --
Common stock, $.01 par value, 45,000,000 shares
authorized, 29,756,250 shares issued .................................. 298 298
Additional paid-in capital .............................................. 136,683 135,917
Retained earnings ....................................................... 185,265 176,073
Accumulated other comprehensive income .................................. 3,197 2,561
Common stock held by ESOP, 855,622 shares in 2002 and
878,533 shares in 2001 ................................................ (11,327) (11,630)
Treasury stock, at cost, 3,975,992 shares in 2002 and
4,075,498 shares in 2001 .............................................. (41,813) (42,602)
----------- ---------
Total stockholders' equity ............................ 272,303 260,617
----------- ---------
Total liabilities and stockholders' equity ............ $ 2,872,223 2,857,946
=========== =========
3
First Niagara Financial Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Income
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(In thousands except per share amounts)
Interest income:
Loans .................................................... $ 34,747 36,111 69,542 72,586
Investment securities .................................... 2,320 2,712 4,615 5,405
Mortgage-backed securities ............................... 4,582 4,934 9,433 10,034
Federal funds sold and other short-term investments ...... 630 456 956 811
Other .................................................... 257 414 523 878
---------- ---------- ---------- ----------
Total interest income .......................... 42,536 44,627 85,069 89,714
Interest expense:
Deposits ................................................. 14,227 19,415 28,789 39,296
Borrowings ............................................... 5,601 6,122 11,358 12,583
---------- ---------- ---------- ----------
Total interest expense ......................... 19,828 25,537 40,147 51,879
---------- ---------- ---------- ----------
Net interest income ............................ 22,708 19,090 44,922 37,835
Provision for credit losses ................................. 1,730 860 3,260 1,900
---------- ---------- ---------- ----------
Net interest income after provision
for credit losses ........................... 20,978 18,230 41,662 35,935
---------- ---------- ---------- ----------
Noninterest income:
Banking service charges and fees ......................... 3,477 2,419 6,816 4,647
Lending and leasing income ............................... 1,192 997 2,231 2,041
Insurance services and fees .............................. 5,553 4,700 10,627 9,487
Bank-owned life insurance income ......................... 683 598 1,337 1,181
Annuity and mutual fund commissions ...................... 773 408 1,246 853
Investment and fiduciary services income ................. 309 358 636 756
Other .................................................... 578 777 882 1,824
---------- ---------- ---------- ----------
Total noninterest income ....................... 12,565 10,257 23,775 20,789
---------- ---------- ---------- ----------
Noninterest expense:
Salaries and employee benefits ........................... 12,057 11,150 24,405 22,819
Occupancy and equipment .................................. 1,955 1,897 3,989 3,972
Technology and communications ............................ 2,345 1,765 4,395 3,755
Marketing and advertising ................................ 621 781 1,161 1,214
Amortization of goodwill ................................. -- 1,184 -- 2,368
Amortization of other intangibles ........................ 211 234 422 468
Other .................................................... 3,176 3,490 6,439 6,622
---------- ---------- ---------- ----------
Total noninterest expense ...................... 20,365 20,501 40,811 41,218
---------- ---------- ---------- ----------
Income before income taxes ..................... 13,178 7,986 24,626 15,506
Income tax expense:
Federal and State ........................................ 4,387 2,973 8,385 5,831
New York State bad debt tax expense recapture (See note 5) 1,784 -- 1,784 --
---------- ---------- ---------- ----------
Net income .................................... $ 7,007 5,013 14,457 9,675
========== ========== ========== ==========
Adjusted net income (See note 3) .............. $ 7,007 6,197 14,457 12,043
========== ========== ========== ==========
Basic earnings per share:
Net income .................................... $ 0.28 0.20 0.58 0.39
Adjusted net income (See note 3) .............. 0.28 0.25 0.58 0.49
Diluted earnings per share:
Net income .................................... $ 0.28 0.20 0.57 0.39
Adjusted net income (See note 3) .............. 0.28 0.25 0.57 0.48
Weighted average common shares outstanding:
Basic ......................................... 24,886 24,697 24,853 24,682
Diluted ....................................... 25,425 24,982 25,347 24,917
4
First Niagara Financial Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(Amounts in thousands)
Net income ................................................................. $ 7,007 5,013 14,457 9,675
Other comprehensive income (loss), net of income taxes:
Securities available for sale:
Net unrealized gains (losses) arising during the period ............ 2,810 (362) 584 1,638
Reclassification adjustment for realized (gains) losses
included in net income ........................................ (49) 127 (41) 126
---------- ---------- ---------- ----------
2,761 (235) 543 1,764
Cash flow hedges:
Net unrealized losses arising during the period .................... (79) (9) (102) (300)
Reclassification adjustment for realized losses
included in net income ........................................ 61 131 195 144
---------- ---------- ---------- ----------
(18) 122 93 (156)
---------- ---------- ---------- ----------
Total other comprehensive income (loss) before
cumulative effect of change in accounting principle ....... 2,743 (113) 636 1,608
Cumulative effect of change in accounting principle
for derivatives, net of tax ....................................... -- -- -- (95)
---------- ---------- ---------- ----------
Total other comprehensive income (loss) ......................... 2,743 (113) 636 1,513
---------- ---------- ---------- ----------
Total comprehensive income ...................................... $ 9,750 4,900 15,093 11,188
========== ========== ========== ==========
5
First Niagara Financial Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Stockholders' Equity
(unaudited)
Accumulated Common
Additional other stock
Common paid-in Retained comprehensive held by Treasury
stock capital earnings income ESOP stock Total
--------- ---------- -------- ------------- ------- ------- -------
(In thousands except share and per share amounts)
Balances at January 1, 2001 ............. $ 298 135,776 163,836 336 (12,378) (43,328) 244,540
Net income .............................. -- -- 9,675 -- -- -- 9,675
Unrealized gain on securities
available for sale, net of
reclassification adjustment and taxes . -- -- -- 1,764 -- -- 1,764
Unrealized loss on interest rate swaps,
net of reclassification
adjustment and taxes .................. -- -- -- (156) -- -- (156)
Cumulative effect of change in
accounting principle for derivatives -- -- -- (95) -- -- (95)
ESOP shares committed to be released
(27,215 shares) ....................... -- (27) -- -- 360 -- 333
Vested restricted stock plan awards
(37,716 shares) ....................... -- (7) -- -- -- 341 334
Common stock dividend of $0.17 per
share ................................. -- -- (4,238) -- -- -- (4,238)
--------- ------- ------- ----- ------- ------- -------
Balances at June 30, 2001 ............... $ 298 135,742 169,273 1,849 (12,018) (42,987) 252,157
========= ======= ======= ===== ======= ======= =======
Balances at January 1, 2002 ............. $ 298 135,917 176,073 2,561 (11,630) (42,602) 260,617
Net income .............................. -- -- 14,457 -- -- -- 14,457
Unrealized gain on securities
available for sale, net of
reclassification adjustment and taxes -- -- -- 543 -- -- 543
Unrealized gain on interest rate swaps,
net of reclassification adjustment
and taxes ............................. -- -- -- 93 -- -- 93
Exercise of stock options (47,350 shares) -- 63 -- -- -- 464 527
ESOP shares committed to be released
(22,911 shares) ....................... -- 171 -- -- 303 -- 474
Vested restricted stock plan awards
(52,156 shares) ....................... -- 532 -- -- -- 325 857
Common stock dividend of $0.21 per share -- -- (5,265) -- -- -- (5,265)
--------- ------- ------- ----- ------- ------- -------
Balances at June 30, 2002 ............... $ 298 136,683 185,265 3,197 (11,327) (41,813) 272,303
========= ======= ======= ===== ======= ======= =======
6
First Niagara Financial Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(unaudited)
Six Months Ended June 30,
-------------------------
2002 2001
----------- -----------
(Amounts in thousands)
Cash flows from operating activities:
Net income ........................................................... $ 14,457 9,675
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization (accretion) of fees and discounts, net ............ 1,109 (150)
Depreciation of premises and equipment ......................... 2,630 2,288
Provision for credit losses .................................... 3,260 1,900
Amortization of goodwill and other intangibles ................. 422 2,836
Net (gain) loss on sale of securities available for sale ....... (68) 210
Defined benefit pension plan curtailment gain .................. (998) --
ESOP compensation expense ...................................... 474 333
Deferred income tax expense .................................... 1,183 256
Increase in other assets ....................................... (2,956) (1,154)
(Decrease) increase in other liabilities ....................... (1,255) 1,256
---------- ------
Net cash provided by operating activities ................ 18,258 17,450
---------- ------
Cash flows from investing activities:
Proceeds from sales of securities available for sale ................ 100,107 58,344
Proceeds from maturities of securities available for sale ........... 190,153 20,294
Principal payments received on securities available for sale ........ 86,805 36,451
Purchases of securities available for sale .......................... (239,725) (124,766)
Net increase in loans ............................................... (60,540) (14,112)
Acquisitions, net of cash acquired .................................. (300) (905)
Other, net .......................................................... (289) (3,793)
---------- ------
Net cash provided by (used in) investing activities ...... 76,211 (28,487)
---------- ------
Cash flows from financing activities:
Net increase in deposits ............................................ 157,444 49,033
Repayments of short-term borrowings ................................. (159,851) (48,210)
Proceeds from long-term borrowings .................................. 15,000 32,500
Repayments of long-term borrowings .................................. (7,397) (9,830)
Proceeds from exercise of stock options ............................. 491 --
Dividends paid on common stock ...................................... (5,265) (4,238)
---------- ------
Net cash provided by financing activities ................. 422 19,255
---------- ------
Net increase in cash and cash equivalents ................................ 94,891 8,218
Cash and cash equivalents at beginning of period ......................... 74,654 62,815
---------- ------
Cash and cash equivalents at end of period ............................... $ 169,545 71,033
========== ======
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes .................................................... $ 9,477 4,851
Interest expense ................................................ $ 40,601 52,416
========== ======
7
First Niagara Financial Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)
(1) Basis of Financial Statement Presentation
The accompanying condensed consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America ("GAAP") for interim financial information and the instructions for
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments necessary for a fair
presentation have been included. Results for the three and six month periods
ended June 30, 2002 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2002. Certain reclassification
adjustments were made to the 2001 financial statements to conform them to the
2002 presentation.
(2) Business and Subsequent Events
First Niagara Financial Group, Inc. ("FNFG") is a Delaware corporation, which
holds all of the capital stock of First Niagara Bank ("First Niagara"), Cortland
Savings Bank ("Cortland") and Cayuga Bank ("Cayuga") (collectively, "the
Banks"). FNFG and its consolidated subsidiaries are hereinafter referred to
collectively as "the Company." FNFG operates under a mutual holding company
Structure. In accordance with New York State law, as long as FNFG remains under
this structure, at least 51% of FNFG's voting shares must be owned by the mutual
holding company. As of June 30, 2002 First Niagara Financial Group, MHC ("the
MHC") owned 61.5% of the Company's shares of common stock outstanding. The
business of FNFG consists of the management of its community banks and financial
services group. The Banks primary business is accepting deposits from customers
through their branch offices and investing those deposits, together with funds
generated from operations and borrowings, in one- to four-family residential,
multi-family and commercial real estate loans, commercial business loans,
consumer loans, and investment securities. Additionally, through its financial
services group, the Company has an expanded product line, which includes
insurance products and services, as well as trust and investment services. The
Company emphasizes personal service and customer convenience in serving the
financial needs of the individuals, families and businesses residing in Western
and Central New York.
On July 12, 2002 the Company filed an application with the Office of Thrift
Supervision ("OTS") to convert FNFG, the MHC and the Banks from state to federal
charters. This application also requested that FNFG be allowed to merge First
Niagara, Cortland and Cayuga into one bank under the First Niagara Bank brand
name ("the consolidated bank"). As part of the conversion to a federally
chartered institution, the Company will be required to comply with several
conditions that it currently is not subject to, the most notable of which is
that the consolidated bank will not be able to invest in marketable equity
securities and will be subject to a qualified thrift lender test. Under the
qualified thrift lender test, the consolidated bank is required to maintain at
least 65% of its "portfolio assets" (total assets minus goodwill and other
intangible assets, office property and specified liquid assets up to 20% of
total assets) in certain "qualified thrift investments" (primarily residential
mortgages, home equity loans, FHLB stock and mortgage-backed securities). The
Company anticipates that the consolidated bank will be able to meet these
requirements and that the charter change and bank consolidation will be
completed in the fourth quarter of 2002.
On July 21, 2002, the Boards of Directors of the MHC and FNFG adopted a Plan of
Conversion and Reorganization pursuant to which the MHC will convert from mutual
to stock form ("the Conversion"). In connection with the Conversion, a new
Delaware corporation, also named First Niagara Financial Group, Inc., will be
formed as the holding company for the consolidated bank and will offer common
stock representing the ownership interest of the MHC in FNFG to eligible
depositors of the Banks and the public ("the Offering"). Stockholders of FNFG,
other than the MHC, will have their shares exchanged for shares of the new
corporation, based on an exchange ratio yet to be determined. Applications for
the Conversion and Offering will be filed with the OTS and the Securities and
Exchange Commission in the third quarter and is subject to the approval of
stockholders of FNFG and depositors of the Banks.
On July 21, 2002, the Company entered into a definitive agreement to acquire all
of the common shares outstanding of Finger Lakes Bancorp, Inc. ("FLBC") the
holding company of Savings Bank of the Finger Lakes ("SBFL") which has
approximately $388 million of assets and seven branch locations. Subsequent to
the acquisition, SBFL will be merged into the consolidated bank. Under the terms
of the agreement, the Company will pay $20.00 per share, in an equal combination
of cash and stock from the Conversion, for all of the outstanding shares and
options of FLBC for an aggregate purchase price of approximately $67 million.
The transaction is expected to be completed in the first quarter of 2003,
simultaneously with the Conversion and Offering, and is subject to approval by
FLBC stockholders and various regulatory agencies.
8
First Niagara Financial Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)
(3) Goodwill and Intangible Assets
Effective January 1, 2002 the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 142 "Goodwill and Other Intangible Assets." SFAS No. 142
requires acquired intangible assets (other than goodwill) to be amortized over
their useful economic life, while goodwill and any acquired intangible asset
with an indefinite useful economic life are not amortized, but are reviewed for
impairment on an annual basis based upon guidelines specified by the Statement.
The following is a reconciliation of reported net income and earnings per share
to net income and earnings per share adjusted as if SFAS No. 142 had been
adopted on January 1, 2001 (in thousands except per share amounts):
Three months ended Six months ended
June 30, June 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net income:
As reported ............................................. $ 7,007 5,013 14,457 9,675
Add back: Goodwill amortization ......................... -- 1,184 -- 2,368
---------- ---------- ---------- ----------
Adjusted net income ..................................... $ 7,007 6,197 14,457 12,043
========== ========== ========== ==========
Basic earnings per share:
As reported ............................................. $ 0.28 0.20 0.58 0.39
Add back: Goodwill amortization ......................... -- 0.05 -- 0.10
---------- ---------- ---------- ----------
Adjusted basic earnings per share ....................... $ 0.28 0.25 0.58 0.49
========== ========== ========== ==========
Diluted earnings per share:
As reported ............................................. $ 0.28 0.20 0.57 0.39
Add back: Goodwill amortization ......................... -- 0.05 -- 0.09
---------- ---------- ---------- ----------
Adjusted diluted earnings per share ..................... $ 0.28 0.25 0.57 0.48
========== ========== ========== ==========
The following tables set forth information regarding the Company's amortizing
intangible assets (in thousands):
June 30, December 31,
2002 2001
---------- -----------
Customer lists:
Gross carrying amount $ 9,936 9,636
Accumulated amortization (3,261) (2,839)
---------- ----------
Net carrying amount $ 6,675 6,797
========== ==========
Estimated intangible asset amortization expense
for the year ended December 31:
2002 $ 844
2003 844
2004 844
2005 844
2006 811
In January 2002, Warren-Hoffman & Associates, Inc. ("WHA"), First Niagara's
wholly owned insurance subsidiary, acquired the customer list of a property and
casualty insurance agency located in Western New York. WHA paid $300 thousand
for the customer list, which is being amortized over five years.
9
First Niagara Financial Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)
The following tables set forth information regarding the Company's goodwill (in
thousands):
Financial Consolidated
Banking segment services segment total
---------------- ---------------- ------------
Balances at January 1, 2002 $ 63,875 10,338 74,213
Contingent earn-out adjustment -- (112) (112)
---------------- ---------------- ----------
Balances at June 30, 2002 $ 63,875 10,226 74,101
================ ================ ==========
The Company has performed the required transitional goodwill impairment test as
of January 1, 2002. Based upon the results of this test, the Company has
determined that goodwill was not impaired.
(4) Earnings Per Share
The computation of basic and diluted earnings per share for the three and six
month periods ended June 30, 2002 and 2001 are as follows (in thousands except
per share amounts):
Three months ended Six months ended
June 30, June 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net income available to common shareholders ................. $ 7,007 5,013 14,457 9,675
========== ========== ========== ==========
Weighted average shares outstanding basic and diluted:
Total shares issued .................................... 29,756 29,756 29,756 29,756
Unallocated ESOP shares ................................ (867) (922) (873) (928)
Treasury shares ........................................ (4,003) (4,137) (4,030) (4,146)
---------- ---------- ---------- ----------
Total basic weighted average shares outstanding ............. 24,886 24,697 24,853 24,682
---------- ---------- ---------- ----------
Incremental shares from assumed exercise of
stock options ..................................... 452 206 408 155
Incremental shares from assumed vesting of
restricted stock awards ........................... 87 79 86 80
---------- ---------- ---------- ----------
Total diluted weighted average shares outstanding ........... $ 25,425 24,982 25,347 24,917
========== ========== ========== ==========
Basic earnings per share .................................... $ 0.28 0.20 0.58 0.39
========== ========== ========== ==========
Diluted earnings per share .................................. $ 0.28 0.20 0.57 0.39
========== ========== ========== ==========
10
First Niagara Financial Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)
(5) New York State Bad Debt Tax Expense Recapture
First Niagara is subject to special provisions in the New York State tax law
that allows it to deduct on its tax return bad debt expenses in excess of those
actually incurred based on a specified formula ("excess reserve"). First Niagara
is required to repay this excess reserve if it does not maintain a certain
percentage of qualified assets (primarily residential mortgages and
mortgage-backed securities) to total assets, as prescribed by the tax law. In
accordance with accounting guidelines, the Company is required to record a
deferred tax liability for the recapture of this excess reserve when it can no
longer assert that the test will continue to be passed for the "foreseeable
future." As a result of the decision to combine its three banks, the Company can
no longer make this assertion and accordingly, recorded a $1.8 million deferred
income tax liability in the second quarter of 2002. It is anticipated that the
tax liability will be repaid over a period of 10 to 15 years through lower bad
debt deductions on the Company's tax return.
(6) Segment Information
Based on the "Management Approach" model as described in the provisions of SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information,"
the Company has determined it has two business segments, banking and financial
services. The financial services segment includes the Company's insurance,
third-party administration and investment advisory subsidiaries, which are
organized under one Financial Services Group. The banking segment includes the
results of First Niagara, Cortland and Cayuga, excluding financial services.
Transactions between the banking and financial services segments primarily
relate to interest income and expense from intercompany deposit accounts, which
are eliminated in consolidation. Information about the Company's segments is
presented in the following table (in thousands):
Financial Consolidated
Banking services Eliminations total
---------- ---------- ------------ ----------
For the three month period ended:
June 30, 2002
- -------------
Interest income ......................................... $ 42,536 24 (24) 42,536
Interest expense ........................................ 19,852 -- (24) 19,828
---------- ---------- ---------- ----------
Net interest income ................................ 22,684 24 -- 22,708
Provision for credit losses ............................. 1,730 -- -- 1,730
---------- ---------- ---------- ----------
Net interest income after
provision for credit losses ........................ 20,954 24 -- 20,978
Noninterest income ...................................... 5,941 6,635 (11) 12,565
Amortization of intangible
assets ............................................. -- 211 -- 211
Other noninterest expense ............................... 15,396 4,769 (11) 20,154
---------- ---------- ---------- ----------
Income before income taxes ......................... 11,499 1,679 -- 13,178
Income tax expense ...................................... 5,525 646 -- 6,171
---------- ---------- ---------- ----------
Net income ......................................... $ 5,974 1,033 -- 7,007
========== ========== ========== ==========
11
First Niagara Financial Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)
Financial Consolidated
Banking services Eliminations total
---------- ---------- ------------ ----------
For the three month period ended:
June 30, 2001
- -------------
Interest income ........................................ $ 44,627 39 (39) 44,627
Interest expense ....................................... 25,576 -- (39) 25,537
---------- ---------- ---------- ----------
Net interest income ............................... 19,051 39 -- 19,090
Provision for credit losses ............................ 860 -- -- 860
---------- ---------- ---------- ----------
Net interest income after
provision for credit losses ....................... 18,191 39 -- 18,230
Noninterest income ..................................... 4,797 5,466 (6) 10,257
Amortization of goodwill and
other intangibles ................................. 945 473 -- 1,418
Other noninterest expense .............................. 14,726 4,363 (6) 19,083
---------- ---------- ---------- ----------
Income before income taxes ........................ 7,317 669 -- 7,986
Income tax expense ..................................... 2,549 424 -- 2,973
---------- ---------- ---------- ----------
Net income ........................................ $ 4,768 245 -- 5,013
========== ========== ========== ==========
For the six month period ended
June 30, 2002
- -------------
Interest income ......................................... $ 85,069 55 (55) 85,069
Interest expense ........................................ 40,202 -- (55) 40,147
---------- ---------- ---------- ----------
Net interest income ................................ 44,867 55 -- 44,922
Provision for credit losses ............................. 3,260 -- -- 3,260
---------- ---------- ---------- ----------
Net interest income after
provision for credit losses ........................ 41,607 55 -- 41,662
Noninterest income ...................................... 11,281 12,509 (15) 23,775
Amortization of intangible
assets ............................................. -- 422 -- 422
Other noninterest expense ............................... 30,818 9,586 (15) 40,389
---------- ---------- ---------- ----------
Income before income taxes ......................... 22,070 2,556 -- 24,626
Income tax expense ...................................... 9,015 1,154 -- 10,169
---------- ---------- ---------- ----------
Net income ......................................... $ 13,055 1,402 -- 14,457
========== ========== ========== ==========
For the six month period ended
June 30, 2001
- -------------
Interest income ......................................... $ 89,714 77 (77) 89,714
Interest expense ........................................ 51,956 -- (77) 51,879
---------- ---------- ---------- ----------
Net interest income ................................ 37,758 77 -- 37,835
Provision for credit losses ............................. 1,900 -- -- 1,900
---------- ---------- ---------- ----------
Net interest income after
provision for credit losses ........................ 35,858 77 -- 35,935
Noninterest income ...................................... 9,703 11,096 (10) 20,789
Amortization of goodwill and
other intangibles .................................. 1,890 946 -- 2,836
Other noninterest expense ............................... 29,498 8,894 (10) 38,382
---------- ---------- ---------- ----------
Income before income taxes ......................... 14,173 1,333 -- 15,506
Income tax expense ...................................... 4,978 853 -- 5,831
---------- ---------- ---------- ----------
Net income ......................................... $ 9,195 480 -- 9,675
========== ========== ========== ==========
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
- -------
This Quarterly Report on Form 10-Q may contain certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
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 largely on the 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 strategies and other factors discussed elsewhere
in this report and other reports filed by the Company with the Securities and
Exchange Commission. Many of these factors are beyond the Company's control.
The Company's results of operations are dependent primarily on net interest
income, the provision for credit losses, noninterest income and noninterest
expenses. Additionally, results of operations are significantly affected by
general economic and competitive conditions, particularly changes in interest
rates, government policies and actions of regulatory authorities.
13
Analysis of Financial Condition
- -------------------------------
Average Balance Sheet. The following table presents, for the periods indicated,
the total dollar amount of interest income from average interest-earning assets
and the resultant yields, as well as the interest expense on average
interest-bearing liabilities, expressed both in dollars and rates. No tax
equivalent adjustments were made. All average balances are average daily
balances. Non-accruing loans have been excluded from the yield calculations in
these tables.
Three Months Ended June 30,
---------------------------------------------------------------------------
2002 2001
----------------------------------- -----------------------------------
Average Interest Average Interest
outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate
----------- ------- ------ ----------- ------- ------
(Dollars in thousands)
Interest-earning assets:
Federal funds sold and other
short-term investments ........................ $ 121,566 $ 630 2.08% $ 41,189 $ 456 4.43%
Investment securities (1) ....................... 223,186 2,320 4.16 202,007 2,712 5.37
Mortgage-backed securities (1) .................. 350,733 4,582 5.23 301,631 4,934 6.54
Loans (2) ....................................... 1,899,023 34,747 7.33 1,834,373 36,111 7.88
Other interest-earning assets (3) ............... 22,998 257 4.48 25,494 414 6.51
---------- ---------- ---------- ----------
Total interest-earning assets ............. 2,617,506 42,536 6.51 2,404,694 44,627 7.43
---------- ---------- ---------- ----------
Allowance for credit losses ........................ (19,260) (18,574)
Other noninterest-earning assets (4)(5) ............ 270,958 267,416
---------- ----------
Total assets .............................. $2,869,204 $2,653,536
========== ==========
Interest-bearing liabilities:
Savings accounts ................................ $ 592,461 $ 3,548 2.40% $ 413,549 $ 2,684 2.60%
Interest-bearing checking ....................... 519,283 2,061 1.59 544,588 4,361 3.21
Certificates of deposit ......................... 900,201 8,550 3.81 876,995 12,285 5.62
Mortgagors' payments held in escrow ............. 16,733 68 1.64 18,207 85 1.87
Borrowed funds .................................. 411,557 5,601 5.46 412,677 6,122 5.95
---------- ---------- ---------- ----------
Total interest-bearing liabilities ........ 2,440,235 19,828 3.26 2,266,016 25,537 4.52
---------- ---------- ---------- ----------
Noninterest-bearing demand deposits ................ 111,738 87,450
Other noninterest-bearing liabilities (4) .......... 46,435 48,151
---------- ----------
Total liabilities ............................. 2,598,408 2,401,617
Stockholders' equity (4) ........................... 270,796 251,919
---------- ----------
Total liabilities and stockholders'
equity ..................................... $2,869,204 $2,653,536
========== ==========
Net interest income ................................ $ 22,708 $ 19,090
========== ==========
Net interest rate spread ........................... 3.25% 2.91%
==== ====
Net earning assets ................................. $ 177,271 $ 138,678
========== ==========
Net interest income as a percentage of
average interest-earning assets ................. 3.47% 3.17%
========== ==========
Ratio of average interest-earning assets
to average interest-bearing liabilities ......... 107.26% 106.12%
========== ==========
14
Six Months Ended June 30,
---------------------------------------------------------------------------
2002 2001
----------------------------------- -----------------------------------
Average Interest Average Interest
outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate
----------- ------- ------ ----------- ------- ------
(Dollars in thousands)
Interest-earning assets:
Federal funds sold and other
short-term investments ........................ $ 98,319 $ 956 1.96% $ 32,914 $ 811 4.96%
Investment securities (1) ....................... 212,229 4,615 4.35 198,993 5,405 5.44
Mortgage-backed securities (1) .................. 347,037 9,433 5.44 303,827 10,034 6.61
Loans (2) ....................................... 1,885,789 69,542 7.40 1,832,253 72,586 7.95
Other interest-earning assets (3) ............... 23,760 523 4.44 25,262 878 7.01
---------- ---------- ---------- ----------
Total interest-earning assets ............. 2,567,134 85,069 6.65 2,393,249 89,714 7.52
---------- ---------- ---------- ----------
Allowance for credit losses ........................ (19,046) (18,330)
Other noninterest-earning assets (4)(5) ............ 273,360 266,201
---------- ----------
Total assets .............................. $2,821,448 $2,641,120
========== ==========
Interest-bearing liabilities:
Savings accounts ................................ $ 545,717 $ 6,580 2.43% $ 412,887 $ 5,402 2.64%
Interest-bearing checking ....................... 528,751 4,424 1.69 540,610 9,144 3.41
Certificates of deposit ......................... 889,903 17,655 4.00 865,643 24,608 5.73
Mortgagors' payments held in escrow ............. 16,039 130 1.64 16,791 142 1.70
Borrowed funds .................................. 417,839 11,358 5.48 421,160 12,583 6.02
---------- ---------- ---------- ----------
Total interest-bearing liabilities ........ 2,398,249 40,147 3.38 2,257,091 51,879 4.64
---------- ---------- ---------- ----------
Noninterest-bearing demand deposits ................ 107,497 83,742
Other noninterest-bearing liabilities (4) .......... 47,316 49,729
---------- ----------
Total liabilities ......................... 2,553,062 2,390,562
Stockholders' equity (4) ........................... 268,386 250,558
---------- ----------
Total liabilities and stockholders'
equity .................................... $2,821,448 $2,641,120
========== ==========
Net interest income ................................ $ 44,922 $ 37,835
========== ==========
Net interest rate spread ........................... 3.27% 2.88%
==== ====
Net earning assets ................................. $ 168,885 $ 136,158
========== ==========
Net interest income as a percentage of
average interest-earning assets ................. 3.49% 3.15%
========== ==========
Ratio of average interest-earning assets
to average interest-bearing liabilities ......... 107.04% 106.03%
========== ==========
- ----------
(1) Amounts shown are at amortized cost.
(2) Net of deferred costs, unearned discounts and non-accruing loans.
(3) Includes Federal Home Loan Bank stock and SBIC investments.
(4) Includes unrealized gains/losses on securities available for sale and
interest rate swaps.
(5) Includes bank-owned life insurance, earnings on which are reflected in
other noninterest income.
Lending Activities
Total loans outstanding at June 30, 2002 increased slightly to $1.93 billion
from the year-end December 31, 2001 balance of $1.87 billion. During the first
six months of 2002, the Company continued to shift its portfolio mix from one-to
four-family real estate loans to higher yielding commercial real estate and
commercial business loans ("commercial loans"). Commercial loans increased $84.0
million or 14% from December 31, 2001 to June 30, 2002, while one-to four-family
real estate loans decreased $36.4 million or 4% during the same period. This
shift was primarily achieved through the Company's continued emphasis on
commercial loan originations through its small business lending unit and
management's strategic initiative to hold less fixed-rate residential real
estate loans. This decision was made as part of the Company's asset/liability
management strategy, and should benefit the Company during periods of higher
interest rates.
15
Loan Portfolio Composition. Set forth below is selected information concerning
the composition of the Company's loan portfolio in dollar amounts and in
percentages (before deductions for deferred costs, unearned discounts and
allowances for credit losses) as of the dates indicated.
June 30, 2002 December 31, 2001
----------------------------- -----------------------------
Amount Percent Amount Percent
------ ------- ------ -------
(Amounts in thousands)
Real estate loans:
- ------------------
One-to four-family..................... $ 944,268 49.0% $ 980,638 52.4%
Home equity............................ 130,642 6.8 114,443 6.1
Multi-family........................... 145,650 7.5 133,439 7.1
Commercial............................. 291,778 15.1 259,457 13.9
Construction........................... 82,133 4.3 64,502 3.5
------------ ---- ----------- ----
Total real estate loans............. 1,594,471 82.7 1,552,479 83.0
------------ ---- ----------- ----
Consumer loans............................ 178,725 9.3 182,126 9.7
Commercial business loans................. 154,778 8.0 135,621 7.3
------------ ---- ----------- ----
Total loans........................ 1,927,974 100% 1,870,226 100%
------------ ==== ----------- ====
Net deferred costs and
unearned discounts.............. 2,365 1,642
Allowance for credit losses............ (19,694) (18,727)
------------ -----------
Total loans, net................... $ 1,910,645 $ 1,853,141
============ ===========
Non-accruing loans were $11.7 million at June 30, 2002 compared to $11.5 million
at December 31, 2001. This slight increase from the end of 2001 can be
attributed to the continued growth in the Company's commercial loan portfolio
partially offset by a decrease in the Company's one-to four-family non-accruing
loans. The allowance for credit losses, which amounted to 167.85% of
non-accruing loans and 1.02% of total loans at June 30, 2002, is based upon
management's review of the loan portfolio and continues to provide adequate
coverage for losses inherent in the loan portfolio.
The adequacy of the Company's allowance for credit losses is reviewed quarterly
with consideration given to estimated losses inherent within the loan portfolio,
the status of particular loans, historical loan loss experience, as well as
current and anticipated economic and market conditions. While management uses
available information to recognize losses on loans, future credit loss
provisions may be necessary based on changes in economic conditions or other
factors such as loan portfolio mix. In addition, various regulatory agencies, as
an integral part of their examination process, periodically review the allowance
for credit losses and may require the Company to recognize additional provisions
based on their judgement of information available to them at the time of their
examination.
Non-Accruing Loans and Non-Performing Assets. The following table sets forth
information regarding non-accruing loans and non-performing assets.
June 30, December 31,
2002 2001
-------- ------------
(Dollars in thousands)
Non-accruing loans (1):
One-to four-family ...................................... $ 4,252 4,833
Home equity ............................................. 488 491
Commercial real estate and multi-family ................. 2,240 2,402
Consumer ................................................ 619 510
Commercial business ..................................... 4,134 3,244
---------- ------
Total .............................................. 11,733 11,480
Non-performing assets ...................................... 310 665
---------- ------
Total non-accruing loans and non-performing assets ......... $ 12,043 12,145
========== ======
Total non-accruing loans and non-performing assets
as a percentage of total assets ......................... 0.42% 0.42%
========== ======
Total non-accruing loans to total loans .................... 0.61% 0.61%
========== ======
Allowance for credit losses to total loans ................. 1.02% 1.00%
========== ======
Allowance for credit losses to non-accruing loans .......... 167.85% 163.13%
========== ======
- ----------
(1) Loans are placed on non-accrual status when they become 90 days or more
past due or if they have been identified by the Company as presenting
uncertainty with respect to the collectibility of interest or principal.
16
Analysis of the Allowance for Credit Losses. The following table sets forth the
analysis of the allowance for credit losses for the periods indicated.
Six months ended June 30,
-------------------------
2002 2001
-------- ------
(Dollars in thousands)
Balance at beginning of period ......................... $ 18,727 17,746
Net charge-offs:
Charge-offs ......................................... (2,902) (1,392)
Recoveries .......................................... 609 319
-------- ------
Total net charge-offs ............................ (2,293) (1,073)
Provision for credit losses ............................ 3,260 1,900
-------- ------
Balance at end of period ............................... $ 19,694 18,573
-------- ------
Ratio of net charge-offs during the period annualized to
average loans outstanding during the period ......... 0.24% 0.12%
======== ======
Investing Activities
The Company's investment securities portfolio decreased from $693.9 million at
December 31, 2001 to $556.2 million at June 30, 2002. This decrease was
primarily a result of the maturity of $155.0 million of U.S. Treasury securities
during the first quarter of 2002, the proceeds from which were used to pay down
borrowings. Additionally, during the first half of 2002 the Company restructured
a portion of its investment portfolio by selling approximately $50 million of
long-term mortgage backed securities and using the proceeds to purchase
short-term investments in order to better match the maturity of the Company's
short-term liabilities.
Funding Activities
Total deposits increased $157.4 million from $1.99 billion at December 31, 2001
to $2.15 billion at June 30, 2002. This increase was a result of the Company's
focus on increasing its customer base, which included the opening of its 38th
Banking Center and the introduction of a money market savings account in the
first quarter of 2002, as well as a general deposit inflow being experienced by
most banks. More specifically, the Company's savings account balances increased
$172.7 million from the end of 2001 to the end of the second quarter of 2002.
Borrowed funds decreased $152.2 million to $406.9 million at June 30, 2002 from
$559.0 million at December 31, 2001. This decrease was a result of the maturity
of $140.0 million of FHLB advances and reverse repurchase agreements during the
first quarter of 2002 that were utilized to purchase U.S. Treasury securities
during the fourth quarter of 2001.
Equity Activities
Stockholders' equity increased to $272.3 million at June 30, 2002 compared to
$260.6 million at December 31, 2001. This increase was primarily attributable to
net income during the first half of 2002 of $14.5 million partially offset by
common stock dividends declared during the same period of $0.21 per share, which
reduced stockholders' equity by $5.3 million. Additionally, stockholders' equity
was positively impacted $1.9 million from the routine exercise of stock options
and vesting of restricted stock and ESOP shares whose positive effect was
increased by the appreciation in the Company's stock price. Finally,
stockholders' equity increased as a result of a decrease in interest rates
during the first half of the year, which caused a $0.5 million (net of tax)
increase in the unrealized gain on investment securities available for sale
included in accumulated other comprehensive income.
17
Results of Operations for the Three Months Ended June 30, 2002
- --------------------------------------------------------------
Net Income
Net income for the quarter ended June 30, 2002 increased 40% to $7.0 million, or
$0.28 per share from $5.0 million, or $0.20 per share for the second quarter of
2001. As discussed in note 3 of the condensed consolidated financial statements
filed herewith in Part I, Item 1, on January 1, 2002, the Company adopted SFAS
No. 142, which no longer requires goodwill to be amortized. Adjusting prior
period results to exclude the effects of goodwill amortization, similar to the
2002 second quarter, net income for the current quarter increased $0.8 million
or 13% from the second quarter of 2001. As discussed in note 5 of the condensed
consolidated financial statements filed herewith in Part I, Item 1, the Company
recorded a $1.8 million deferred tax charge related to the recapture of excess
bad debt reserves for New York State tax purposes, triggered by the Company's
decision to combine its three banking subsidiaries. Additionally, during the
second quarter the Company realized a $0.9 million ($0.6 million net of tax)
gain from the curtailment of its defined benefit pension plan, $0.4 ($0.3
million net of tax) additional insurance income from the receipt of 2001
contingent profit sharing, which was greater than originally projected,
partially offset by severance costs of $0.4 million ($0.3 million net of tax)
related to the consolidation of its three banking subsidiaries. Net income for
the second quarter of 2002 represented an annualized return on average
stockholders' equity of 10.38% as compared to 9.87% for the same period of 2001,
adjusted for goodwill amortization.
Net Interest Income
Net interest income rose 19% to $22.7 million for the quarter ended June 30,
2002 from $19.1 million for the same period in 2001. Additionally, the Company's
net interest margin increased to 3.47% for the second quarter of 2002 from 3.17%
for the second quarter of 2001. The increase in net interest income and margin
resulted primarily from a 34 basis point increase in net interest rate spread,
as the Company's interest-bearing liabilities repriced faster than its
interest-earning assets during the declining rate environment in 2001 and the
first half of 2002. Additionally, the Company's net interest rate spread
benefited from the Company's strategic initiative to shift its loan portfolio
mix from lower yielding residential mortgages to higher yielding commercial
loans. The increase in net interest income and margin can also be attributed to
the increase in average net earning assets from $138.7 million for the second
quarter of 2001 to $177.3 million for the same period in 2002. This increase in
average net earning assets is primarily due to a $24.3 million increase in
average noninterest-bearing demand deposits for the same period as a result of
increased commercial business and the introduction of a "totally free" checking
account product near the end of 2001.
Interest income decreased $2.1 million for the quarter ended June 30, 2002
compared to the same period in 2001. This decrease reflects a 92 basis point
decrease in the overall yield on interest-earning assets from 7.43% for the
three months ended June 30, 2001 to 6.51% for the same period in 2002. This
decrease primarily resulted from the lower interest rate environment, which
caused interest-earning assets to reprice at lower rates partially offset by the
shift in loan portfolio mix to higher yielding commercial loans. Additionally,
the yield on interest-earning assets was negatively impacted by the Company's
strategic decision to invest funds received from deposits, loan payments and
maturity/payments of investment securities in lower yielding short-term
investments with minimal extension risk or potential market value fluctuations
in case of rising interest rates. This decreased rate earned on interest-earning
assets was partially offset by an increase in average interest-earning asset
balances to $2.6 billion for the second quarter of 2002 from $2.4 billion for
the same period in 2001.
Interest expense decreased $5.7 million from the second quarter of 2001 to the
second quarter of 2002, primarily due to the 126 basis point decrease in the
rate paid on interest-bearing liabilities from 4.52% to 3.26% for the same
period due to the lower interest rate environment. This decreased rate paid on
interest-bearing liabilities was partially offset by an increase in average
interest-bearing liabilities to $2.4 billion for the second quarter of 2002 from
$2.3 billion for the same period in 2001.
Provision for Credit Losses
Net charge-offs for the second quarter of 2002 amounted to $1.0 million compared
to $0.4 million for the same period in 2001. This increase was primarily a
result of an increase in the amount of commercial loans outstanding as a
percentage of total loans and the downturn in the economy. As a percentage of
average loans outstanding, annualized net charge-offs increased to 0.21% for the
three months ended June 30, 2002 from 0.09% for the same period in 2001. Given
the increase in non-accrual loans compared to those outstanding at June 30, 2001
and the higher concentration of commercial loans, the Company increased the
provision for credit losses to $1.7 million for the quarter ending June 30,
2002, from $0.9 million for the same quarter in 2001. The provision is based on
management's quarterly assessment of the adequacy of the allowance for credit
losses with consideration given to such interrelated factors as the composition
and inherent risk within the loan portfolio, the level of non-accruing loans and
charge-offs, and both current and historic economic conditions. The Company
establishes provisions for credit losses, which are charged to operations, in
order to maintain the allowance for credit losses at a level sufficient to
absorb credit losses inherent in the existing loan portfolio.
18
Noninterest Income
For the second quarter of 2002 the Company had $12.6 million in noninterest
income, an increase of 23% over the $10.3 million for the same period in 2001.
This increase primarily resulted from internal growth, which included the
addition of new banking services in the fourth quarter of 2001, as well as the
Company's continued emphasis on the sales of mutual fund, annuity and insurance
products. Additionally, during the second quarter of 2002, the Company's
insurance agency realized an additional $0.4 million from the receipt of 2001
contingent profit sharing, as actual loss experience was better than originally
projected. These increases were partially offset by the Company's decision to
eliminate its covered call option program near the end of the first quarter of
2002. Noninterest income continues to be a strong stable source of earnings for
the Company as it represented 36% of net revenue for the quarter ended June 30,
2002.
Noninterest Expense
Noninterest expense for the three months ended June 30, 2002 was $20.4 million
as compared to $20.5 million for the comparable period of 2001. Adjusting the
second quarter of 2001 amounts to exclude goodwill amortization, noninterest
expense for the second quarter of 2002 increased $1.0 million primarily due to a
$0.9 million increase in salaries and benefits. This increase in salaries and
benefits was a result of internal growth and $0.4 million of severance costs
incurred in the second quarter of 2002, partially offset by a $0.9 million
pension plan curtailment gain. Technology and communications expense increased
$0.6 million when comparing the second quarter of 2002 to the same period of
2001 as a result of the opening of two branches since the second quarter of 2001
and an upgrading of systems. The Company's efficiency ratio improved to 57.9%
for the quarter ended June 30, 2002 from 65.4% for the same quarter in 2001,
adjusted for the new accounting for goodwill. Excluding the severance costs,
pension plan curtailment gain and contingent profit sharing discussed above,
this ratio was 59.8% as the Company continued to focus on efficiency through its
Adding Value Always ("AVA") initiative.
Income Taxes
The effective tax rate increased to 46.8% for the second quarter of 2002
compared to 32.4% for the second quarter of 2001, adjusted for goodwill
amortization. Excluding the New York State bad debt tax recapture charge, the
effective tax rate for the second quarter of 2002 increased to 33.3% as First
Niagara was no longer able to take advantage of the special provisions in the
New York State tax law that allowed it to deduct bad debt expenses in excess of
those actually incurred based on a specified formula.
Results of Operations for the Six Months Ended June 30, 2002
- ------------------------------------------------------------
Net Income
Net income for the six month period ended June 30, 2002 increased 49% to $14.5
million, or $0.57 per diluted share from $9.7 million, or $0.39 per diluted
share for the same period of 2001. Adjusting prior period results to exclude the
effects of goodwill amortization similar to the 2002 results, net income for the
first half of 2002 increased $2.4 million or 20% from the first half of 2001.
Net income for the first six months of 2002 represented an annualized return on
average stockholders' equity of 10.86% as compared to 9.69% for the same period
of 2001, adjusted for goodwill amortization.
Net Interest Income
Net interest income rose 19% to $44.9 million for the six month period ended
June 30, 2002 from $37.8 million for the same period in 2001. Additionally, the
Company's net interest margin increased to 3.49% for the first six months of
2002 from 3.15% for the first six months of 2001. The increase in net interest
income and margin resulted primarily from a 39 basis point increase in net
interest rate spread, as the Company's interest-bearing liabilities repriced
faster than its interest-earning assets during the declining rate environment in
2001 and the first half of 2002. Additionally, the Company's net interest rate
spread benefited from the Company's strategic initiative to shift its loan
portfolio mix from lower yielding residential mortgages to higher yielding
commercial loans. The increase in net interest income and margin can also be
attributed to the increase in average net earning assets from $136.2 million for
the first half of 2001 to $168.9 million for the same period in 2002. This
increase in average net earning assets is primarily due to a $23.8 million
increase in average noninterest-bearing demand deposits for the same period as a
result of increased commercial business and the introduction of a "totally free"
checking account product near the end of 2001.
19
Interest income decreased $4.6 million for the six month period ended June 30,
2002 compared to the same period in 2001. This decrease reflects an 87 basis
point decrease in the overall yield on interest-earning assets from 7.52% for
the six months ended June 30, 2001 to 6.65% for the same period in 2002. This
decrease primarily resulted from the lower interest rate environment, which
caused interest-earning assets to reprice at lower rates partially offset by the
shift in loan portfolio mix to higher yielding commercial loans. Additionally,
the yield on interest-earning assets was negatively impacted by the Company's
strategic decision to invest funds received from deposits, loan payments and
maturity/payments of investment securities in lower yielding short-term
investments with minimal extension risk or potential market value fluctuations
in case of rising interest rates. This decreased rate earned on interest-earning
assets was partially offset by an increase in average interest-earning asset
balances to $2.6 billion for the first two quarters of 2002 from $2.4 billion
for the same period in 2001.
Interest expense decreased $11.7 million from the first half of 2001 to the
first half of 2002, primarily due to the 126 basis point decrease in the rate
paid on interest bearing liabilities from 4.64% to 3.38% for the same period due
to the lower interest rate environment. This decreased rate paid on
interest-bearing liabilities was partially offset by an increase in average
interest-bearing liabilities to $2.4 billion for the six month period ended June
30, 2002 from $2.3 billion for the same period in 2001.
Provision for Credit Losses
Net charge-offs for the first six months of 2002 amounted to $2.3 million
compared to $1.1 million for the same period in 2001. This increase was
primarily a result of an increase in the amount of commercial loans outstanding
as a percentage of total loans and the downturn in the economy. As a percentage
of average loans outstanding, annualized net charge-offs increased to 0.24% for
the six months ended June 30, 2002 from 0.12% for the same period in 2001. Given
the increase in non-accrual loans compared to those outstanding at June 30, 2001
and the higher concentration of commercial loans, the Company increased the
provision for credit losses to $3.3 million for the first two quarters of 2002,
from $1.9 million for the same two quarters in 2001.
Noninterest Income
For the first half of 2002 the Company had $23.8 million in noninterest income,
an increase of 14% over the $20.8 million for the same period in 2001. This
increase primarily resulted from internal growth, which included the addition of
new banking services in the fourth quarter of 2001, as well as the Company's
continued emphasis on the sale of mutual fund, annuity and insurance products.
Additionally, during the second quarter of 2002, the Company's insurance agency
realized an additional $0.4 million from the receipt of 2001 contingent profit
sharing, as actual loss experience was better than originally projected. These
increases were partially offset by the Company's decision to eliminate its
covered call option program near the end of the first quarter of 2002 and to
hold more direct finance leases it originates versus selling them service
released to third parties. Noninterest income continues to be a strong stable
source of earnings for the Company, as it represented 35% of net revenue for the
first two quarters of 2002.
Noninterest Expense
Noninterest expense for the six months ended June 30, 2002 was $40.8 million as
compared to $41.2 million for the comparable period of 2001. Adjusting 2001
amounts to exclude goodwill amortization, noninterest expense for the first half
of 2002 increased $2.0 million primarily due to a $1.6 million increase in
salaries and benefits. This increase in salaries and benefits was a result of
internal growth and $0.4 million of severance costs incurred in the second
quarter of 2002, partially offset by a $0.9 million pension plan curtailment
gain realized in the second quarter of 2002. Technology and communications
expense increased $0.6 million when comparing the first half of 2002 to the same
period of 2001 as a result of the opening of two branches since the second
quarter of 2001. The Company's efficiency ratio improved to 59.5% for the six
months ended June 30, 2002 from 66.3% for the same period in 2001, adjusted for
the new accounting for goodwill. Excluding the severance costs, pension plan
curtailment gain and contingent profit sharing in the second quarter, this ratio
was 60.5% as the Company continued to focus on efficiency through its Adding
Value Always ("AVA") initiative.
Income Taxes
The effective tax rate increased to 41.3% for the first two quarters of 2002
compared to 32.6% for the same period in 2001, adjusted for goodwill
amortization. Excluding the New York State bad debt tax recapture charge, the
effective tax rate for the six months ended June 30, 2002 increased to 34.0% as
First Niagara was no longer able to take advantage of the special provisions in
the New York State tax law that allowed it to deduct bad debt expenses in excess
of those actually incurred based on a specified formula.
20
Liquidity and Capital Resources
- -------------------------------
In addition to the Company's primary funding sources of income from operations,
deposits and borrowings, funding is provided from the principal and interest
payments on loans and investment securities, proceeds from the maturities and
sale of investment securities, as well as proceeds from the sale of fixed rate
mortgage loans in the secondary market. While maturities and scheduled
amortization of loans and securities are predictable sources of funds, deposit
outflows and mortgage prepayments are greatly influenced by general interest
rates, economic conditions and competition.
The primary investing activities of the Company are the origination of
residential one- to four-family mortgages, commercial loans, consumer loans, as
well as the purchase of mortgage-backed and other debt securities. During the
first two quarters of 2002, loan originations totaled $347.9 million compared to
$230.4 million for the first two quarters of 2001. However, loans only increased
$57.7 million as these loan originations were partially offset by payments
received on loans and the normal sale of fixed-rate residential mortgages.
Purchases of investment securities totaled $239.7 million during the first half
of 2002 as funds obtained from the sale, maturity and payments received on
securities available for sale were reinvested in shorter-term investments.
Deposit growth, the sales, maturity and principal payments on loans and
investment securities were used to fund the investing activities described
above. During the first two quarters of 2002 cash flows provided by the sale,
principal payments and maturity of securities available for sale amounted to
$377.1 million compared to $115.1 million for the same period in 2001. This
increase from the prior year was primarily due to the maturity of $155.0 million
of U.S. Treasury securities, the proceeds from which were used to repay
short-term borrowings, as well as the Company's strategic decision to shorten
the duration of its investment portfolio, and the prepayments received on
mortgage-backed securities due to the lower interest rate environment. Deposit
growth, primarily the Company's savings accounts, provided $157.4 million of
funding for the six months ended June 30, 2002. In addition to the above funding
sources, the Company has lines of credit with the Federal Home Loan Bank,
Federal Reserve Bank and the MHC that provide funding sources, for lending,
liquidity and asset/liability management.
In the ordinary course of business the Company extends commitments to originate
one- to four-family mortgages, commercial loans and other consumer loans. As of
June 30, 2002, the Company had outstanding commitments to originate loans of
approximately $69.7 million, which generally have an expiration period of less
than one year. These commitments do not necessarily represent future cash
requirements since certain of these instruments may expire without being funded.
Commitments to sell residential mortgages amounted to $5.5 million at June 30,
2002.
The Company extends credit to consumer and commercial customers, up to a
specified amount, through lines of credit. The borrower is able to draw on these
lines as needed, thus the funding is generally unpredictable. Unused consumer
and commercial lines of credit amounted to $151.6 million at June 30, 2002 and
generally have an expiration period of less than one year. The Company also
issues standby letters of credit to third parties, which guarantees payments on
behalf of commercial customers in the event that the customer fails to perform
under the terms of the contract between the customer and the third-party.
Standby letters of credit amounted to $6.4 million at June 30, 2002 and
generally have an expiration period greater than one year. Since the majority of
unused lines of credit and outstanding standby letters of credit expire without
being funded, the Company expects that its obligation to fund the above
commitment amounts is substantially less than the amounts reported. It is
anticipated that there will be sufficient funds available to meet the current
loan commitments and other obligations through the sources described above.
Cash, interest-bearing demand accounts at correspondent banks and brokers,
federal funds sold and other short-term investments are the Company's most
liquid assets. The level of these assets are monitored daily and are dependent
on operating, financing, lending and investing activities during any given
period. Excess short-term liquidity is usually invested in overnight federal
funds sold or other short-term investments with maturities of less than 60 days.
In the event that funds beyond those generated internally are required as a
result of higher than expected loan commitment fundings, loan originations,
deposit outflows or the amount of debt being called, additional sources of funds
are available through the use of reverse repurchase agreements, the sale of
loans or investments or the Company's various lines of credit. As of June 30,
2002, the total of cash, interest-bearing demand accounts, federal funds sold
and other short-term investments was $169.5 million.
21
At June 30, 2002, the Company and each of its banking subsidiaries exceeded all
regulatory capital requirements. The current requirements and the actual levels
for the Company are detailed in the following table.
As of June 30, 2002
-------------------------------------------------------------------
Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
Total Capital (to risk-weighted assets) ..... $207,070 11.25% $147,237 8.00% $184,046 10.00%
Tier 1 Capital (to risk-weighted assets) .... 187,376 10.18 73,618 4.00 110,427 6.00
Leverage Capital (to average assets) ........ 187,376 6.73 $ 83,573 3.00 139,289 5.00
Critical Accounting Policies
Pursuant to SEC guidance, management of the Company is encouraged to evaluate
and disclose those accounting policies that are judged to be critical - those
most important to the portrayal of the Company's financial condition and
results, and that require management's most difficult, subjective and complex
judgements. Management considers the accounting policy relating to the allowance
for credit losses to be a critical accounting policy given the inherent
uncertainty in evaluating the levels of the allowance required to cover credit
losses in the portfolio and the material effect that such judgement can have on
the results of operations. A more detailed description of the Company's
methodology for calculating the allowance for credit losses and assumptions made
is included within the "Lending Activities" section filed in Part I, Item 1,
"Business" of the Company's 2001 10-K dated March 19, 2002.
22
Item 3. Quantitative and Qualitative Disclosure about Market Risk
- --------------------------------------------------------------------------------
Net Interest Income Analysis
Market risk is the risk of loss from adverse changes in market prices and/or
interest rates of the Company's financial instruments. The primary market risk
the Company is exposed to is interest rate risk. Interest rate risk occurs when
assets and liabilities reprice at different times as interest rates change. The
Company monitors this interest rate sensitivity through the use of a net
interest income model, which generates estimates of changes in net income over a
range of interest rate scenarios.
The Asset-Liability Committee, which includes members of senior management,
monitors the Company's interest rate sensitivity. When deemed prudent,
management has taken actions, and intends to do so in the future, to mitigate
exposure to interest rate risk through the use of on- or off-balance sheet
financial instruments. Possible actions include, but are not limited to, changes
in the pricing of loan and deposit products, modifying the composition of
interest-earning assets and interest-bearing liabilities, and the use of
interest rate swap agreements.
The accompanying table as of June 30, 2002 sets forth the estimated impact on
the Company's net interest income resulting from changes in the interest rates
during the next twelve months. These estimates require making certain
assumptions including loan and mortgage-related investment prepayment speeds,
reinvestment rates, and deposit maturities and decay rates. These assumptions
are inherently uncertain and, as a result, the Company cannot precisely predict
the impact of changes in interest rates on net interest income. Actual results
may differ significantly due to timing, magnitude and frequency of interest rate
changes and changes in market condition.
Calculated increase (decrease) at
June 30, 2002
--------------------------------------------------
Changes in
interest rates Net interest income % Change
- ----------------- ------------------- ----------------
(Dollars in thousands)
+200 basis points $ 255 0.27%
+100 basis points 243 0.26
- -100 basis points (324) (0.34)
- -200 basis points $ (1,260) (1.34)%
23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
- --------------------------------------------------------------------------------
There are no material pending legal proceedings to which the Company or
its subsidiaries are a party other than ordinary routine litigation
incidental to their respective businesses.
Item 2. Changes in Securities and Use of Proceeds
- --------------------------------------------------------------------------------
Not applicable.
Item 3. Defaults upon Senior Securities
- --------------------------------------------------------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
- --------------------------------------------------------------------------------
The 2002 Annual Meeting of Stockholders of First Niagara Financial
Group, Inc. was held on May 7, 2002. The Annual Meeting was conducted
for purpose of considering and acting upon the election of four
directors for a three year term, the approval of the 2002 Long-Term
Incentive Stock Benefit Plan and the ratification of the appointment of
KPMG LLP as independent auditors for the Company for the year ending
December 31, 2002. The following table reflects the tabulation of the
votes with respect to each matter voted upon at the 2002 Annual
Meeting.
Number of Votes (a)
----------------------------------------------------------
Matter Considered For Against Abstain
- -------------------------------------------------------- ------------------- ---------------- ---------------
(1) Election of Directors (b)
John J. Bisgrove, Jr. 24,626,781 -- 59,192
James W. Currie 24,630,013 -- 55,960
B. Thomas Mancuso 24,621,373 -- 64,600
Robert G. Weber 24,608,112 -- 77,861
(2) Approval of the 2002 Long-Term Incentive Stock
Benefit Plan (c) 23,929,426 680,969 75,575
(3) Ratification of KPMG LLP as independent
auditors for the Company for the year ending
December 31, 2002 24,574,964 71,113 39,896
(a) For matters (1), (2) and (3) there were no broker non-votes.
(b) In addition, the following directors' terms of office continued after the
Annual Meeting: Gary B. Fitch, Daniel W. Judge, James Miklinski, Gordon P.
Assad, Harvey D. Kaufman and William E. Swan.
(c) For New York banking regulation purposes the tabulation was as follows for
proposal 2: For - 8,059,998; Against - 698,786; and Abstain - 77,536.
Item 5. Other Information
- --------------------------------------------------------------------------------
Not applicable.
24
Item 6. Exhibits and Reports on Form 8-K
- --------------------------------------------------------------------------------
(a) The following exhibits are filed herewith:
Exhibits
--------
99.1 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.2 Summary of Quarterly Financial Data
(b) Reports on Form 8-K
On July 2, 2002 the Company filed a Current Report on Form 8-K which
disclosed that the Company took a $1.8 million tax charge during the
second quarter of 2002 and reconfirming earnings guidance of $1.21
per diluted share for 2002. Such Current Report, as an Item 7
exhibit included the Company's press release dated July 2, 2002.
On July 22, 2002 the Company filed a Current Report on Form 8-K
which disclosed that First Niagara Financial Group, MHC intends to
convert from mutual to stock form and the Company's intention to
acquire Finger Lakes Bancorp, Inc. and its wholly owned subsidiary,
Savings Bank of the Finger Lakes. Such Current Report, as an Item 7
exhibit included the Company's press release and conference call
presentation dated July 22, 2002.
On July 26, 2002 the Company filed a Current Report on Form 8-K
which included, as an Item 7 exhibit, the Agreement and Plan of
Reorganization by and between First Niagara Financial Group, MHC,
First Niagara Financial Group, Inc., New First Niagara Financial
Group, Inc., First Niagara Bank and Finger Lakes Bancorp, Inc. and
Savings Bank of the Finger Lakes, FSB dated July 21, 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST NIAGARA FINANCIAL GROUP, INC.
Date: August 12, 2002 By: /s/ William E. Swan
---------------------------------------------
William E. Swan
Chairman, President and Chief
Executive Officer
Date: August 12, 2002 By: /s/ Paul J. Kolkmeyer
---------------------------------------------
Paul J. Kolkmeyer
Executive Vice President, Chief Operating
Officer and Chief Financial Officer
25