UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X} ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED] For the Fiscal Year Ended December 31, 2002 OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transaction period from ___________________ to ___________________
Commission File Number: 0-23975
FIRST NIAGARA FINANCIAL GROUP, INC.
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(Exact Name of Registrant as specified in its Charter)
Delaware 42-1556195
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(State or Other Jurisdiction of Incorporation or Organization (I.R.S. Employer Identification Number)
6950 South Transit Road, P.O. Box 514, Lockport, NY 14095-0514
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(Address of Principal Executive Officer) (Zip Code)
(716) 625-7500
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(Registrant's Telephone Number Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
None
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Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file reports) and (2) has been subject to such requirements for the
past 90 days.
Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) Yes [X] No [_]
As of March 14, 2003, there were outstanding, 70,735,114 shares of the
Registrant's Common Stock.
The aggregate market value of the 67,583,850 shares of voting stock held by
non-affiliates of the Registrant was $784,648,499, as computed by reference to
the last sales price on March 14, 2003, as reported by the NASDAQ National
Market. Solely for purposes of this calculation, all persons who are directors
and executive officers of the Registrant and all persons who are beneficial
owners of more than 10% of its outstanding stock have been deemed to be
affiliates.
34
DOCUMENTS INCORPORATED
BY REFERENCE
The following documents, in whole or in part, are specifically incorporated by
reference in the indicated Part of the Company's Proxy Statement:
Document Part
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Proxy Statement for the 2003 Annual Part III, Item 10
Meeting of Stockholders "Directors and Executive Officers of the Registrant"
Part III, Item 11
"Executive Compensation"
Part III, Item 12
"Security Ownership of Certain Beneficial Owners and Management"
Part III, Item 13
"Certain Relationships and Related Transactions"
2
TABLE OF CONTENTS
ITEM PAGE
NUMBER NUMBER
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PART I
1 Business.............................................................................................. 4
2 Properties............................................................................................ 22
3 Legal Proceedings..................................................................................... 22
4 Submission of Matters to a Vote of Security Holders................................................... 23
PART II
5 Market for Registrant's Common Equity and Related Stockholder Matters................................. 23
6 Selected Financial Data............................................................................... 24
7 Management's Discussion and Analysis of Financial Condition and Results of Operations................. 27
7A Quantitative and Qualitative Disclosure about Market Risk............................................. 45
8 Financial Statements and Supplementary Data........................................................... 48
9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................. 91
PART III
10 Directors and Executive Officers of the Registrant.................................................... 91
11 Executive Compensation................................................................................ 91
12 Security Ownership of Certain Beneficial Owners and Management........................................ 91
13 Certain Relationships and Related Transactions........................................................ 91
14 Controls and Procedures............................................................................... 91
PART IV
15 Exhibits, Financial Statement Schedules and Reports on Form 8-K....................................... 92
Signatures............................................................................................ 93
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002..................................................................................... 95
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002..................................................................................... 96
3
PART I
ITEM 1. BUSINESS
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GENERAL
First Niagara Financial Group, Inc.
First Niagara Financial Group, Inc. ("FNFG") is a Delaware corporation, which
holds all of the capital stock of First Niagara Bank ("First Niagara"), a
federally chartered savings bank. FNFG and First Niagara are hereinafter
referred to collectively as "the Company." At December 31, 2002, FNFG had
consolidated assets of $2.9 billion, deposits of $2.1 billion and stockholders'
equity of $283.7 million. First Niagara originally was organized in 1870 as a
New York State chartered mutual savings bank. FNFG was organized by First
Niagara in connection with its conversion from a New York State chartered mutual
savings bank to a New York State chartered stock savings bank and the
reorganization to a two-tiered mutual holding company, which was completed in
April 1998. As part of the reorganization, FNFG sold shares of common stock to
eligible depositors of First Niagara and issued approximately 53% of its shares
of common stock to First Niagara Financial Group, MHC ("the MHC"), a mutual
holding company. As a result of share repurchases subsequent to the
reorganization, the MHC's ownership interest grew to 61% of the issued and
outstanding shares of common stock of FNFG.
The Company utilized the proceeds raised in its initial offering to make three
bank and five non-bank acquisitions between 1999 and 2001. In March 2000, FNFG
acquired Albion Banc Corp, Inc., the holding company of Albion Federal Savings
and Loan Association ("Albion"). Subsequent to the acquisition, Albion's two
branch locations were merged into First Niagara's banking center network. In
July 2000, FNFG acquired CNY Financial Corporation ("CNY"), the holding company
of Cortland Savings Bank ("Cortland"). In November 2000, FNFG acquired all of
the common stock of Iroquois Bancorp, Inc. ("Iroquois"), the holding company of
Cayuga Bank ("Cayuga") and The Homestead Savings, FA. Following completion of
this transaction, The Homestead Savings was merged into Cayuga. Initially,
Cortland and Cayuga were operated as wholly owned subsidiaries of FNFG.
In June 2002, FNFG announced its decision to convert to a federal charter
subject to Office of Thrift Supervision ("OTS") regulation, and to merge
Cortland and Cayuga into First Niagara. The mergers of Cortland and Cayuga into
First Niagara, as well as the conversion to federal charters for First Niagara
and the MHC were approved by the OTS and were effective November 8, 2002. The
conversion of FNFG to a federal charter was approved by stockholders' of the
Company on January 9, 2003 and was effective January 17, 2003. The merger of the
three banks will allow the Company to further promote the First Niagara brand
and gain operational efficiencies, while the conversion to a federal charter
provides the Company with greater corporate flexibility.
On July 21, 2002, the Boards of Directors of the MHC, FNFG and First Niagara
adopted a plan of conversion and reorganization to convert the MHC from mutual
to stock form ("the Conversion"). In connection with the Conversion, the 61%
ownership interest of the MHC in FNFG was sold to depositors of First Niagara
and the public ("the Offering"). Completion of the Conversion and Offering was
effective on January 17, 2003 and resulted in the issuance of 67.4 million
shares of common stock. A total of 41.0 million shares were sold in
subscription, community and syndicated offerings, at $10.00 per share, and an
additional 26.4 million shares were issued to the former public stockholders of
FNFG based upon an exchange ratio of 2.58681 new shares for each share of FNFG
held as of the close of business on January 17, 2003. Share and per share data
have not been restated in this annual report on Form 10-K to give retroactive
recognition to the exchange ratio applied. Following the completion of the
Conversion and Offering, FNFG was succeeded by a new, fully public, Delaware
corporation with the same name and the MHC ceased to exist.
On January 17, 2003, in conjunction with the Conversion and Offering, the
Company acquired Finger Lakes Bancorp, Inc. ("FLBC") the holding company of
Savings Bank of the Finger Lakes ("SBFL"), headquartered in Geneva, New York.
FLBC operated seven branch locations and had assets of $379.0 million and
deposits of $259.8 million at December 31, 2002. Subsequent to the acquisition,
SBFL was merged into First Niagara and its branch located in Cayuga County was
merged into an existing First Niagara banking center. The SBFL branches bridged
the Company's western and central New York markets and provided an initial
branch presence in two additional central New York counties (Ontario and
Seneca).
The business of FNFG consists of the management of First Niagara and its
Financial Services Group. First Niagara's business is primarily accepting
deposits from customers through its banking centers and investing those
deposits, together with funds generated from operations and borrowings, in one-
to four-family residential, multi-family residential and commercial real estate
loans, commercial business loans and leases, consumer loans, and investment
securities. The Company's Financial Services Group focuses
4
on the delivery of risk and wealth management products and services. The former
consists primarily of consumer and commercial insurance products and services
and the latter primarily consists of investment products and advisory services,
and trust services. The Company emphasizes personal service, attention and
customer convenience in serving the financial needs of the individuals, families
and businesses residing in its market areas.
The Company maintains a website at www.fnfg.com and makes available, free of
charge, through this website its annual reports on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K, and all amendments to those reports
as soon as reasonably practicable after such material is electronically filed
with or furnished to the Securities and Exchange Commission ("SEC"). These forms
can be accessed within the Investor Relations portion of the Company's website
by clicking on "SEC Filings."
First Niagara Bank
First Niagara was organized in 1870 as a New York State chartered mutual savings
bank and operates as a wholly owned subsidiary of FNFG. Through demutualization,
acquisitions, de novo expansion and the introduction of new products and
services, First Niagara has become a full-service, multi-market
community-oriented savings bank that provides financial services to individuals,
families and businesses through 38 banking centers, a loan production office and
75 ATM's located in western and central New York. Giving effect to the merger of
SBFL into First Niagara and the opening of an additional banking center in
January 2003, First Niagara now conducts its business through 45 banking centers
and 84 ATM's. As of December 31, 2002, First Niagara had $2.9 billion of assets,
deposits of $2.1 billion, $270.9 million of stockholder's equity and employed
over one thousand people.
First Niagara Bank Subsidiaries
First Niagara Securities, Inc. (formerly First Niagara Financial Services, Inc.)
First Niagara Securities, Inc. ("FNS"), a wholly owned subsidiary of First
Niagara incorporated in 1984, is engaged in the sale of annuities, mutual funds
and other investment products, as well as insurance, through First Niagara's
banking center network. FNS acts as an agent for third-party companies to sell
and service their investment and insurance products.
First Niagara Funding, Inc. First Niagara Funding, Inc. is a wholly owned real
estate investment trust ("REIT") of First Niagara incorporated in 1997 that
primarily owns commercial mortgage loans. The REIT supplements its holdings of
commercial real estate loans with fixed rate residential mortgages, home equity
loans and commercial business loans.
First Niagara Leasing, Inc. First Niagara Leasing, Inc. ("FNL") was acquired by
First Niagara on January 1, 2000 and provides direct financing in the commercial
small ticket lease market to the equipment industry.
First Niagara Portfolio Management, Inc. (formerly First Niagara Securities,
Inc.) First Niagara Portfolio Management, Inc., a wholly-owned subsidiary of
First Niagara incorporated in 1984, is a New York State Article 9A company,
which is primarily involved in the investment in U.S. government agency and
Treasury obligations.
First Niagara Investment Advisors, Inc. (formerly Niagara Investment Advisors,
Inc.) First Niagara Investment Advisors, Inc. ("FNIA") is a registered
investment advisory firm that was acquired by First Niagara on May 31, 2000.
FNIA specializes in equity, fixed-income and balanced portfolio accounts for
individuals, pension plans, corporations, unions and charitable institutions.
NOVA Healthcare Administrators, Inc. NOVA Healthcare Administrators, Inc.
("NOVA") was acquired by First Niagara on January 1, 1999 in conjunction with
its acquisition of Warren-Hoffman & Associates, Inc. NOVA provides third-party
administration of employee benefit plans. Effective February 19, 2003, First
Niagara sold NOVA to an independent third party, as it was not considered one of
the Company's strategic core businesses of banking, investments or insurance.
First Niagara Risk Management, Inc. (formerly Warren-Hoffman & Associates, Inc.)
First Niagara Risk Management, Inc. ("FNRM") was acquired on January 1, 1999 by
First Niagara and is a full service insurance agency engaged in the sale of
insurance products including business and personal insurance, surety bonds, risk
management, life, disability and long-term care coverage. FNRM was founded in
1968 and serves commercial and personal clients throughout the Company's market
areas. In July 2001, FNRM began offering consulting and risk management services
to commercial customers in the areas of alternative risk and self-insurance. On
January 1, 2001, FNRM acquired Allied Claim Services, Inc. ("Allied"), an
independent insurance adjusting firm and third party administrator. Allied
represents insurance companies and self-insured employers in the investigation,
settlement and administration of claims brought under an insurance contract or
as a self-insured. It operates primarily in the coverage areas of workers'
compensation, automobile, general liability and property.
5
During 2001, FNFG organized all of its financial services activities, namely
insurance, fiduciary and investment products and services, under one Financial
Services Group directed by one dedicated executive. The Financial Services Group
includes the operations of the Company's FNRM, FNIA and FNS subsidiaries and a
trust department of First Niagara. This reorganization was done in order to
maximize the Company's cross-selling capabilities and management of its
financial services subsidiaries.
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), that involve substantial risks and uncertainties.
These forward-looking statements can be identified by the use of such words as
estimate, project, believe, intend, anticipate, plan, seek, expect and similar
expressions. These forward-looking statements include: statements of the
Company's goals, intentions and expectations; statements regarding the Company's
business plans, prospects, growth and operating strategies; statements regarding
the asset quality of the Company's loan and investment portfolios; and estimates
of the Company's risks and future costs and benefits.
These forward-looking statements are subject to significant risks, assumptions
and uncertainties, including, among other things, the following important
factors that could affect the actual outcome of future events: general economic
conditions, either nationally or in the Company's market areas, that are worse
than expected; significantly increased competition among depository and other
financial institutions; inflation and changes in the interest rate environment
that reduce the Company's margins or reduce the fair value of financial
instruments; changes in laws or government regulations affecting financial
institutions, including changes in regulatory fees and capital requirements; the
Company's ability to enter new markets successfully and capitalize on growth
opportunities; the Company's ability to successfully integrate acquired
entities; changes in consumer spending, borrowing and savings habits; changes in
accounting policies and practices, as may be adopted by the bank regulatory
agencies and the Financial Accounting Standards Board ("FASB"); and changes in
the Company's organization, compensation and benefit plans.
Because of these and other uncertainties, the Company's actual future results
may be materially different from the results indicated by these forward-looking
statements. Discussion of some of these uncertainties and others can be found in
the "Risk Factors" section filed herewith beginning on page 19.
MARKET AREAS AND COMPETITION
The Company's primary lending and deposit gathering areas have historically been
concentrated in the same counties as its banking centers. The Company faces
significant competition in both making loans and attracting deposits. The
upstate New York regions have a high density of financial institutions, some of
which are significantly larger and have greater financial resources than the
Company, and all of which are competitors of the Company to varying degrees. The
Company's competition for loans comes principally from commercial banks, savings
banks, savings and loan associations, mortgage banking companies, credit unions,
insurance companies and other financial services companies. Its most direct
competition for deposits has historically come from savings and loan
associations, savings banks, commercial banks and credit unions. The Company
faces additional competition for deposits from non-depository competitors such
as the mutual fund industry, securities and brokerage firms and insurance
companies. Further competition may arise as a result of, among other things,
Internet banking, the elimination of restrictions on the interstate operations
of financial institutions, and legislation that permits affiliations between
banks, securities firms and insurance companies.
The Company offers a variety of financial services to meet the needs of the
communities it serves and function under a philosophy that includes a commitment
to customer service and the community. Giving effect to the merger of SBFL into
First Niagara and the opening of an additional banking center in January 2003,
the Company presently operates 45 banking centers in eleven counties that span
from Buffalo to Utica, New York where the aggregate deposit market provides
significant scale to grow. The three largest cities in the markets the Company
does business are Buffalo, Rochester and Syracuse. They have a combined total
population of nearly 3.0 million and are the 36th, 40th and 59th largest
Metropolitan Statistical Areas in the nation and the 1st, 2nd and 4th largest in
New York State outside of New York City, respectively. In Niagara, Cayuga and
Cortland Counties, the Company has one of the largest deposit market shares of
27%, 47% and 40%, respectively. Growth opportunity is most evident in the
Buffalo/Erie, Rochester/Monroe, Utica/Oneida and Syracuse/Onondaga markets that
respectively are $19.8 billion, $13.5 billion, $3.1 billion and $5.9 billion
deposit markets.
6
LENDING ACTIVITIES
General. The Company's principal lending activity has been the origination of
one- to four-family residential, adjustable-rate commercial real estate and
multi-family residential loans and short-term or variable rate commercial
business loans and equipment leases to customers located within its primary
market areas. The Company generally sells in the secondary market 20-30 year
monthly fixed rate and 25-30 year bi-weekly fixed rate residential mortgage
loans, and retains for its portfolio both commercial real estate and residential
adjustable-rate loans and fixed-rate monthly 10-15 year residential mortgage
loans, together with fixed-rate bi-weekly mortgage loans with maturities of 20
years or less. In line with its long-term customer relationship strategic focus,
the Company retains the servicing rights on all residential mortgage loans sold,
which results in monthly service fee income. The Company also originates for
retention in its portfolio, home equity and consumer loans with the exception of
education loans, which, as they enter their out of school repayment phase, are
sold to the Student Loan Marketing Association ("Sallie Mae").
One- to Four-Family Real Estate Lending. The Company's primary lending activity
has been the origination of mortgage loans to enable borrowers to finance one-
to four-family, owner-occupied properties located in its primary market areas.
The Company offers conforming and non-conforming, fixed-rate and
adjustable-rate, monthly and bi-weekly, residential mortgage loans with
maturities up to 30 years and maximum loan amounts generally up to $500
thousand. The Company's bi-weekly mortgages, feature an accelerated repayment
structure and a linked deposit account.
The Company currently offers both fixed and adjustable rate conventional and
government guaranteed Federal Housing Administration ("FHA") and Veterans
Administration ("VA") mortgage loans with terms of 10 to 30 years that are fully
amortizing with monthly or bi-weekly loan payments. One- to four-family
residential loans are generally underwritten according to the Federal National
Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corporation
("FHLMC") uniform guidelines. The Company generally originates both fixed-rate
and adjustable-rate loans in amounts up to the maximum conforming loan limits as
established by FNMA and FHLMC secondary market standards. Private mortgage
insurance ("PMI") and mortgage escrow accounts, from which disbursements are
made for real estate taxes, hazard and flood insurance, are required for loans
with loan-to-value ratios in excess of 80%.
The Company generally sells newly originated conventional, conforming 20-30 year
monthly fixed, and 25-30 year bi-weekly, loans in the secondary market to
government sponsored enterprises such as FNMA and FHLMC. The Company intends to
continue to sell into the secondary market its newly originated loans to assist
in asset/liability management. In addition to removing a level of interest rate
risk from the balance sheet, the operation of a secondary marketing function
within the lending area allows the Company the flexibility to continue to make
loans available to customers when deposit flows decline or funds are not
otherwise available for lending purposes.
In an effort to provide financing for low and moderate income buyers, the
Company actively participates in residential mortgage programs and products
sponsored by FNMA, FHLMC, and the State of New York Mortgage Agency ("SONYMA").
The SONYMA mortgage programs provide low and moderate income households with
fixed-rate loans which are generally set below prevailing fixed-rate mortgage
loans and which allow below-market down payments. These loans are sold by the
Company to SONYMA, with the Company retaining the contractual servicing rights.
The Company currently offers several one- to four-family, adjustable-rate
monthly and bi-weekly mortgage loan ("ARM") products secured by residential
properties. The one- to four-family ARMs are offered with terms up to 30 years,
with rates that adjust every one, five or seven years. After origination, the
interest rate on one- to four-family ARMs is reset based upon a contractual
spread or margin above a specified index (i.e. U.S. Treasury Constant Maturity
Index). The appropriate index utilized at each interest rate change date
corresponds to the initial one, five, or seven year adjustment period of the
loan.
ARMs are generally subject to limitations on interest rate increases of up to 2%
per adjustment period and an aggregate adjustment of up to 6% over the life of
the loan. The ARMs require that any payment adjustment resulting from a change
in the interest rate be sufficient to result in full amortization of the loan by
the end of the loan term, and thus, do not permit any of the increased payment
to be added to the principal amount of the loan, commonly referred to as
negative amortization.
7
The retention of ARMs in the Company's portfolio helps to reduce its exposure to
interest rate risk. However, ARMs generally pose credit risks different from the
credit risks inherent in fixed-rate loans primarily because, as interest rates
rise, the underlying debt service payments of the borrowers rise, thereby
increasing the potential for default. In order to minimize this risk, borrowers
of one- to four-family one year adjustable-rate loans are qualified at the rate
which would be in effect after the first interest rate adjustment, if that rate
is higher than the initial rate. The Company believes that these risks, which
have not had a material adverse effect on the Company to date, generally are
less onerous than the interest rate risks associated with holding fixed-rate
loans. Certain of the Company's conforming ARMs can be converted at a later date
to a fixed-rate mortgage loan with interest rates based upon the then-current
market rates plus a predetermined margin or spread that was established at the
loan closing. The Company sells ARMs, which are converted to 25 to 30 year
fixed-rate term loans, to either FNMA or FHLMC.
Home Equity Lending. The Company offers fixed-rate, fixed-term, monthly and
bi-weekly home equity loans, and prime rate, variable rate home equity lines of
credit ("HELOCs") in its market areas. Both fixed-rate and floating rate home
equity products are offered in amounts up to 100% of the appraised value of the
property (including the first mortgage) with a maximum loan amount generally up
to $150 thousand. PMI is required for all fixed rate home equity loans and
HELOCs with combined first and second mortgage loan-to-value ratios in excess of
80%. Monthly fixed-rate home equity loans are offered with repayment terms up to
15 years and HELOCs are offered with terms up to 30 years. The line may be drawn
upon for 10 years, during which time principal and interest is paid on the
outstanding balance. Repayment of the remaining principal and interest is then
amortized over the remaining 20 years. Bi-weekly fixed-rate home equity loans
are offered with repayment terms up to 20 years, however, because the loan
amortizes bi-weekly and two additional half payments are made each year, actual
loan terms are significantly less.
Commercial Real Estate and Multi-family Lending. The Company originates real
estate loans secured predominantly by first liens on apartment houses, office
complexes, and commercial and industrial real estate. The commercial real estate
loans are predominately secured by properties such as office buildings, shopping
centers, retail strip centers, industrial and warehouse properties and to a
lesser extent, by more specialized properties such as nursing homes, churches,
mobile home parks, restaurants, motels/hotels and auto dealerships. The
Company's current policy with regard to such loans is to emphasize geographic
distribution within its market areas, diversification of property types and
minimization of credit risk.
As part of the Company's ongoing strategic initiative to minimize interest rate
risk, commercial and multi-family real estate loans originated for the Company's
portfolio are generally limited to one, three or five year ARM products which
are priced at prevailing market interest rates. The initial interest rates are
subsequently reset after completion of the initial one, three or five year
adjustment period at new market rates that generally range between 200 and 300
basis points over the then, current one, three or five year U.S. Treasury
Constant Maturity Index subject to interest rate floors. The maximum term for
commercial real estate loans is generally not more than 10 years, with a payment
schedule based on not more than a 25-year amortization schedule for multi-family
loans, and 20 years for commercial real estate loans.
The Company also offers commercial real estate and multi-family construction
mortgage loans. Most construction loans are made as "construction/permanent"
loans, which provide for disbursement of loan funds during the construction
period and conversion to a permanent loan upon the completion of construction
and the attainment of either tenant lease-up provisions or prescribed debt
service coverage ratios. The construction phase of the loan is made on a
short-term basis, usually not exceeding 2 years, with floating interest rate
levels generally established at a spread in excess of either the LIBOR or prime
rate. The construction loan application process includes the same criteria which
are required for permanent commercial mortgage loans, as well as a submission to
the Company of completed plans, specifications and cost estimates related to the
proposed construction. These items are used as an additional basis to determine
the appraised value of the subject property. Construction loans involve
additional risks attributable to the fact that loan funds are advanced upon the
security of the project under construction, which is of uncertain value prior to
the completion of construction.
The Company has increased its emphasis on commercial real estate and
multi-family lending desiring to invest in assets bearing higher interest rates,
which are more sensitive to changes in market interest rates but are less
susceptible to prepayment risk. Commercial real estate and multi-family loans,
however, entail significant additional risk as compared with one- to four-family
residential mortgage lending, as they typically involve larger loan balances
concentrated with single borrowers or groups of related borrowers. In addition,
the payment experience on loans secured by income producing properties is
typically dependent on the successful operation of the related real estate
project and thus, may be subject to a greater extent to adverse conditions in
the real estate market or in the general economy. To help mitigate this risk,
the Company has put in place concentration limits based upon loan types and
property types and maximum amounts that may be lent to an individual or group of
borrowers.
8
Consumer Loans. The Company originates a variety of fixed-rate installment and
variable rate lines-of-credit consumer loans, including indirect new and used
automobile loans, mobile home loans, education loans and personal secured and
unsecured loans.
Mobile home loans have shorter terms to maturity than traditional 30-year
residential loans and higher yields than single-family residential mortgage
loans. The Company generally offers mobile home loans in New York and New Jersey
with fixed-rate, fully amortizing loan terms of 10 to 20 years. The Company has
contracted with an independent third party to generate all mobile home loan
applications. However, prior to funding, all mobile home loan originations must
be underwritten and approved by designated Company underwriters. As part of a
negotiated servicing contract, the third party originator will, at the request
of the Company, contact borrowers who become delinquent in their payments and
when necessary, will oversee the repossession and sale of mobile homes on the
Company's behalf. For such services, and as part of the origination and
servicing contract, the Company pays the originator a fee at loan funding, of
which generally 50% is deposited into a noninterest bearing escrow account, and
is under the sole control of the Company to absorb future losses which may be
incurred on the loans.
The Company participates in indirect automobile lending programs with New York
State auto dealerships. These loans are underwritten by the Company's consumer
lending officers in accordance with Company policy. The Company does not engage
in sub-prime lending. The Company also purchases "A" quality lease paper through
a third-party finance company. While the Company retains the credit risk
associated with the auto leases, the residual risk, repossessions and
remarketing remains the contractual responsibility of the financing company.
Indirect auto loans have terms up to 72 months while auto leases have terms up
to 60 months.
The Company originates personal secured and unsecured fixed rate installment
loans and variable rate lines of credit. Terms of the loans range from 6 to 60
months and generally do not exceed $50 thousand. Secured loans are
collateralized by vehicles, savings accounts or certificates of deposit.
Unsecured loans are only approved for more creditworthy customers.
The Company continues to be an active originator of education loans.
Substantially all of the loans are originated under the auspices of the New York
State Higher Education Services Corporation ("NYSHESC") or the American Student
Association ("ASA"). Under the terms of these loans, no repayment is due until
the student graduates, with 98% of the principal guaranteed by NYSHESC or ASA.
The Company's general practice is to sell these education loans to Sallie Mae as
the loans reach repayment status. The Company generally receives a premium of
0.50% to 1.25% on the sale of these loans.
Consumer loans generally entail greater risk than residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured by
assets that tend to depreciate, such as automobiles and mobile homes. In such
cases, repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment for the outstanding loan and the remaining
deficiency often does not warrant further substantial collection efforts against
the borrower. In addition, consumer loan collections are dependent on the
borrower's continued financial stability, which can be adversely affected by job
loss, divorce, illness or personal bankruptcy.
Commercial Business Loans. The Company offers commercial business term loans,
letters of credit, equipment leases and lines-of-credit to small and medium size
companies in its market areas, some of which are secured in part by additional
real estate collateral. Additionally, secured and unsecured commercial loans and
lines-of-credit are made for the purpose of financing equipment acquisition,
inventory, business expansion, working capital and other general business
purposes. The terms of these loans generally range from less than one year to
seven years. The loans are either negotiated on a fixed-rate basis or carry
variable interest rates indexed to the prime rate or LIBOR. Lines of credit
expire after one year and generally carry a variable rate of interest indexed to
the prime rate. The Company has recently increased its strategic focus to
allocate a greater portion of available funds and personnel resources to both
the commercial middle market and small business lending markets. To facilitate
the Company's expansion of these areas, the Company has added commercial
business products such as cash management, merchant services, wire transfer
capabilities, business credit and debit cards, and Internet banking to enhance
customer service.
The Company offers installment direct financing "small ticket" equipment leases,
generally in amounts between $15 thousand to $125 thousand with terms no greater
than 60 months, which are guaranteed by the principals of the lessee and
collateralized by the leased equipment, and generally bear rates in excess of
8%. Given the Company's strategy to shift its loan portfolio mix to higher
yielding commercial loans, this product line continues to be an area of focus.
9
In 2000, the Company began to dedicate more resources to commercial business and
real-estate loans, which are 50% - 85% government guaranteed through the Small
Business Administration ("SBA"). Terms of these loans range from one year to
twenty-five years and generally carry a variable rate of interest indexed to the
prime rate. This product allows the Company to better meet the needs of its
small business customers in the market areas it serves, while protecting the
Company from undue credit risk.
Commercial business lending is generally considered to involve a higher degree
of credit risk than secured real estate lending. The repayment of unsecured
commercial business loans are wholly dependent upon the success of the
borrower's business, while secured commercial business loans may be secured by
collateral that is not readily marketable.
Classification of Assets. Loans are reviewed on a regular basis and are placed
on nonaccrual status when, in the opinion of management, the collection of
additional interest is doubtful. Loans are generally placed on nonaccrual status
when either principal or interest is 90 days or more past due. Interest accrued
and unpaid at the time a loan is placed on nonaccrual status is reversed from
interest income.
Real estate acquired as a result of foreclosure or by deed in lieu of
foreclosure is classified as Real Estate Owned ("REO") until such time as it is
sold. When real estate is acquired through foreclosure or by deed in lieu of
foreclosure, it is recorded at its fair value, less estimated costs of disposal.
If the value of the property is less than the carrying value of the loan, the
difference is charged against the allowance for credit losses. Any subsequent
write-down of REO is charged against earnings.
Consistent with regulatory guidelines, the Company provides for the
classification of loans considered to be of lesser quality as "substandard,"
"doubtful," or "loss" assets. A loan is considered substandard if it is
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. Substandard loans include those
characterized by the distinct possibility that the Company will sustain some
loss if the deficiencies are not corrected. Loans classified as doubtful have
all of the weaknesses inherent in those classified substandard with the added
characteristic that the weaknesses present make collection or liquidation in
full, on the basis of currently existing facts, conditions, and values, highly
questionable and improbable. Loans classified as loss are those considered
uncollectible and of such little value that their continuance as assets without
the establishment of a specific loss reserve is not warranted. Loans that do not
expose the Company to risk sufficient to warrant classification in one of the
aforementioned categories, but which possess some weaknesses, are required to be
designated "watch" or "special mention" by management.
When the Company classifies problem loans as either substandard or doubtful, it
establishes a specific valuation allowance in an amount deemed prudent by
management. General allowances represent loss allowances that have been
established to recognize the inherent risk associated with outstanding loans,
but which, unlike specific allowances, have not been allocated to particular
problem loans. When the Company classifies problem loans as a loss, it is
required either to establish a specific allowance for losses equal to 100% of
the amount of the loans classified, or to charge-off such amount. The Company's
determination as to the classification of its loans and the amount of its
valuation allowance is subject to review by its regulatory agencies, which can
order the establishment of additional general or specific loss allowances. The
Company regularly reviews its loan portfolio to determine whether any loans
require classification in accordance with Company policy or applicable
regulations.
The allowance for credit losses is established through a provision for credit
losses based on management's evaluation of both known and inherent losses in the
loan portfolio. Such evaluation, which includes a review of all loans on which
full collectibility may not be reasonably assured, considers among other
matters, the estimated net realizable value or the fair value of the underlying
collateral, economic conditions, historical loan loss experience and other
factors that warrant recognition in determining the credit loss allowance. The
Company continues to monitor and modify the level of the allowance for credit
losses in order to include all known and inherent losses at each reporting date
that are both probable and reasonable to estimate. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for credit losses and valuation of
REO.
Management's evaluation of the allowance for credit losses is based on a
continuing review of the loan portfolio. The methodology for determining the
amount of the allowance for credit losses consists of several elements. Both
commercial business lines of credit, as well as all individual borrower
commercial loan credit concentrations in excess of $1.0 million have annual
credit reviews in accordance with Company policy. Non-accruing, impaired and
delinquent commercial loans are reviewed individually every month and the value
of any underlying collateral is considered in determining estimates of losses
associated with those loans and the need, if any, for a specific reserve.
Another element involves estimating losses inherent in categories of smaller
balance homogeneous loans (one- to four-family, home equity, consumer) based
primarily on historical experience, industry trends and trends in the real
estate market and the current economic environment in the Company's market
areas. The unallocated portion of the allowance for credit losses is based on
management's evaluation of various conditions, and involves a higher degree of
uncertainty because this
10
component of the allowance for credit losses is not identified with specific
problem credits or portfolio segments. The conditions evaluated in connection
with this element include the following: industry and regional conditions
(primarily upstate New York where the Company is subject to a high degree of
concentration risk); seasoning of the loan portfolio and changes in the
composition of and growth in the loan portfolio; the strength and duration of
the current business cycle; existing general economic and business conditions in
the lending areas; credit quality trends, including trends in nonaccruing loans;
historical loan charge-off experience; and the results of regulatory
examinations.
INVESTMENT ACTIVITIES
General. The Company's investment policy, established by the Board of Directors
of First Niagara, provides that investment decisions will be made based on the
safety of the investment, liquidity requirements, potential returns, cash flow
targets, and desired risk parameters. In pursuing these objectives,
consideration is given to the ability of an investment to provide earnings
consistent with factors of quality, maturity, marketability and risk
diversification.
The Company limits securities investments to U.S. Government and agency
securities, municipal bonds, corporate debt obligations and corporate equity
securities. In addition, the policy permits investments in mortgage-related
securities, including securities issued and guaranteed by FNMA, FHLMC,
Government National Mortgage Association ("GNMA") and privately-issued
collateralized mortgage obligations ("CMOs"). Also permitted are investments in
asset-backed securities ("ABSs"), backed by auto loans, credit card receivables,
home equity loans, student loans, and home improvement loans. The investment
strategy generally utilizes a risk management approach of diversified investing
between short-, intermediate- and long-term categories in order to increase
overall investment yields in addition to managing interest rate risk. To
accomplish these objectives, the Company's focus is on investments in
mortgage-backed securities, CMOs and ABSs, while U.S. Government and other
non-amortizing securities are utilized for call protection and liquidity
purposes. The Company attempts to maintain a high degree of liquidity in its
investment securities and generally does not invest in debt securities with
expected average lives in excess of 10 years.
During 2002 emphasis was placed on investments with shorter durations as a
result of the lower interest rate environment. Although this puts pressure on
the Company's margins, in the long-run it should benefit the Company as interest
rates rise. Additionally, as a result of converting to a federal charter in
2002, First Niagara is no longer permitted to hold equity securities beyond
November 8, 2003. Accordingly, management transferred $1.6 million of equity
securities owned by First Niagara to FNFG in January 2003.
SOURCES OF FUNDS
General. Deposits and borrowed funds, primarily Federal Home Loan Bank ("FHLB")
advances and reverse repurchase agreements, are the primary sources of the
Company's funds for use in lending, investing and for other general purposes. In
addition, repayments on loans, proceeds from sales of loans and securities, and
cash flows from operations have historically been additional sources of funds.
The Company has available lines of credit with the FHLB and Federal Reserve Bank
("FRB"), which can provide liquidity if the above funding sources are not
sufficient to meet the Company's short-term liquidity needs.
Deposits. The Company offers a variety of deposit account products with a range
of interest rates and terms. The deposit accounts consist of savings accounts,
negotiable order of withdrawal ("NOW") accounts, checking accounts, money market
accounts, and certificates of deposit. The Company offers certificates of
deposit with balances in excess of $100 thousand at preferential rates (jumbo
certificates) and also offers Individual Retirement Accounts ("IRAs") and other
qualified plan accounts. To enhance its deposit product offerings, the Company
also provides commercial business, as well as totally free checking accounts.
Borrowed Funds. Borrowings are utilized to lock-in lower cost funding, better
match interest rates and maturities of certain assets and liabilities and
leverage capital for the purpose of improving return on equity. Such borrowings
primarily consist of advances and reverse repurchase agreements entered into
with the FHLB, with nationally recognized securities brokerage firms and with
commercial customers.
11
FINANCIAL SERVICES GROUP
General. To complement its traditional core banking products, the Company offers
a wide-range of insurance and investment products and services to help customers
achieve their financial goals. These products and services are delivered through
the Company's Financial Services Group, a business unit that is organized along
the lines of Risk Management and Wealth Management. The goal of this unified
financial services team is to help customers identify and achieve long- and
short-range financial goals, regardless of their entry point or changing
financial needs.
Risk Management. The Company's Risk Management services consists of the sale of
personal and commercial insurance on an agency basis to individual consumers, as
well as small and medium sized companies located in its market areas. The
Company offers life, auto, home, long-term care, disability, key-person life,
property insurance, and general liability business insurance, which includes
product professional and umbrella policies. In addition to its insurance
products sold, the Company provides claims investigation and adjusting services,
as well as alternative risk management and self-insurance consulting services.
The revenue attributable to the Company's Risk Management services consists
primarily of fees paid by clients and commissions, fees and contingent income
paid by insurance companies. These revenues may be affected by premium rate
levels in the insurance markets and available insurance capacity, since
compensation is frequently related to the premiums paid by insureds. Revenue is
also affected by insured values, the development of new products, markets and
services, new and lost business, as well as merging of and the volume of
business from new and existing clients. Contingent income includes payments or
allowances by insurance companies based upon such factors as the overall volume
of business placed by the Company with that insurer and/or the profitability or
loss to the insurer of the risks placed. Revenues vary from quarter to quarter
as a result of the timing of policy renewals, the net effect of new and lost
business and achievement of contingent compensation thresholds, whereas expenses
tend to be more uniform throughout the year. Commission rates vary in amount
depending upon the type of insurance coverage provided, the particular insurer,
the capacity in which the agent acts and negotiations with clients.
Wealth Management. The Company's Wealth Management services consist of the sale
of mutual funds and annuities, including various individual retirement accounts
and education savings plans. Additionally, the Company offers investment
advisory services, trust services and individual managed account programs.
Revenue from the sale of mutual funds and annuities consist primarily of
commissions paid by investment product providers. Revenue is affected by the
development of new products, markets and services, new and lost business,
marketing of new investment products, the relative attractiveness of the
investment products offered under prevailing market conditions, changes in the
investment patterns of clients and the flow of monies to and from accounts.
The investment management services are performed pursuant to advisory contracts,
which provide for fees payable to the Company. The amount of the fees varies
depending on the individual account and is usually based upon a sliding scale in
relation to the level of assets under management. Investment management revenues
depend largely on the total value and composition of assets under management.
Assets under management and revenue levels are particularly affected by
fluctuations in stock and bond market prices, the composition of assets under
management and by the level of investments and withdrawals for current and new
clients. U.S. equity markets were volatile throughout 2002 and 2001 and declined
in each of those years after several years of substantial growth. This
volatility contributed to the decline in assets under management and,
accordingly, to the reduction in revenue recognized by the Company. A continued
decline in general market levels will reduce future revenue. Items affecting
revenue also include, but are not limited to, actual and relative investment
performance, service to clients, the relative attractiveness of the investment
style under prevailing market conditions, changes in the investment patterns of
clients and the ability to maintain investment management fees at appropriate
levels. Assets managed by the Company aggregated approximately $132.9 million
and $190.4 million as of December 31, 2002 and 2001, respectively.
The Company provides personal trust, employee benefit trust, and custodial
services to clients in its market areas. Similar to its investment management
services, trust revenue is derived primarily from investment management fees,
which depend largely on the total value and composition of assets under
management. Assets under management relating to trust services are included
within the assets managed amounts reported above.
12
SEGMENT INFORMATION
Information about the Company's business segments is included in note 18 of
"Notes to Consolidated Financial Statements" filed herewith in Part II, Item 8,
"Financial Statements and Supplementary Data." Based on the "Management
Approach" model as described in the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an
Enterprise and Related Information," the Company has determined it has two
business segments, its banking activities and its financial services activities.
Financial services activities consist of the results of the Company's insurance
and investment advisory subsidiaries, as well as First Niagara's trust
department, which were organized under one Financial Services Group in 2001.
Banking activities consists of the results of FNFG's banking subsidiaries
excluding financial services activities.
SUPERVISION AND REGULATION
General. As a result of the conversion of First Niagara to a federally chartered
savings bank, FNFG became a savings and loan holding company. First Niagara is
examined and supervised by the OTS and the Federal Deposit Insurance Corporation
("FDIC"), while FNFG is examined and supervised by the OTS. This regulation and
supervision establishes a comprehensive framework of activities in which an
institution may engage and is intended primarily for the protection of the
FDIC's deposit insurance funds and depositors. Under this system of federal
regulation, financial institutions are periodically examined to ensure that they
satisfy applicable standards with respect to their capital adequacy, assets,
management, earnings, liquidity and sensitivity to market interest rates.
Following completion of its examination, the federal agency critiques the
institution's operations and assigns its rating (known as an institution's
CAMELS rating). Under federal law, an institution may not disclose its CAMELS
rating to the public. First Niagara also is a member of and owns stock in the
FHLB of New York, which is one of the twelve regional banks in the FHLB System.
First Niagara also is regulated to a lesser extent by the Board of Governors of
the Federal Reserve System, governing reserves to be maintained against deposits
and other matters. The OTS examines First Niagara and prepares reports for the
consideration of its Board of Directors on any operating deficiencies. First
Niagara's relationship with its depositors and borrowers also is regulated to a
great extent by both federal and state laws, especially in matters concerning
the ownership of deposit accounts and the form and content of First Niagara's
loan documents.
Any change in these laws or regulations, whether by the FDIC, OTS or Congress,
could have a material adverse impact on the Company and its operations.
Federal Banking Regulation
Business Activities. A federal savings bank derives its lending and investment
powers from the Home Owners' Loan Act, as amended, and the regulations of the
OTS. Under these laws and regulations, First Niagara may invest in mortgage
loans secured by residential and commercial real estate, commercial business and
consumer loans, certain types of debt securities and certain other assets. First
Niagara also may establish subsidiaries that may engage in activities not
otherwise permissible, including real estate investment and securities and
insurance brokerage.
Capital Requirements. OTS regulations require savings banks to meet three
minimum capital standards: A 1.5% tangible capital ratio, a 4% leverage ratio
(3% for banks receiving the highest rating on the CAMELS rating system) and an
8% risk-based capital ratio. The prompt corrective action standards discussed
below, in effect, establish a minimum 2% tangible capital standard.
The risk-based capital standard for savings banks requires the maintenance of
Tier 1 (core) and total capital (which is defined as core capital and
supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 200%, assigned by the OTS capital regulation based on the risks
believed inherent in the type of asset. Core capital is defined as common
stockholders' equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus and minority interests in equity
accounts of consolidated subsidiaries, less intangibles other than certain
mortgage servicing rights and credit card relationships. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock, the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net
unrealized gains on available-for-sale equity securities with readily
determinable fair market values. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
13
At December 31, 2002, First Niagara exceeded all minimum regulatory capital
requirements. The current requirements and the actual levels for First Niagara
are detailed in note 11 of "Notes to Consolidated Financial Statements" filed
herewith in Part II, Item 8, "Financial Statements and Supplementary Data."
Loans-to-One-Borrower. A federal savings bank generally may not make a loan or
extend credit to a single or related group of borrowers in excess of 15% of
unimpaired capital and surplus on an unsecured basis. An additional amount may
be loaned, equal to 10% of unimpaired capital and surplus, if the loan is
secured by readily marketable collateral, but generally does not include real
estate. First Niagara is in compliance with the loans-to-one-borrower
limitations. As a result of the recently completed Offering, the Company's
regulatory loans-to-one-borrower limit has increased to approximately $65.0
million (15% of unimpaired capital and surplus) as of January 31, 2003. However,
given the Company's conservative underwriting standards and risk management
philosophy, management and the Board of Directors has established an internal
loans-to-one-borrower limit of approximately $43.5 million (10% of unimpaired
capital and surplus) as of January 31, 2003.
Qualified Thrift Lender Test. As a federal savings bank, First Niagara is
subject to a qualified thrift lender ("QTL") test. Under the QTL test, First
Niagara must maintain at least 65% of its "portfolio assets" in "qualified
thrift investments" in at least nine months of the most recent 12-month period.
"Portfolio assets" generally means total assets of a savings institution, less
the sum of specified liquid assets up to 20% of total assets, goodwill and other
intangible assets, and the value of property used in the conduct of the savings
bank's business.
"Qualified thrift investments" includes various types of loans made for
residential and housing purposes, investments related to such purposes,
including certain mortgage-backed and related securities, and loans for
personal, family, household and certain other purposes up to a limit of 20% of
portfolio assets. "Qualified thrift investments" also include 100% of an
institution's credit card loans, education loans and small business loans. First
Niagara also may satisfy the QTL test by qualifying as a "domestic building and
loan association" as defined in the Internal Revenue Code of 1986, as amended.
Capital Distributions. OTS regulations govern capital distributions by a federal
savings bank, which include cash dividends, stock repurchases and other
transactions charged to the capital account. A savings bank must file an
application for approval of a capital distribution if: The total capital
distributions for the applicable calendar year exceed the sum of the savings
bank's net income for that year to date plus the savings bank's retained net
income for the preceding two years; the bank would not be at least adequately
capitalized following the distribution; the distribution would violate any
applicable statute, regulation, agreement or OTS-imposed condition; or the
savings bank is not eligible for expedited treatment of its filings.
Even if an application is not otherwise required, every savings bank that is a
subsidiary of a holding company must file a notice with the OTS at least 30 days
before the Board of Directors declares a dividend or approves a capital
distribution. The OTS may disapprove a notice or application if: The savings
bank would be undercapitalized following the distribution; the proposed capital
distribution raises safety and soundness concerns; or the capital distribution
would violate a prohibition contained in any statute, regulation or agreement.
In addition, the Federal Deposit Insurance Act provides that an insured
depository institution shall not make any capital distribution, if after making
such distribution, the institution would be undercapitalized.
Liquidity. A federal savings bank is required to maintain a sufficient amount of
liquid assets to ensure its safe and sound operation.
Community Reinvestment Act and Fair Lending Laws. All savings banks have a
responsibility under the Community Reinvestment Act ("CRA") and related
regulations of the OTS to help meet the credit needs of their communities,
including low- and moderate-income neighborhoods. In connection with its
examination of a federal savings bank, the OTS is required to assess the savings
bank's record of compliance with the CRA. In addition, the Equal Credit
Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in
their lending practices on the basis of characteristics specified in those
statutes. A bank's failure to comply with the provisions of the CRA could, at a
minimum, result in regulatory restrictions on its activities. The failure to
comply with the Equal Credit Opportunity Act and the Fair Housing Act could
result in enforcement actions by the OTS, as well as other federal regulatory
agencies and the Department of Justice. First Niagara received a "satisfactory"
CRA rating in its most recent federal examination.
Transactions with Related Parties. A federal savings bank's authority to engage
in transactions with its "affiliates" is limited by OTS regulations and by
Sections 23A and 23B of the Federal Reserve Act (the "FRA"). The term
"affiliates" for these purposes generally means any company that controls or is
under common control with an institution. FNFG and its non-savings institution
subsidiaries are affiliates of First Niagara. In general, transactions with
affiliates must be on terms that are as favorable to the savings bank as
comparable transactions with non-affiliates. In addition, certain types of these
transactions are restricted to an aggregate percentage of the savings bank's
capital. Collateral in specified amounts must usually be provided by affiliates
in order to receive loans from the
14
savings bank. In addition, OTS regulations prohibit a savings bank from lending
to any of its affiliates that are engaged in activities that are not permissible
for bank holding companies and from purchasing the securities of any affiliate,
other than a subsidiary.
First Niagara's authority to extend credit to its directors, executive officers
and 10% stockholders, as well as to entities controlled by such persons, is
currently governed by the requirements of Sections 22(g) and 22(h) of the FRA
and Regulation O of the Federal Reserve Board. Among other things, these
provisions require that extensions of credit to insiders (i) be made on terms
that are substantially the same as, and follow credit underwriting procedures
that are not less stringent than, those prevailing for comparable transactions
with unaffiliated persons and that do not involve more than the normal risk of
repayment or present other unfavorable features, and (ii) do not exceed certain
limitations on the amount of credit extended to such persons, individually and
in the aggregate, which limits are based, in part, on the amount of First
Niagara's capital. In addition, extensions of credit in excess of certain limits
must be approved by First Niagara's Board of Directors.
Enforcement. The OTS has primary enforcement responsibility over federal savings
institutions and has the authority to bring enforcement action against all
"institution-affiliated parties," including stockholders, and attorneys,
appraisers and accountants who knowingly or recklessly participate in wrongful
action likely to have an adverse effect on an insured institution. Formal
enforcement action may range from the issuance of a capital directive or a cease
and desist order for the removal of officers and/or directors of the
institution, receivership, conservatorship or the termination of deposit
insurance. Civil penalties cover a wide range of violations and actions, and
range up to $25 thousand per day, unless a finding of reckless disregard is
made, in which case penalties may be as high as $1.1 million per day. The FDIC
also has the authority to recommend to the Director of the OTS that enforcement
action be taken with respect to a particular savings institution. If action is
not taken by the OTS Director, the FDIC has authority to take action under
specified circumstances.
Standards for Safety and Soundness. Federal law requires each federal banking
agency to prescribe certain standards for all insured depository institutions.
These standards relate to, among other things, internal controls, information
and audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, compensation, and other operational and managerial
standards as the agency deems appropriate. The federal banking agencies adopted
Interagency Guidelines Prescribing Standards for Safety and Soundness to
implement the safety and soundness standards required under federal law. The
guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. The guidelines address internal controls and
information systems, internal audit systems, credit underwriting, loan
documentation, interest rate risk exposure, asset growth, compensation, fees and
benefits. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard. If an institution fails to meet these
standards, the appropriate federal banking agency may require the institution to
submit a compliance plan.
Prompt Corrective Action Regulations. Under the prompt corrective action
regulations, the OTS is required and authorized to take supervisory actions
against undercapitalized savings banks. For this purpose, a savings bank is
placed in one of the following five categories based on the bank's capital:
well-capitalized (at least 5% leverage capital, 6% tier 1 risk-based capital and
10% total risk-based capital); adequately capitalized (at least 3% leverage
capital, 4% tier 1 risk-based capital and 8% total risk-based capital);
undercapitalized (less than 8% total risk-based capital, 4% tier 1 risk-based
capital or 3% leverage capital); significantly undercapitalized (less than 6%
total risk-based capital, 3% tier 1 risk-based capital or 3% leverage capital);
and critically undercapitalized (less than 2% tangible capital).
Generally, the banking regulator is required to appoint a receiver or
conservator for a bank that is "critically undercapitalized." The regulation
also provides that a capital restoration plan must be filed with the OTS within
45 days of the date a bank receives notice that it is "undercapitalized,"
"significantly undercapitalized," or "critically undercapitalized." A capital
restoration plan must disclose, among other things, the steps an insured
institution will take to become adequately capitalized without appreciably
increasing the risk to which the institution is exposed. In addition, each
company that controls the institution must guarantee that the institution will
comply with the plan until the institution has been adequately capitalized on
average during each of four consecutive calendar quarters. Such guarantee could
have a material adverse affect on the financial condition of such guarantor. In
addition, numerous mandatory supervisory actions become immediately applicable
to the bank, including, but not limited to, restrictions on growth, investment
activities, capital distributions and affiliate transactions. The OTS may also
take any one of a number of discretionary supervisory actions against
undercapitalized banks, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
15
At December 31, 2002, First Niagara met the criteria for being considered
"well-capitalized." The current requirements and the actual levels for First
Niagara are detailed in note 11 of "Notes to Consolidated Financial Statements"
filed herewith in Part II, Item 8, "Financial Statements and Supplementary
Data."
Insurance of Deposit Accounts. Deposit accounts in First Niagara are insured by
the FDIC, primarily through the Bank Insurance Fund, generally up to a maximum
of $100 thousand per separately insured depositor. First Niagara's deposits
therefore are subject to FDIC deposit insurance assessments. The FDIC has
adopted a risk-based system for determining deposit insurance assessments. The
FDIC is authorized to raise the assessment rates as necessary to maintain the
required ratio of reserves to insured deposits of 1.25%. In addition, all
FDIC-insured institutions must pay assessments to the FDIC at an annual rate, as
of January 1, 2002, of approximately 0.0182% of insured deposits to fund
interest payments on bonds maturing in 2017 issued by a federal agency to
recapitalize the predecessor to the Savings Association Insurance Fund.
Prohibitions Against Tying Arrangements. Federal savings banks are prohibited,
subject to some exceptions, from extending credit to or offering any other
service, or fixing or varying the consideration for such extension of credit or
service, on the condition that the customer obtain some additional service from
the institution or its affiliates or not obtain services of a competitor of the
institution.
Federal Home Loan Bank System. First Niagara is a member of the FHLB System,
which consists of 12 regional Federal Home Loan Banks. The FHLB System provides
a central credit facility primarily for member institutions. As a member of the
FHLB of New York, First Niagara is required to acquire and hold shares of
capital stock in the FHLB in an amount at least equal to 1% of the aggregate
principal amount of its unpaid residential mortgage loans and similar
obligations at the beginning of each year, or 1/20 of its borrowings from the
FHLB, whichever is greater. First Niagara is in compliance with this
requirement.
Federal Reserve System
The Federal Reserve Board regulations require savings banks to maintain
non-interest-earning reserves against their transaction accounts, such as NOW
and regular checking accounts. First Niagara is in compliance with these reserve
requirements. The balances maintained to meet the reserve requirements imposed
by the Federal Reserve Board may be used to satisfy liquidity requirements
imposed by the OTS.
Holding Company Regulation
Upon completion of the Conversion of First Niagara to a federally chartered
savings bank, FNFG became a savings and loan holding company, subject to
regulation and supervision by the OTS. The OTS has enforcement authority over
FNFG and its non-savings institution subsidiaries. Among other things, this
authority permits the OTS to restrict or prohibit activities that are determined
to be a risk to First Niagara.
Under prior law, a unitary savings and loan holding company generally had no
regulatory restrictions on the types of business activities in which it may
engage, provided that its subsidiary savings bank was a qualified thrift lender.
The Gramm-Leach-Bliley ("GLB") Act of 1999, however, restricts unitary savings
and loan holding companies not existing or applied for before May 4, 1999 to
those activities permissible for financial holding companies or for multiple
savings and loan holding companies. FNFG is not a grandfathered unitary savings
and loan holding company and, therefore, is limited to the activities
permissible for financial holding companies or for multiple savings and loan
holding companies. A financial holding company may engage in activities that are
financial in nature, including underwriting equity securities and insurance,
incidental to financial activities or complementary to a financial activity. A
multiple savings and loan holding company is generally limited to activities
permissible for bank holding companies under Section 4(c)(8) of the Bank Holding
Company Act, subject to the prior approval of the OTS, and certain additional
activities authorized by OTS regulations.
Federal law prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring control of
another savings institution or holding company thereof, without prior written
approval of the OTS. It also prohibits the acquisition or retention of, with
specified exceptions, more than 5% of the equity securities of a company engaged
in activities that are not closely related to banking or financial in nature or
acquiring or retaining control of an institution that is not federally insured.
In evaluating applications by holding companies to acquire savings institutions,
the OTS must consider the financial and managerial resources, future prospects
of the savings institution involved, the effect of the acquisition on the risk
to the insurance fund, the convenience and needs of the community and
competitive factors.
16
Recent Legislation
USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 ("the
Patriot Act") was enacted in response to the terrorist attacks in New York,
Pennsylvania and Washington, D.C., which occurred on September 11, 2001. The
Patriot Act is intended to strengthen U.S. law enforcement's and the
intelligence communities' abilities to work cohesively to combat terrorism on a
variety of fronts. The potential impact of the Patriot Act on financial
institutions of all kinds is significant and wide ranging. The Patriot Act
contains sweeping anti-money laundering and financial transparency laws and
requires various regulations, including standards for verifying customer
identification at account opening, and rules to promote cooperation among
financial institutions, regulators, and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering.
Financial Services Modernization Legislation. In November 1999, the GLB Act of
1999 was enacted. The GLB repeals provisions of the Glass-Steagall Act which
restricted the affiliation of Federal Reserve member banks with firms "engaged
principally" in specified securities activities, and which restricted officer,
director, or employee interlocks between a member bank and any company or person
"primarily engaged" in specified securities activities.
In addition, the GLB also contains provisions that expressly preempt any state
law restricting the establishment of financial affiliations, primarily related
to insurance. The general effect of the law is to establish a comprehensive
framework to permit affiliations among commercial banks, insurance companies,
securities firms, and other financial service providers by revising and
expanding the Bank Holding Company Act framework to permit a holding company to
engage in a full range of financial activities through a new entity known as a
"financial holding company." "Financial activities" is broadly defined to
include not only banking, insurance and securities activities, but also merchant
banking and additional activities that the Federal Reserve Board, in
consultation with the Secretary of the Treasury, determines to be financial in
nature, incidental to such financial activities, or complementary activities
that do not pose a substantial risk to the safety and soundness of depository
institutions or the financial system.
The GLB provides that no company may acquire control of an insured savings
association unless that company engages, and continues to engage, only in the
financial activities permissible for a financial holding company, unless the
company is grandfathered as a unitary savings and loan holding company on May 4,
1999 or became a unitary savings and loan holding company pursuant to an
application pending on that date.
The GLB also permits national banks to engage in expanded activities through the
formation of financial subsidiaries. A national bank may have a subsidiary
engaged in any activity authorized for national banks directly or any financial
activity, except for insurance underwriting, insurance investments, real estate
investment or development, or merchant banking, which may only be conducted
through a subsidiary of a financial holding company. Financial activities
include all activities permitted under new sections of the Bank Holding Company
Act or permitted by regulation.
Sarbanes-Oxley Act. On July 30, 2002, the Sarbanes-Oxley Act of 2002 ("SOA") was
signed into law. The stated goals of the SOA are to increase corporate
responsibility, to provide for enhanced penalties for accounting and auditing
improprieties at publicly traded companies and to protect investors by improving
the accuracy and reliability of corporate disclosures pursuant to the securities
laws.
The SOA includes very specific additional disclosure requirements and new
corporate governance rules, requires the SEC and securities exchanges to adopt
extensive additional disclosure, corporate governance and other related rules
and mandates further studies of certain issues by the SEC and the Comptroller
General. The SOA represents significant federal involvement in matters
traditionally left to state regulatory systems, such as the regulation of the
accounting profession, and to state corporate law, such as the relationship
between a board of directors and management and between a board of directors and
its committees.
The SOA addresses, among other matters: Audit committees; certification of
financial statements by the chief executive officer and the chief financial
officer; the forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's securities by directors and senior officers
in the twelve month period following initial publication of any financial
statements that later require restatement; a prohibition on insider trading
during pension plan black out periods; disclosure of off-balance sheet
transactions; a prohibition on certain loans to directors and officers;
expedited filing requirements for Forms 4; disclosure of a code of ethics and
filing a Form 8-K for a change or waiver of such code; "real time" filing of
periodic reports; the formation of a public accounting oversight board; auditor
independence; and various increased criminal penalties for violations of
securities laws.
The SOA contains provisions that became effective upon enactment, and provisions
that will become effective from within 30 days to one year from enactment. The
SEC has been delegated the task of enacting rules to implement various
provisions with respect to, among other matters, disclosure in periodic filings
pursuant to the Exchange Act.
17
TAXATION
Federal Taxation
General. FNFG and First Niagara are subject to federal income taxation in the
same general manner as other corporations, with some exceptions discussed below.
The following discussion of federal taxation is intended only to summarize
certain pertinent federal income tax matters and is not a comprehensive
description of the tax rules applicable to FNFG and First Niagara.
Method of Accounting. For federal income tax purposes, First Niagara currently
reports its income and expenses on the accrual method of accounting and uses a
tax year ending December 31 for filing its consolidated federal income tax
returns.
Bad Debt Reserves. The Small Business Protection Act of 1996 eliminated the use
of the reserve method of accounting for bad debt reserves by savings
institutions, effective for taxable years beginning after 1995. Prior to this,
First Niagara was permitted to establish a reserve for bad debts and to make
annual additions to the reserve. These additions could, within specified formula
limits, be deducted in arriving at First Niagara's taxable income. As a result
of the Small Business Protection Act, First Niagara must use the specific charge
off method in computing its bad debt deduction beginning with its 1996 federal
tax return. In addition, the federal legislation required the recapture (over a
six-year period) of the excess of tax bad debt reserves at December 31, 1995
over those established as of December 31, 1987. As of December 31, 2002, First
Niagara had fully recaptured these excess reserves.
Taxable Distributions and Recapture. Prior to the Small Business Protection Act
of 1996, bad debt reserves created prior to January 1, 1988 were subject to
recapture into taxable income should First Niagara fail to meet certain thrift
asset and definitional tests. New federal legislation eliminated these thrift
related recapture rules. However, under current law, pre-1988 reserves remain
subject to recapture should First Niagara make certain nondividend distributions
or cease to maintain a bank charter. At December 31, 2002, First Niagara's
federal pre-1988 reserve, which no federal income tax provision has been made,
was approximately $7.7 million.
Minimum Tax. The Internal Revenue Code of 1986 imposes an alternative minimum
tax ("AMT") at a rate of 20% on a base of regular taxable income plus certain
tax preferences ("alternative minimum taxable income" or "AMTI"). The AMT is
payable to the extent such AMTI is in excess of an exemption amount. Net
operating losses can offset no more than 90% of AMTI. Certain payments of
alternative minimum tax may be used as credits against regular tax liabilities
in future years. First Niagara has not been subject to the alternative minimum
tax and has no such amounts available as credits for carryover.
Net Operating Loss Carryovers. A financial institution may carry back net
operating losses to the preceding five taxable years (for losses incurred in
2001 and subsequent years) and forward to the succeeding 20 taxable years. At
December 31, 2002, First Niagara had no net operating loss carryforwards for
federal income tax purposes.
Corporate Dividends. FNFG may exclude from its income 100% of dividends received
from First Niagara as a member of the same affiliated group of corporations.
Status of Internal Revenue Service Audits. FNFG's federal income tax returns
have not been audited by the Internal Revenue Service during the last five
years.
State Taxation
State of New York. FNFG will report income on a consolidated calendar year basis
to New York State. New York State franchise tax on corporations is imposed in an
amount equal to the greater of (a) 8.0% (for 2002) and 7.5% (for 2003 and
forward) of "entire net income" allocable to New York State, (b) 3% of
"alternative entire net income" allocable to New York State, (c) 0.01% of the
average value of assets allocable to New York State, or (d) nominal minimum tax.
Entire net income is based on Federal taxable income, subject to certain
modifications. Alternative entire net income is based on entire net income with
certain modifications.
18
RISK FACTORS
In addition to the various risks and uncertainties discussed throughout this
Form 10-K, the Company is also subject to the following risk factors:
Commercial Real Estate, Commercial Business and Multi-Family Loans Expose the
Company to Increased Credit Risks
The Company plans to continue its emphasis on the origination of commercial real
estate, commercial business and multi-family loans. These types of loans
generally expose a lender to greater risk of non-payment and loss than one- to
four-family residential mortgage loans because repayment of the loans often
depends on the successful operations and the income stream of the borrowers.
Such loans typically involve larger loan balances to single borrowers or groups
of related borrowers compared to one- to four-family residential mortgage loans.
Also, many of the Company's borrowers have more than one commercial real estate,
commercial business or multi-family loan outstanding with the Company.
Consequently, an adverse development with respect to one loan or one credit
relationship can expose the Company to a significantly greater risk of loss
compared to an adverse development with respect to a one- to four-family
residential mortgage loan.
If the Allowance for Credit Losses is Not Sufficient to Cover Actual Loan
Losses, the Company's Earnings Could Decrease.
The Company's loan customers may not repay their loans according to the terms of
the loans, and the collateral securing the payment of those loans may be
insufficient to pay any remaining loan balance. The Company may experience
significant loan losses, which could have a material adverse effect on its
operating results. Management makes various assumptions and judgments about the
collectibility of the loan portfolio, including the creditworthiness of
borrowers and the value of the real estate and other assets serving as
collateral for the repayment of loans. In determining the amount of the
allowance for credit losses, management relies on its loan quality reviews,
experience and evaluation of economic conditions, among other factors. If the
assumptions prove to be incorrect, the allowance for credit losses may not be
sufficient to cover losses inherent in the loan portfolio, resulting in
additions to the allowance for credit losses. Material additions to the
allowance for credit losses would materially decrease the Company's net income.
Management's emphasis on continued diversification of the Company's loan
portfolio through the origination of commercial real estate, multi-family and
commercial business loans is one of the more significant factors management
takes into account in evaluating the allowance for credit losses and provision
for credit losses. As the Company further increases the amount of such types of
loans, management may determine to make additional or increased provisions for
credit losses, which could adversely affect the Company`s earnings.
In addition, bank regulators periodically review the Company's allowance for
credit losses and may require it to increase the provision for credit losses or
recognize further loan charge-offs. Any increase in the allowance for credit
losses or loan charge-offs as required by these regulatory authorities could
have a material adverse effect on the Company's results of operations and
financial condition.
The Continuing Concentration of Loans in the Company's Primary Market Areas May
Increase Risk
The Company's success depends primarily on the general economic conditions in
upstate New York. Unlike larger banks that are more geographically diversified,
the Company provides banking and financial services to customers primarily in
upstate New York. The local economic conditions in upstate New York have a
significant impact on the Company's loans, the ability of borrowers to repay
these loans and the value of the collateral securing these loans. A significant
decline in general economic conditions caused by inflation, recession,
unemployment or other factors beyond the Company's control would impact these
local economic conditions and could negatively affect the financial results of
the Company's operations. Additionally, because the Company has a significant
amount of commercial real estate loans, decreases in tenant occupancy may also
have a negative effect on the ability of borrowers to make timely repayments of
their loans, which would have an adverse impact on the Company's earnings.
The Company targets its business lending and marketing strategy towards loans
that primarily serve the banking and financial services needs of small- to
medium-sized businesses in upstate New York. These small to medium-sized
businesses generally have fewer financial resources in terms of capital or
borrowing capacity than larger entities. If general economic conditions
negatively impact these businesses, the Company's results of operations and
financial condition may be adversely affected.
19
Changes in Interest Rates Could Adversely Affect the Company's Results of
Operations and Financial Condition.
The Company's results of operations and financial condition are significantly
affected by changes in interest rates. The Company's results of operations
depend substantially on net interest income, which is the difference between the
interest income earned on interest-earning assets and the interest expense paid
on interest-bearing liabilities. Because the Company's interest-bearing
liabilities generally reprice or mature more quickly than its interest-earning
assets, an increase in interest rates generally would tend to result in a
decrease in net interest income. Management has taken steps to mitigate this
risk such as holding fewer longer-term residential mortgages, as well as
investing excess funds in short-term investments. As a result of these steps, as
of December 31, 2002, the Company's net interest income simulation model
indicates that the Company's net interest income would benefit from a rise in
interest rates. See the "Quantitative and Qualitative Disclosure About Market
Risk" section filed herewith in Part II, Item 7A, for further detail on the
Company's interest rate risk management strategy.
Changes in interest rates also affect the value of the Company's
interest-earning assets, and in particular its securities portfolio. Generally,
the value of securities fluctuates inversely with changes in interest rates. At
December 31, 2002, investment and mortgage-backed securities available for sale
totaled $632.4 million. Unrealized gains on securities available for sale, net
of tax, amounted to $4.2 million and are reported as a separate component of
stockholders' equity. Decreases in the fair value of securities available for
sale, therefore, could have an adverse effect on stockholders' equity.
The Company is also subject to reinvestment risk associated with changes in
interest rates. Changes in interest rates may affect the average life of loans
and mortgage-related securities. Decreases in interest rates can result in
increased prepayments of loans and mortgage-related securities, as borrowers
refinance to reduce borrowing costs. Under these circumstances, the Company is
subject to reinvestment risk to the extent that it is unable to reinvest the
cash received from such prepayments at rates that are comparable to the rates on
existing loans and securities. Additionally, increases in interest rates may
decrease loan demand and make it more difficult for borrowers to repay
adjustable rate loans.
The Company's Ability to Grow May Be Limited if it Cannot Make Acquisitions
In an effort to fully deploy the additional capital raised in the Offering, and
to increase its loan and deposit growth, the Company will continue to seek to
expand its banking and financial services franchise by acquiring other financial
institutions or branches primarily in the Company's market areas. The Company's
ability to grow through selective acquisitions of other financial institutions
or branches will depend on successfully identifying, acquiring and integrating
them. The Company competes with other financial institutions with respect to
proposed acquisitions and cannot assure that it will be able to identify
attractive acquisition candidates or make acquisitions on favorable terms. In
addition, management cannot assure that it can successfully integrate any
acquired institutions or branches into the Company's organization in a timely or
efficient manner, that it will be successful in retaining existing customer
relationships or that it can achieve anticipated operating efficiencies.
The Company May Have Difficulty Managing its Growth, Which May Divert Resources
and Limit its Ability to Successfully Expand its Operations.
The Company expects to continue to experience significant growth in assets,
deposits, customers and operations. There can be no assurance that the Company's
ongoing banking center expansion strategy will be accretive to earnings, or that
it will be accretive to earnings within a reasonable period of time. Numerous
factors contribute to the performance of a new banking center, such as a
suitable location, qualified personnel and an effective marketing strategy.
Additionally, it takes time for a new banking center to gather significant loans
and deposits to generate enough income to offset its expenses, some of which,
like salaries and occupancy expense, are relatively fixed costs.
The Company has incurred substantial expenses to build its management team and
personnel, develop its delivery systems and establish its infrastructure to
support future growth. The Company's future success will depend on the ability
of its officers and key employees to continue to implement and improve
operational, financial and management controls, reporting systems and
procedures, and to manage a growing number of client relationships. The Company
may not be able to successfully implement improvements to its management
information and control systems in an efficient or timely manner and may
discover deficiencies in existing systems and controls. Thus, the Company cannot
give assurances that its growth strategy will not place a strain on
administrative and operational infrastructure or require the Company to incur
additional expenditures beyond current projections to support future growth. The
Company's future profitability will depend in part on its continued ability to
grow and can give no assurance that it will be able to sustain its historical
growth rate or even be able to grow at all.
20
Strong Competition Within the Company's Market Areas May Limit Growth and
Profitability
Competition in the banking and financial services industry is intense. In the
Company's market areas, it competes with commercial banks, savings institutions,
mortgage brokerage firms, credit unions, finance companies, mutual funds,
insurance companies, and brokerage and investment banking firms operating
locally and elsewhere. Many of these competitors (whether regional or national
institutions) have substantially greater resources and lending limits than the
Company and may offer certain services that it does not or cannot provide. The
Company's profitability depends upon its continued ability to successfully
compete in its market areas.
The Company Operates in a Regulated Environment and May be Adversely Affected by
Changes in Laws and Regulations.
The Company is subject to extensive regulation, supervision and examination by
the OTS, its chartering authority, and by the FDIC, as insurer of its deposits.
As a savings and loan holding company, FNFG is subject to regulation and
supervision by the OTS. Such regulation and supervision govern the activities in
which a savings bank and its holding company may engage and are intended
primarily for the protection of the insurance fund and depositors. These
regulatory authorities have extensive discretion in connection with their
supervisory and enforcement activities, including the imposition of restrictions
on the operation of a bank, the classification of assets by a bank and the
adequacy of a bank's allowance for loan losses. Any change in such regulation
and oversight, whether in the form of regulatory policy, regulations, or
legislation, could have a material impact on the Company's operations.
The Company's operations are also subject to extensive regulation by other
federal, state and local governmental authorities and is subject to various laws
and judicial and administrative decisions imposing requirements and restrictions
on part or all of its operations. Management believe's that the Company is in
substantial compliance, in all material respects, with applicable federal, state
and local laws, rules and regulations. Because the Company's business is highly
regulated, the laws, rules and regulations applicable to it are subject to
regular modification and change. There are currently proposed various laws,
rules and regulations that, if adopted, would impact the Company's operations,
including, among other things, matters pertaining to corporate governance,
requirements for listing and maintenance on national securities exchanges and
over the counter markets, and SEC rules pertaining to public reporting
disclosures. In addition, the FASB, is considering changes which may require,
among other things, expensing the costs relating to the issuance of stock
options. There can be no assurance that these proposed laws, rules and
regulations, or any other laws, rules or regulations, will not be adopted in the
future, which could make compliance more difficult or expensive or otherwise
adversely affect the Company's business, financial condition or prospects.
Various Factors May Make Takeover Attempts More Difficult to Achieve
The Company's Board of Directors has no current intention to sell control of
FNFG. Provisions of the Company's certificate of incorporation and bylaws,
federal regulations and various other factors may make it more difficult for
companies or persons to acquire control of FNFG without the consent of its Board
of Directors. The factors that may discourage takeover attempts or make them
more difficult include:
OTS regulations. OTS regulations prohibit, for three years following the
completion of a mutual-to-stock conversion, the acquisition of more than 10% of
any class of equity security of a converted institution without the prior
approval of the OTS. In addition, the OTS has required, as a condition to
approval of the conversion, that First Niagara maintain a federal thrift charter
for a period of three years.
Certificate of incorporation and statutory provisions. Provisions of the
certificate of incorporation and bylaws of FNFG and Delaware law may make it
more difficult and expensive to pursue a takeover attempt that management
opposes. These provisions also make more difficult the removal of the current
Board of Directors or management, or the appointment of new directors. These
provisions include: limitations on voting rights of beneficial owners of more
than 10% of FNFG common stock; supermajority voting requirements for certain
business combinations; and the election of directors to staggered terms of three
years. The Company's bylaws also contain provisions regarding the timing and
content of stockholder proposals and nominations and qualification for service
on the Board of Directors.
Required change in control payments. The Company has entered into employment
agreements with certain executive officers that will require payments to be made
to them in the event their employment is terminated following a change in
control of FNFG or First Niagara. These payments may have the effect of
increasing the costs of acquiring FNFG, thereby discouraging future attempts.
21
The Company May Fail to Realize the Anticipated Benefits of the Merger with FLBC
The success of the merger with FLBC will depend on, among other things, the
Company's ability to realize anticipated cost savings, to combine the businesses
of First Niagara and SBFL in a manner that does not materially disrupt the
existing customer relationships of SBFL nor result in decreased revenues
resulting from any loss of customers, and permits growth opportunities to occur.
If the Company is not able to successfully achieve these objectives, the
anticipated benefits of the merger may not be realized fully or at all or may
take longer to realize than expected. It is possible that the integration
process could result in the loss of key employees, the disruption of FLBC's
ongoing businesses or inconsistencies in standards, controls, procedures and
policies that adversely affect the Company's ability to maintain relationships
with customers and employees or to achieve the anticipated benefits of the
merger.
ITEM 2. PROPERTIES
Both FNFG and First Niagara maintain their executive offices at an
administrative center, located at 6950 South Transit Road, Lockport, New York.
The administrative center, built in 1997, has 76 thousand square feet of space
and is owned by First Niagara.
In addition to its banking center network, First Niagara leases eight offices
and owns eight buildings that it utilizes for its financial services
subsidiaries, back office operations, training, tenant rental and storage. The
total square footage for these facilities is approximately 199 thousand square
feet, which are located in Cayuga, Cortland, Erie, Niagara and Oneida Counties.
As of December 31, 2002, First Niagara conducted its business through 38
full-service banking centers, a loan production office and 75 ATM locations. Of
the 38 banking centers, 13 are located in Erie County, 5 each in Cayuga, Niagara
and Oneida Counties, 4 in Monroe County, 3 in Cortland County, 2 in Orleans
County and 1 in Genesee County. Additionally, 22 of the banking centers are
owned and 16 are leased. The loan production office is leased and located in
Monroe County. Taking into consideration the merger of SBFL into First Niagara
and the opening of an additional banking center in January 2003, First Niagara
now conducts its business through 45 banking centers and 84 ATM's. The
additional banking centers are located in Ontario (3), Seneca (1) and Tompkins
(3) Counties, of which 5 are leased and 2 are owned.
At December 31, 2002, the Company's premises and equipment had an aggregate net
book value of $40.4 million. See note 6 of the "Notes to Consolidated Financial
Statements" filed herewith in Part II, Item 8, "Financial Statements and
Supplementary Data" for further detail on the Company's premises and equipment
and operating leases. All of these properties are generally in good condition
and are appropriate for their intended use.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any legal proceedings other than proceedings
occurring in the ordinary course of business.
22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A special meeting of stockholders of FNFG was held on January 9, 2003. The
Meeting was conducted for the purpose of considering and acting upon the
approval of the plan of re-chartering and approval of the plan of conversion and
reorganization. The following table reflects the tabulation of the votes with
respect to each matter voted upon at the special meeting:
Number of votes (1)
-----------------------------------------------------------
Matters considered For Against Abstain
- ----------------------------------------------------------------- ------------------- ---------------- --------------
(1) A plan of re-chartering by which 23,589,821 32,840 3,516
FNFG will convert its charter from
a Delaware corporation to a Federal
corporation.
(2) A plan of conversion and 23,587,735 34,724 3,717
reorganization pursuant to which
the MHC will be merged into First
Niagara and FNFG will be succeeded
by a new Delaware corporation with
the same name. As part of the
conversion and reorganization,
shares of common stock representing
the MHC's ownership interest in
FNFG will be offered for sale in a
subscription and community
offering.
(1) For matters (1) and (2) there were no broker non-votes.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of FNFG is traded under the symbol of FNFG on the NASDAQ
National Market. At March 14, 2003, FNFG had 70,735,114 shares of common stock
outstanding and had approximately 12,982 shareholders of record. During 2002,
the high and low sales price of the common stock was $32.10 and $15.70,
respectively. FNFG paid dividends of $0.43 per common share during the year
ended December 31, 2002. Share and per share data have not been restated in this
annual report on Form 10-K to give retroactive recognition to the 2.58681
exchange ratio applied on January 17, 2003. See additional information regarding
the market price and dividends paid filed herewith in Part II, Item 6, "Selected
Financial Data."
The Company does not have any equity compensation program that was not approved
by stockholders, other than its employee stock ownership plan. Set forth below
is certain information as of December 31, 2002 regarding equity compensation to
directors and employees of the Company that has been approved by stockholders.
Number of securities
to be issued upon
Equity compensation exercise of Number of securities
plans approved by outstanding options Weighted average remaining available for
stockholders and rights exercise price issuance under the plan
- --------------------------------------------------- -------------------- ---------------- -----------------------
First Niagara Financial Group, Inc.
1999 Stock Option Plan........................ 1,209,843 $11.18 17
First Niagara Financial Group, Inc. 1999
Recognition and Retention Plan................ 203,675 (1) Not Applicable 160,399
First Niagara Financial Group, Inc. 2002
Long-Term Incentive Stock Benefit Plan........ 116,900 $30.29 717,496
-------------- ------------
Total...................................... 1,530,418 $12.86 877,912
============== ============
(1) Represents shares that have been granted but have not yet vested.
23
ITEM 6. SELECTED FINANCIAL DATA
At or for the year ended December 31,
-------------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(Dollar and share amounts in thousands, except per share amounts)
Selected financial condition data:
Total assets ........................... $2,934,795 $2,857,946 $2,624,686 $1,711,712 $1,508,734
Loans, net ............................. 1,974,560 1,853,141 1,823,174 985,628 744,739
Securities available for sale:
Mortgage-backed ..................... 340,319 339,881 302,334 384,329 392,975
Other ............................... 292,045 354,016 199,500 179,144 187,776
Deposits ............................... 2,129,469 1,990,830 1,906,351 1,113,302 1,060,897
Borrowings ............................. 397,135 559,040 429,567 335,645 142,597
Stockholders' equity ................... $ 283,696 $ 260,617 $ 244,540 $ 232,616 $ 263,825
Common shares outstanding (5) .......... 25,005 24,802 24,667 25,658 28,716
Selected operations data:
Interest income ........................ $ 167,637 $ 178,368 $ 137,040 $ 107,814 $ 92,102
Interest expense ....................... 76,107 99,352 76,862 57,060 47,966
---------- ---------- ---------- ---------- ----------
Net interest income ................. 91,530 79,016 60,178 50,754 44,136
Provision for credit losses ............ 6,824 4,160 2,258 2,466 2,084
---------- ---------- ---------- ---------- ----------
Net interest income after provision
for credit losses ..................... 84,706 74,856 57,920 48,288 42,052
Noninterest income (1) ................. 49,691 42,072 34,090 27,688 9,182
Noninterest expense .................... 84,448 83,005 61,518 47,643 35,946 (4)
---------- ---------- ---------- ---------- ----------
Income before income taxes ............. 49,949 33,923 30,492 28,333 15,288
Income taxes (2) ....................... 19,154 12,703 10,973 9,893 4,906
---------- ---------- ---------- ---------- ----------
Net income ........................... $ 30,795 $ 21,220 $ 19,519 $ 18,440 $ 10,382 (4)
========== ========== ========== ========== ===========
Adjusted net income (3) .............. $ 30,795 $ 25,962 $ 21,633 $ 18,992 $ 10,382
========== ========== ========== ========== ===========
Stock and related per share data (5):
Earnings per common share:
Basic ............................... $ 1.24 $ 0.86 $ 0.79 $ 0.69 $ --
Diluted ............................. 1.21 0.85 0.79 0.69 --
Adjusted earnings per common share (3):
Basic ............................... 1.24 1.05 0.87 0.71 --
Diluted ............................. 1.21 1.04 0.87 0.71 --
Cash dividends ........................ 0.43 0.36 0.28 0.14 0.06
Book value ............................ $ 11.35 $ 10.51 $ 9.91 $ 9.07 $ 9.19
Market Price (NASDAQ: FNFG):
High ................................ $ 32.10 $ 17.90 $ 11.06 $ 11.13 $ 17.06
Low ................................. 15.70 10.75 8.25 9.00 8.38
Close ............................... 26.12 16.83 10.81 10.25 10.50
24
At or for the year ended December 31,
----------------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(Dollars in thousands)
Selected financial ratios and other data:
Performance ratios:
Return on average assets ........................... 1.08% 0.79% 0.98% 1.13% 0.77 (4)
Adjusted return on average assets (3) .............. 1.08 0.97 1.09 1.17 0.77 (4)
Return on average equity ........................... 11.22 8.30 8.38 7.52 4.65 (4)
Adjusted return on average equity (3) .............. 11.22 10.16 9.29 7.75 4.65 (4)
Net interest rate spread ........................... 3.30 2.99 2.82 2.72 2.75
Net interest margin ................................ 3.52 3.25 3.26 3.33 3.48
As a percentage of average assets:
Noninterest income (6) .......................... 1.78 1.57 1.73 1.67 0.67
Noninterest expense (3) ......................... 2.96 2.92 2.98 2.89 2.68 (4)
---- ---- ---- ---- ----
Net overhead .................................. 1.18 1.35 1.25 1.22 2.01 (4)
Efficiency ratio (3)(6) ............................ 59.36 64.59 62.79 60.40 67.59 (4)
Dividend payout ratio .............................. 34.68% 41.86% 35.44% 20.30% 16.60%
Capital Ratios (7):
Total risk-based capital ........................... 11.34% 11.36% 11.13% 23.56% 32.88%
Tier 1 risk-based capital .......................... 10.27 10.27 9.96 22.40 31.67
Core (leverage) capital ............................ 6.54 6.71 6.78 13.51 18.05
Tangible capital ................................... 6.54 N/A N/A N/A N/A
Ratio of stockholders' equity to total assets ...... 9.67% 9.12% 9.32% 13.59% 17.49%
Asset quality ratios:
Total non-accruing loans ........................... $ 7,478 $ 11,480 $ 6,483 $ 1,929 $ 3,296
Other non-performing assets ........................ 1,423 665 757 1,073 589
Allowance for credit losses ........................ 20,873 18,727 17,746 9,862 8,010
Net loan charge-offs ............................... $ 4,678 $ 3,179 $ 735 $ 614 $ 995
Total non-accruing loans to total loans ............ 0.38% 0.61% 0.35% 0.19% 0.44%
Total non-performing assets as a percentage of total
assets .......................................... 0.30 0.42 0.28 0.18 0.26
Allowance for credit losses to non-accruing loans .. 279.13 163.13 273.73 511.25 243.02
Allowance for credit losses to total loans ......... 1.05 1.00 0.96 0.99 1.06
Net charge-offs to average loans ................... 0.24% 0.17% 0.06% 0.07% 0.15%
Other data:
Number of banking centers .......................... 38 37 36 18 18
Full time equivalent employees ..................... 945 919 930 625 402
25
2002 2001
---------------------------------------- ----------------------------------------
Fourth Third Second First Fourth Third Second First
quarter quarter quarter quarter quarter quarter quarter quarter
-------- -------- -------- -------- -------- -------- -------- -------
Selected Quarterly Data: (In thousands except per share amounts)
- -----------------------
Interest income ........................... $40,654 $41,914 $42,536 $42,533 $43,774 $44,880 $44,627 $45,087
Interest expense .......................... 17,103 18,857 19,828 20,319 22,686 24,787 25,537 26,342
------- ------- ------- ------- ------- ------- ------- -------
Net interest income .................. 23,551 23,057 22,708 22,214 21,088 20,093 19,090 18,745
Provision for credit losses ............... 1,835 1,729 1,730 1,530 1,150 1,110 860 1,040
------- ------- ------- ------- ------- ------- ------- -------
Net interest income after
provision for credit losses ...... 21,716 21,328 20,978 20,684 19,938 18,983 18,230 17,705
Noninterest income (1) .................... 13,936 11,980 12,565 11,210 11,112 10,171 10,257 10,532
Noninterest expense ....................... 22,167 21,019 20,154 20,235 20,393 18,552 19,083 19,299
Amortization of goodwill and other
intangibles ............................... 224 227 211 211 1,421 1,421 1,418 1,418
------- ------- ------- ------- ------- ------- ------- -------
Net income before income
taxes ............................ 13,261 12,062 13,178 11,448 9,236 9,181 7,986 7,520
Income taxes (2) .......................... 4,859 4,126 6,171 3,998 3,440 3,432 2,973 2,858
------- ------- ------- ------- ------- ------- ------- -------
Net income ........................... $ 8,402 $ 7,936 $ 7,007 $ 7,450 $ 5,796 $ 5,749 $ 5,013 $ 4,662
======= ======= ======= ======= ======= ======= ======= =======
Adjusted net income (3) ............... $ 8,402 $ 7,936 $ 7,007 $ 7,450 $ 6,983 $ 6,936 $ 6,197 $ 5,846
======= ======= ======= ======= ======= ======= ======= =======
Earnings per share (5):
Basic ................................ $ 0.34 $ 0.32 $ 0.28 $ 0.30 $ 0.23 $ 0.23 $ 0.20 $ 0.19
Diluted .............................. 0.33 0.31 0.28 0.30 0.23 0.23 0.20 0.19
Adjusted earnings per common share (3) (5):
Basic ................................. 0.34 0.32 0.28 0.30 0.28 0.28 0.25 0.24
Diluted ............................... 0.33 0.31 0.28 0.30 0.28 0.28 0.25 0.24
Market price (5)
(NASDAQ:FNFG):
High ................................. $ 32.04 $ 32.10 $ 29.99 $ 19.45 $ 17.45 $ 17.90 $ 15.99 $ 12.00
Low .................................. 25.95 26.66 17.00 15.70 15.20 12.76 10.75 10.75
Close ................................ 26.12 31.59 27.76 17.44 16.83 15.87 15.53 11.19
Cash Dividends (5) ........................ $ 0.11 $ 0.11 $ 0.11 $ 0.10 $ 0.10 $ 0.09 $ 0.09 $ 0.08
(1) On October 25, 2002, the Company sold its Lacona Banking Center. In
connection with this transaction, $2.6 million of assets and $26.4 million
of deposits were sold, which resulted in a pre-tax gain of $2.4 million.
(2) 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. For accounting purposes, First Niagara is
required to record a 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 Company's decision
to combine its three subsidiary banks, First Niagara could no longer make
this assertion and accordingly, recorded a $1.8 million tax liability in
the second quarter of 2002. It is anticipated that this tax liability will
be repaid over the next 10-15 years.
(3) With the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets"
on January 1, 2002, the Company is no longer required to amortize
goodwill. Accordingly, for the prior periods presented, goodwill
amortization has been excluded from adjusted amounts for consistency
purposes. The remaining amortization relates to identifiable intangible
assets.
(4) FNFG completed its initial public offering on April 17, 1998. In
connection with the completion of the conversion, FNFG contributed $4.0
million, net of applicable income taxes to the First Niagara Foundation.
Noninterest expense includes $6.8 million for the one-time contribution of
cash and common stock. The following presentation excludes the effect of
the contribution, and the earnings per share calculation includes pro
forma earnings of $0.10 per share for the period January 1, 1998 through
April 17, 1998. (Dollars in thousands except per share amounts):
Net income................................ $14,366
Net income per share (5):
Basic.................................. $ 0.50
Diluted................................ $ 0.50
Return on average assets.................. 1.07%
Return on average equity.................. 6.43%
As a percentage of average assets:
Noninterest expense.................... 2.18%
Net overhead........................... 1.50%
Efficiency ratio.......................... 54.90%
(5) Share and per share data have not been restated to give retroactive
recognition to the 2.58681 exchange ratio applied in the January 17, 2003
conversion.
(6) Excludes net gain/loss on securities available for sale.
(7) Effective November 8, 2002, First Niagara converted to a federal charter
subject to OTS capital requirements. These capital requirements apply only
to First Niagara, and do not consider additional capital retained by FNFG.
Prior to converting to federal charters, FNFG and First Niagara were
required to maintain minimum capital ratios calculated in a similar manner
to, but not entirely the same as, the framework of the OTS. Amounts prior
to 2002 have not been recomputed to reflect OTS requirements.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The following is an analysis of the financial condition and results of
operations of the Company, which should be read in conjunction with the
consolidated financial statements and related notes filed herewith in Part II,
Item 8, "Financial Statements and Supplementary Data." 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. As discussed further in note 2
of the "Notes to Consolidated Financial Statements," as a result of the
Conversion and Offering former public stockholders of FNFG received an exchange
ratio of 2.58681 new shares for each share of FNFG held as of the close of
business on January 17, 2003. Share and per share data have not been restated in
this annual report on Form 10-K to give retroactive recognition to the exchange
ratio.
ANALYSIS OF FINANCIAL CONDITION
Overview
Total assets increased to $2.93 billion at December 31, 2002 from $2.86 billion
at December 31, 2001. This $76.8 million, or 3%, increase was primarily a result
of a $15.9 million and $121.4 million increase in cash and cash equivalents and
net loans, respectively, partially offset by a decrease in securities available
for sale of $61.5 million. The increase in cash and cash equivalents is mainly
attributable to the decrease in securities available for sale and a $138.6
million increase in deposits from December 31, 2001 to December 31, 2002, the
excess funds from which were invested in short-term assets in anticipation of
rising interest rates. During 2002, the Company continued to shift its loan
portfolio mix from one- to four-family real estate loans to higher yielding
commercial real estate, multi-family, commercial construction and commercial
business loans (commercial loans). As a result, commercial loans increased
$168.8 million or 29% from December 31, 2001 to December 31, 2002, while one- to
four-family real estate loans decreased $55.7 million or 6% during the same
period.
During 2001, total assets increased $233.3 million, or 9%, from $2.62 billion at
December 31, 2000, primarily due to an increase in net loans and investment
securities available for sale of $30.0 million and $192.1 million, respectively.
Total liabilities increased from $2.4 billion at December 31, 2000 to $2.6
billion at December 31, 2001. Of this $217.2 million increase, approximately
$84.5 million was attributable to growth in deposits, while $129.5 million can
be attributed to an increase in borrowings.
Lending Activities
Loan Portfolio Composition. Set forth below is selected information concerning
the composition of the Company's loan portfolio in dollar amounts and in
percentages as of the dates indicated.
At December 31,
-------------------------------------------------------------------------------------
2002 2001 2000 1999
-------------------- -------------------- -------------------- -------------------
Amount Percent Amount Percent Amount Percent Amount Percent
---------- ------- ---------- ------- ------- ------- --------- -------
(Dollars in thousands)
Real estate loans:
One- to four-family ...... $ 927,453 46.54% $ 980,638 52.44% $1,089,607 59.21% $ 609,742 61.55%
Home equity .............. 136,986 6.87 114,443 6.12 104,254 5.67 22,499 2.27
Multi-family ............. 170,357 8.55 133,439 7.13 111,668 6.07 74,652 7.54
Commercial ............... 303,136 15.21 259,457 13.87 217,759 11.83 120,758 12.19
Construction (1) ......... 107,200 5.38 64,502 3.45 35,059 1.91 28,413 2.87
---------- ------ ---------- ------ ---------- ------ --------- ------
Total real estate loans ..... 1,645,132 82.55 1,552,479 83.01 1,558,347 84.69 856,064 86.42
Total consumer loans ........ 169,155 8.49 182,126 9.74 188,129 10.22 110,233 11.13
Total commercial business
loans .................... 178,555 8.96 135,621 7.25 93,730 5.09 24,301 2.45
---------- ------ ---------- ------ ---------- ------ --------- ------
Total loans ................. 1,992,842 100.00% 1,870,226 100.00% 1,840,206 100.00% 990,598 100.00%
========== ====== ========== ====== ========== ====== ========= ======
Net deferred costs and
unearned discounts ....... 2,591 1,642 714 4,892
Allowance for credit losses . (20,873) (18,727) (17,746) (9,862)
---------- ---------- ---------- ---------
Total loans, net ............ $1,974,560 $1,853,141 $1,823,174 $ 985,628
========== ========== ========== =========
At December 31,
--------------------
1998
--------------------
Amount Percent
---------- -------
(Dollars in thousands)
Real estate loans:
One- to four-family ...... $ 456,197 60.97%
Home equity .............. 15,520 2.07
Multi-family ............. 72,672 9.71
Commercial ............... 98,693 13.19
Construction (1) ......... 19,476 2.60
--------- ------
Total real estate loans ..... 662,558 88.54
Total consumer loans ........ 79,059 10.58
Total commercial business
loans .................... 6,616 0.88
--------- ------
Total loans ................. 748,233 100.00%
========= ======
Net deferred costs and
unearned discounts ....... 4,516
Allowance for credit losses . (8,010)
---------
Total loans, net ............ $ 744,739
========
(1) Construction loans consist primarily of commercial construction loans and
to a lesser extent residential construction loans. See note 5 to the
Consolidated Financial Statements.
27
Total loans outstanding at December 31, 2002 increased 7% to $1.99 billion from
the December 31, 2001 balance of $1.87 billion. During 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 to
improve net interest margins and to diversify the loan portfolio. Commercial
loans increased $168.8 million or 29% from December 31, 2001 to December 31,
2002, while one- to four-family real estate loans decreased $55.7 million or 6%
during the same period. This shift was primarily achieved through continued
emphasis on the origination of variable-rate commercial loans through the
Company's Commercial Business Banking unit and management's asset/liability
strategy of selling the majority of longer-term fixed rate residential mortgage
loans originated, which should benefit the Company during periods of higher
interest rates. Additionally, during 2002 home equity loans increased $22.5
million, or 20%, as a result of the low interest rate environment and sales
efforts by the Company, while consumer loans decreased $13.0 million due to
decreased emphasis on these types of loans.
During 2001, loans increased $30.0 million from $1.84 billion at December 31,
2000. This increase is mainly attributable to commercial loans, which increased
$132.6 million, or 29% for 2001, which was almost entirely offset by a decrease
in one- to four-family residential mortgage loans of $106.7 million for the same
period. These variances were a result of management's strategy, which began in
2000, of transforming the Company's loan portfolio to become more commercial
bank-like, as discussed above. Additionally, home equity loans increased $10.2
million, or 10%, from December 31, 2000 to December 31, 2001.
Allocation of Allowance for Credit Losses. The following table sets forth the
allocation of the allowance for credit losses by loan category as of the dates
indicated.
At December 31,
-------------------------------------------------------------------------------
2002 2001 2000
---------------------- ----------------------- ----------------------
Percent Percent Percent
of loans of loans of loans
Amount of in each Amount of in each Amount of in each
allowance category allowance category allowance category
for credit to total for credit to total for credit to total
losses loans losses loans losses loans
--------- -------- --------- -------- ---------- ----------
(Dollars in thousands)
One- to four-family ......................... $ 1,828 47% $ 1,996 53% $ 3,248 59%
Home equity ................................. 524 7 614 6 885 6
Commercial real estate and multi-family ..... 4,917 29 4,824 24 4,027 19
Consumer .................................... 3,811 8 3,379 10 3,014 11
Commercial business ......................... 7,329 9 4,883 7 4,307 5
Unallocated ................................. 2,464 -- 3,031 -- 2,265 --
------- --- ------- --- ------- ---
Total .................................... $20,873 100% $18,727 100% $17,746 100%
======= === ======= === ======= ===
At December 31,
-------------------------------------------------
1999 1998
------------------------ ----------------------
Percent Percent
of loans of loans
Amount of in each Amount of in each
allowance category allowance category
for credit to total for credit to total
losses loans losses loans
--------- --------- --------- --------
(Dollars in thousands)
One- to four-family ......................... $1,522 62% $1,155 61%
Home equity ................................. 352 2 237 2
Commercial real estate and multi-family ..... 1,944 22 1,809 25
Consumer .................................... 1,739 12 1,177 11
Commercial business ......................... 1,790 2 599 1
Unallocated ................................. 2,515 -- 3,033 --
------ --- ------ ---
Total .................................... $9,862 100% $8,010 100%
====== === ====== ===
28
The allowance for credit losses increased $2.1 million, or 11%, from $18.8
million at December 31, 2001 to $20.9 million at December 31, 2002. This
increase is primarily attributable to a $2.4 million increase in the reserve on
commercial business loans due to a 32% increase in the aggregate balance of
these loans from the end of 2001, as well as the increased charge-offs
experienced on these loans in 2002. Additionally, the amount of the allowance
for credit losses allocated to consumer loans increased $432 thousand from the
end of 2001 to the end of 2002 as a result of the increased charge-offs relating
to the Company's overdraft protection service. These increases were partially
offset by a decrease in the amount of the allowance for credit losses allocated
to one- to four-family and commercial real estate loans as a result of a decline
in the aggregate balance and the amount of non-accrual loans related to these
loans, respectively. The allowance for credit losses increased as a percentage
of total loans to 1.05% at December 31, 2002, compared to 1.00% at December 31,
2001.
The allowance for credit losses increased $981 thousand, or 6%, from December
31, 2000 to December 31, 2001. This increase can primarily be attributed to the
increase in delinquent and non-accrual commercial loans in 2001. Additionally,
the unallocated reserve increased $766 thousand as a result of the economic
downturn in 2001 and the trend observed near the end of 2001 of increased
balances in classified and non-accruing loans. These increases were partially
offset by a decrease in the amount of allowance for credit losses allocated to
one- to four-family residential mortgage loans primarily due to the decline in
the aggregate balance of these loans.
While management uses available information to recognize losses on loans, future
credit loss provisions may be necessary based on changes in economic conditions.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the allowance for credit losses and may
require the Company to recognize additional provisions based on their judgment
of information available to them at the time of their examination. To the best
of management's knowledge, the allowance for credit losses includes all known
and inherent losses at each reporting date that are both probable and reasonable
to estimate. However, there can be no assurance that the allowance for loan
losses will be adequate to cover all losses that may in fact be realized in the
future or that additional provisions for loan losses will not be required.
Non-Accruing Loans and Non-Performing Assets. The following table sets forth
information regarding non-accruing loans and other non-performing assets.
At December 31,
---------------------------------------------------
2002 2001 2000 1999 1998
------ ------- ------ ------ ------
(Dollars in thousands)
Non-accruing loans (1):
Real estate:
One- to four-family .............. $4,071 $ 4,833 $3,543 $ 974 $1,459
Home equity ...................... 332 491 641 130 13
Commercial and multi-family ...... 1,225 2,402 926 640 1,706
Consumer ............................ 652 510 515 33 62
Commercial business ................. 1,198 3,244 858 152 56
------ ------- ------ ------ ------
Total non-accruing loans ............... 7,478 11,480 6,483 1,929 3,296
------ ------- ------ ------ ------
Non-performing assets:
Real estate owned (2) ............... 1,423 665 757 1,073 589
------ ------- ------ ------ ------
Total non-performing assets (3) ........ $8,901 $12,145 $7,240 $3,002 $3,885
====== ======= ====== ====== ======
Total non-performing assets as a
percentage of total assets (3) ...... 0.30% 0.42% 0.28% 0.18% 0.26%
====== ======= ====== ====== ======
Total non-accruing loans to
total loans (3) ..................... 0.38% 0.61% 0.35% 0.19% 0.44%
====== ======= ====== ====== ======
(1) Loans generally are placed on non-accrual status when they become 90 days
or more past due or if they have been identified by the Company as
presenting uncertainty with respect to the collectibility of interest or
principal.
(2) Real estate owned balances are shown net of related allowances.
(3) Excludes loans that are 90 days or more past due but are still accruing
interest, which is primarily comprised of loans that have matured and the
Company has not formally extended the maturity date. Regular principal and
interest payments continue in accordance with the original terms of the
loan. The Company continued to accrue interest on these loans as long as
regular payments received were less than 90 days delinquent. These loans
totaled $510 thousand, $221 thousand and $379 thousand at December 31,
2001, 2000 and 1999, respectively. There were no such loans at December
31, 2002 and 1998.
29
Non-accruing loans were $7.5 million at December 31, 2002 compared to $11.5
million at December 31, 2001. This decrease is the result of the Company's
continued focus on credit quality and resolving classified credits, as well as
the "deed in lieu" transfer to REO of a commercial real estate participation
loan in the fourth quarter of 2002. This transfer resulted in a $1.9 million
decrease in non-accrual loans from December 31, 2001 and caused REO and net
charge-offs at and for the year ended December 31, 2002 to increase $975
thousand and $889 thousand, respectively. Interest income that would have been
recorded if non-accrual loans had been performing in accordance with their
original terms amounted to $182 thousand for the year ended December 31, 2002.
The ratio of non-accruing loans to total loans decreased to 0.38% at December
31, 2002 from 0.61% at December 31, 2001.
Nonaccrual loans increased $5.0 million from December 31, 2000 to December 31,
2001. This increase was primarily attributable to the higher level of commercial
loans at the end of 2001 compared to 2000. Interest income that would have been
recorded if non-accrual loans had been performing in accordance with their
original terms amounted to $604 thousand for the year ended December 31, 2001.
The ratio of non-accruing loans to total loans increased to 0.61% at December
31, 2001 from 0.35% at December 31, 2000.
Investing Activities
Securities Portfolio. At December 31, 2002, all of the Company's security
investments were classified as available for sale in order to maintain
flexibility in satisfying future investment and lending requirements. The
following table sets forth certain information with respect to the amortized
cost and fair values of the Company's portfolio as of the dates indicated.
At December 31,
---------------------------------------------------------------------
2002 2001 2000
-------------------- -------------------- ----------------------
Amortized Fair Amortized Fair Amortized Fair
cost value cost value cost value
---------- -------- ---------- -------- ----------- ---------
Investment securities available for sale: (Dollars in thousands)
Debt securities:
U.S. Treasury ............................ $140,060 $140,054 $164,992 $165,120 $ 37,970 $ 38,216
U.S. Government agencies ................. 89,522 90,529 79,419 81,016 56,379 56,928
Corporate ................................ 14,665 14,563 27,264 27,026 8,209 8,193
States and political subdivisions ........ 32,957 34,566 26,696 27,208 23,548 23,948
---------- -------- ---------- -------- ---------- --------
Total debt securities .................... 277,204 279,712 298,371 300,370 126,106 127,285
---------- -------- ---------- -------- ---------- --------
Asset-backed securities ....................... 3,776 3,837 28,062 28,850 41,783 42,007
Equity securities ............................. 3,677 3,497 21,530 20,325 23,547 25,764
Other securities .............................. 4,953 4,999 4,453 4,471 4,453 4,444
---------- -------- ---------- -------- ---------- --------
Total investment securities ............. $289,610 $292,045 $352,416 $354,016 $195,889 $199,500
========== ======== ========== ======== ========== ========
Average remaining life of investment
securities (1) ............................. 2.31 years 2.09 years 3.75 years
========== ========== ==========
Mortgage-backed securities:
FHLMC .................................... $ 51,024 $ 52,960 $ 37,081 $ 38,339 $ 48,891 $ 49,526
GNMA ..................................... 9,910 10,569 16,094 16,799 22,645 23,016
FNMA ..................................... 12,619 13,790 18,213 19,169 18,668 19,447
CMOs ..................................... 262,161 263,000 265,489 265,574 215,181 210,345
---------- -------- ---------- -------- ---------- --------
Total mortgage-backed securities .......... $335,714 $340,319 $336,877 $339,881 $305,385 $302,334
========== ======== ========== ======== ========== ========
Average remaining life of mortgage-
backed securities (1) ...................... 1.64 years 4.82 years 6.41 years
========== ========== ==========
Net unrealized gains on available for sale
securities .................................. $ 7,040 $ 4,604 $ 560
---------- ---------- ----------
Total securities available for sale .... $632,364 $632,364 $693,897 $693,897 $501,834 $501,834
========== ======== ========== ======== ========== ========
Average remaining life of investment
securities available for sale (1) .......... 1.94 years 3.48 years 5.46 years
========== ========== ==========
(1) Average remaining life does not include common stock or other securities
available for sale and is computed utilizing estimated maturities and
prepayment assumptions.
30
The Company's investment securities available for sale decreased from $693.9
million at December 31, 2001 to $632.4 million at December 31, 2002. This $61.5
million decrease was primarily a result of the Company restructuring its
investment portfolio in 2002 by selling longer-term asset and mortgage backed
securities and equity securities as part of its asset/liability management
strategy and in order to comply with OTS regulations, which doesn't allow First
Niagara to hold equity securities. Additionally, any excess funds generated
during the year were used to purchase short-term investments (included in
securities available for sale and federal funds sold and other short-term
investments) in order to better match the maturities of the Company's short-term
liabilities. As a result, the average estimated remaining life of the investment
securities portfolio decreased from 3.48 years at December 31, 2001 to 1.94
years at December 31, 2002, which should benefit the Company during periods of
higher interest rates. The unrealized gain on investment securities increased
$2.4 million during 2002 mainly due to the declining interest rate environment,
which caused the Company's fixed income securities to appreciate in value.
During 2001, the Company's investment securities portfolio increased $192.1
million from $501.8 million at December 31, 2000. This increase primarily
resulted from the purchase of $155.0 million of U.S. Treasury securities in late
2001. Additionally, investment securities increased due to the investment of
excess funds generated from the sale and prepayment of fixed rate residential
real estate loans and the increase in deposits during 2001. These funds were
invested in shorter-term investments (included in securities available for sale
and federal funds sold and other short-term investments) in order to reduce the
Company's interest rate risk. The unrealized gain on investment securities
increased $4.0 million during 2001 mainly due to the declining interest rate
environment.
Funding Activities
Deposits. The following tables set forth information regarding the average daily
balance and rate of deposits by type for the years indicated.
For the year ended December 31,
------------------------------------------------------------------------------------------------------
2002 2001 2000
-------------------------------- -------------------------------- ------------------------------------
Percent of Percent of Percent of
total Weighted total Weighted total Weighted
Average average average Average average average Average average average
balance deposits rate balance deposits rate balance deposits rate
----------- ---------- -------- ---------- ---------- -------- ---------- ---------- --------
(Dollars in thousands)
Money market accounts ...... $ 344,580 16.29% 1.87% $ 391,745 20.10% 3.66% $ 295,588 21.56% 5.02%
Savings accounts ........... 590,965 27.93 2.16 417,256 21.41 2.62 338,475 24.69 2.77
NOW accounts ............... 162,725 7.69 0.83 153,373 7.87 1.01 116,190 8.48 1.02
Noninterest-bearing accounts 115,977 5.48 -- 90,023 4.62 -- 46,799 3.41 --
---------- ------ ---------- ----- ---------- ------
Total transaction
accounts .............. 1,214,247 57.39 1.69 1,052,397 54.00 2.55 797,052 58.14 3.19
Mortgagors' payments held in
escrow ................... 17,579 0.83 1.69 19,198 0.98 1.71 14,959 1.09 1.74
---------- ------ ---------- ----- ---------- ------
Total ................... 1,231,826 58.22 1.69 1,071,595 54.98 2.53 812,011 59.23 3.16
---------- ------ ---------- ----- ---------- ------
Certificates of deposit:
Less than 6 months ......... 292,232 13.81 3.77 342,596 17.58 5.55 201,279 14.67 N/A
Over 6 through 12 months ... 231,044 10.92 3.45 241,709 12.40 5.34 168,686 12.31 N/A
Over 12 through 24 months .. 150,986 7.14 3.72 100,549 5.16 5.20 83,437 6.09 N/A
Over 24 months ............. 38,128 1.80 4.85 34,295 1.76 5.56 18,046 1.32 N/A
Over $100,000 .............. 171,477 8.11 3.70 158,279 8.12 5.18 87,412 6.38 N/A
---------- ------ ---------- ----- ---------- ------
Total certificates of
deposit ............... 883,867 41.78 3.71 877,428 45.02 5.39 558,860 40.77 5.47
---------- ------ ---------- ----- ---------- ------
Total average deposits .. $2,115,693 100.00% 2.54% $1,949,023 100.00% 3.82% $1,370,871 100.00% 4.10%
========== ====== ========== ====== ========== ======
N/A - Information is not available.
31
Total deposits increased $138.6 million from $1.99 billion at December 31, 2001
to $2.13 billion at December 31, 2002. This increase was a result of the
Company's focus on increasing its customer base, which included the opening of
two new banking centers and the introduction of a money market savings account
in 2002. As a result, savings accounts increased $182.1 million from December
31, 2001 to December 31, 2002. Additionally, non-interest bearing deposits
increased $24.3 million or 22% during 2002 as a result of a "totally free"
checking product introduced in late 2001, an increase in commercial business
relationships and the popularity of the Company's bi-weekly mortgage product,
which generally results in new deposit relationships, as customers have loan
repayments made directly from a deposit account. These increases were partially
offset by the sale of the Lacona Banking Center in 2002, which was outside of
the Company's strategic market area, and resulted in a $26.4 million deposit
outflow.
Total deposits increased $84.5 million, or 4% during 2001 from $1.91 billion at
December 31, 2000. This increase was generally across all product lines and was
a result of the Company's focus on increasing its customer base, which included
the opening of a new banking center. Additionally, noninterest-bearing deposits
increased $23.7 million during 2001 primarily due to an increase in commercial
business accounts and the popularity of the Company's bi-weekly mortgage
product.
Borrowings. The following table sets forth certain information as to the
Company's borrowings for the years indicated.
At or for the year ended December 31,
-------------------------------------
2002 2001 2000
-------- -------- --------
(Dollars in thousands)
Period end balance:
FHLB advances ............................ $236,003 $315,416 $294,876
Reverse repurchase agreements ............ 155,132 235,124 118,691
Other borrowings ......................... 6,000 8,500 16,000
-------- -------- --------
Total borrowings ......................... $397,135 $559,040 $429,567
======== ======== ========
Maximum balance:
FHLB advances ............................ $315,416 $315,416 $314,043
Reverse repurchase agreements ............ 235,124 235,124 137,365
Other borrowings ......................... 8,500 16,000 16,000
Average balance:
FHLB advances ............................ $249,974 $277,813 $224,014
Reverse repurchase agreements ............ 157,890 136,452 121,339
Other borrowings ......................... 6,201 11,278 2,606
Period end weighted average interest rate:
FHLB advances ............................ 5.52% 5.01% 6.05%
Reverse repurchase agreements ............ 5.09% 3.97% 5.77%
Other borrowings ......................... 2.19% 3.01% 8.64%
Borrowed funds decreased to $397.1 million at December 31, 2002 from $559.0
million at December 31, 2001. This $161.9 million decrease, as well as the
increase in period end weighted average interest rate, was the result of the
maturity of $140.0 million of FHLB advances and reverse repurchase agreements
during 2002, which had been utilized to purchase U.S. Treasury securities at the
end of 2001. Excluding these funds, borrowings decreased $21.9 million as cash
on hand, as well as funds from the decrease in investment securities and the
increase in deposits for 2002, were more than adequate to meet the funding needs
of the Company.
During 2001, borrowed funds increased $129.5 million from $429.6 million at
December 31, 2000. This increase was almost exclusively attributable to the
$140.0 million of FHLB advances and reverse repurchase agreements utilized to
purchase U.S. Treasury securities near the end of 2001. Excluding these funds,
borrowings decreased $10.5 million from December 31, 2000 to December 31, 2001.
32
Equity Activities
Stockholders' equity increased to $283.7 million at December 31, 2002 compared
to $260.6 million at December 31, 2001. This increase was primarily attributable
to net income during 2002 of $30.8 million partially offset by common stock
dividends declared of $0.43 per share, which reduced stockholders' equity by
$10.8 million. During 2002, stockholders' equity also increased $3.6 million
from the exercise of stock options and vesting of restricted stock and ESOP
shares. Additionally, a decrease in interest rates during 2002 resulted in a
$1.5 million (net of tax) increase in the unrealized gain on investment
securities available for sale included in accumulated other comprehensive
income. This increase was partially offset by a $2.2 million (net of tax)
reduction of accumulated other comprehensive income related to the minimum
pension liability recorded by the Company due to the underfunded status of its
defined benefit pension plan. This underfunded status was primarily a result of
the weak equity markets and the lower interest rate environment over the last
several years, which caused the fair value of the Company's pension plan assets
to fall below the plans' accumulated benefit obligation. Accordingly, in the
fourth quarter of 2002, the Company was required to record an additional minimum
pension liability and a charge to stockholders' equity. As of December 31, 2002,
the Company has met all ERISA minimum funding requirements. See note 16 of the
"Notes to Consolidated Financial Statements" filed herewith in Part II, Item 8,
"Financial Statements and Supplementary Data" for further details.
The increase in stockholders' equity of $16.1 million from December 31, 2000 to
December 31, 2001 was primarily attributable to net income of $21.2 million.
Additionally, accumulated other comprehensive income increased $2.4 million as a
result of the increase in the unrealized gain on securities available for sale.
These increases were partially offset by the payment of dividends of $9.0
million during 2001.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002 AND DECEMBER 31,
2001
Net Income
Net income for the year ended December 31, 2002 increased 45% to $30.8 million,
or $1.21 per diluted share from $21.2 million, or $0.85 per diluted share for
the year ended December 31, 2001. On January 1, 2002, the Company was required
to adopt a new accounting standard, which no longer permits goodwill to be
amortized. Adjusting 2001 amounts to exclude the effects of goodwill
amortization, similar to the 2002 results, net income for 2002 increased $4.8
million or 19% from 2001. Net income for 2002 represented an annualized return
on average stockholders' equity of 11.22% as compared to 10.16% for 2001,
adjusted for goodwill amortization. Net income growth in 2002 can mainly be
attributed to a $12.5 million increase in net interest income as a result of the
declining interest rate environment in 2002, expansion of the Company's
noninterest income and effective cost control. During 2002 the Company recorded
a $1.8 million tax charge related to the recapture of excess bad debt reserves
for New York State tax purposes, triggered by its decision to combine its three
banking subsidiaries. Additionally, during 2002 the Company realized $998
thousand in gains from the curtailment of its defined benefit pension plan, a
$2.4 million gain from the sale of its Lacona Banking Center and recorded $1.0
million of losses from investment securities.
33
Net Interest Income
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. No tax equivalent adjustments were made. All
average balances are average daily balances. Non-accruing loans have been
excluded from the yield calculations in this table.
For the year ended December 31,
------------------------------------------------------------------------
2002 2001
Average Interest Average Interest
outstanding earned/ outstanding earned/
balance paid Yield/rate balance paid Yield/rate
------------ ------- ---------- ---------- ------- ----------
(Dollars in thousands)
Interest-earning assets:
Federal funds sold and other short-term
investments ................................. $ 137,639 $ 2,446 1.78% $ 39,533 $ 1,503 3.80%
Investment securities (1) ....................... 192,992 7,496 3.88 206,415 10,888 5.27
Mortgage-backed securities (1) .................. 320,569 16,100 5.02 312,863 20,138 6.44
Loans (2) ....................................... 1,920,101 140,459 7.32 1,845,812 144,274 7.82
Other interest-earning assets (3) ............... 25,841 1,136 4.40 24,544 1,565 6.38
----------- -------- ------ ----------- -------- -----
Total interest-earning assets ................. 2,597,142 $167,637 6.45% 2,429,167 $178,368 7.34
----------- -------- ------ ----------- -------- -----
Allowance for credit losses ....................... (19,815) (18,469)
Other noninterest-earning assets (4)(5) ........... 275,472 268,633
----------- -----------
Total assets .................................. $ 2,852,799 $ 2,679,331
=========== ===========
Interest-bearing liabilities:
Savings accounts ................................ $ 590,965 $ 12,750 2.16% $ 417,256 $ 10,919 2.62%
NOW and money market accounts ................... 507,305 7,791 1.54 545,118 15,878 2.91
Certificates of deposit ......................... 883,867 32,774 3.71 877,428 47,284 5.39
Mortgagors' payments held in escrow ............. 17,579 296 1.69 19,198 328 1.71
Borrowed funds .................................. 414,065 22,496 5.43 425,543 24,943 5.86
----------- -------- ------ ----------- -------- -----
Total interest-bearing liabilities ............ 2,413,781 $ 76,107 3.15% 2,284,543 $ 99,352 4.35%
----------- -------- ------ ----------- -------- -----
Noninterest-bearing deposits ...................... 115,977 90,023
Other noninterest-bearing liabilities ............. 48,508 49,128
----------- -----------
Total liabilities ............................. 2,578,266 2,423,694
Stockholders' equity (4) .......................... 274,533 255,637
----------- -----------
Total liabilities and
stockholders' equity .................. $ 2,852,799 $ 2,679,331
=========== ===========
Net interest income ............................... $ 91,530 $ 79,016
======== ========
Net interest rate spread .......................... 3.30% 2.99%
====== =====
Net earning assets ................................ $ 183,361 $ 144,624
=========== ===========
Net interest income as a percentage of average
interest-earning assets ....................... 3.52% 3.25%
======== ========
Ratio of average interest-earning assets to average
interest-bearing liabilities .................. 107.60% 106.33%
=========== ===========
For the year ended December 31,
------------------------------------
2000
Average Interest
outstanding earned/
balance paid Yield/rate
----------- -------- ----------
(Dollars in thousands)
Interest-earning assets:
Federal funds sold and other short- term
investments ................................. $ 12,312 $ 771 6.26%
Investment securities (1) ....................... 159,464 8,804 5.52
Mortgage-backed securities (1) .................. 361,890 24,045 6.64
Loans (2) ....................................... 1,288,978 101,825 7.90
Other interest-earning assets (3) ............... 24,186 1,595 6.59
----------- -------- -----
Total interest-earning assets ................. 1,846,830 $137,040 7.42%
----------- -------- -----
Allowance for credit losses ....................... (12,766)
Other noninterest-earning assets (4)(5) ........... 157,968
-----------
Total assets .................................. $ 1,992,032
===========
Interest-bearing liabilities:
Savings accounts ................................ $ 338,475 $ 9,380 2.77%
NOW and money market accounts ................... 411,778 16,038 3.89
Certificates of deposit ......................... 558,860 30,593 5.47
Mortgagors' payments held in escrow ............. 14,959 261 1.74
Borrowed funds .................................. 347,959 20,590 5.92
----------- -------- -----
Total interest-bearing liabilities ............ 1,672,031 $ 76,862 4.60%
----------- -------- -----
Noninterest-bearing deposits ...................... 46,799
Other noninterest-bearing liabilities ............. 40,253
-----------
Total liabilities ............................. 1,759,083
Stockholders' equity (4) .......................... 232,949
-----------
Total liabilities and
stockholders' equity .................. $ 1,992,032
===========
Net interest income ............................... $ 60,178
========
Net interest rate spread .......................... 2.82%
=====
Net earning assets ................................ $ 174,799
===========
Net interest income as a percentage of average
interest-earning assets ....................... 3.26%
========
Ratio of average interest-earning assets to average
interest-bearing liabilities .................. 110.45%
========
(1) Amounts shown are at amortized cost.
(2) Net of deferred costs, unearned discounts, negative balance deposits
reclassified to loans and non-accruing loans.
(3) Primarily includes FHLB stock.
(4) Includes unrealized gains/losses on securities available for sale.
(5) Includes bank-owned life insurance, earnings from which are reflected in
other noninterest income, and non-accruing loans.
34
Net interest income rose 16% to $91.5 million for the year ended December 31,
2002 from $79.0 million for the year ended December 31, 2001. Additionally, the
Company's net interest margin increased to 3.52% for 2002 from 3.25% for 2001.
The increase in net interest income and margin resulted primarily from a 31
basis point increase in the net interest rate spread, as the Company's
interest-bearing liabilities repriced faster than its interest-earning assets
during the declining rate environment in 2002. Additionally, the Company's net
interest rate spread benefited in 2002 from the redeployment of funds from lower
yielding residential mortgages into 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 $144.6 million for 2001 to $183.4
million for 2002, which was primarily funded by a $26.0 million, increase in
average noninterest-bearing demand deposits. Management anticipates that the
Company's net interest margin will decline in 2003 as the proceeds from the
stock offering are invested in lower yielding short-term investments with
minimal extension risk, and as the Company's assets begin to reprice faster than
its liabilities due to the continuation of the low interest rate environment and
competitive interest rate floors on the Company's deposit products.
Rate/Volume Analysis. The following table presents the extent to which changes
in interest rates and changes in the volume of interest-earning assets and
interest-bearing liabilities have affected the Company's interest income and
interest expense during the years indicated. Information is provided in each
category with respect to: (i) changes attributable to changes in volume (changes
in volume multiplied by prior rate); (ii) changes attributable to changes in
rate (changes in rate multiplied by prior volume); and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
For the year ended December 31,
--------------------------------------------------------------------
2002 vs. 2001 2001 vs. 2000
------------------------------- -------------------------------
Increase/(decrease) Total Increase/(decrease) Total
due to increase due to increase
Volume Rate (decrease) Volume Rate (decrease)
------ ---- ---------- ------ ---- ----------
(In thousands)
Interest-earning assets:
Federal funds sold and other short-term investments .. $ 2,095 $ (1,152) $ 943 $ 1,136 $ (404) $ 732
Investment securities ................................ (671) (2,721) (3,392) 2,499 (415) 2,084
Mortgage-backed securities ........................... 485 (4,523) (4,038) (3,185) (722) (3,907)
Loans ................................................ 5,663 (9,478) (3,815) 43,488 (1,039) 42,449
Other interest-earning assets ........................ 79 (508) (429) 23 (53) (30)
-------- -------- -------- -------- --------- --------
Total interest-earning assets ........................... $ 7,651 $(18,382) $(10,731) $ 43,961 $ (2,633) $ 41,328
-------- -------- -------- -------- --------- --------
Interest-bearing liabilities:
Savings accounts ..................................... $ 3,968 $ (2,137) $ 1,831 $ 2,076 $ (537) $ 1,539
NOW and money market accounts ........................ (1,035) (7,052) (8,087) 4,464 (4,624) (160)
Certificates of deposit .............................. 345 (14,855) (14,510) 17,169 (478) 16,691
Mortgagors' payments held in escrow .................. (27) (5) (32) 72 (5) 67
Borrowed funds ....................................... (661) (1,786) (2,447) 4,554 (201) 4,353
-------- -------- -------- -------- --------- --------
Total interest-bearing liabilities ...................... $ 2,590 $(25,835) $(23,245) $ 28,335 $ (5,845) $ 22,490
======== ======== ======== ======== ========= ========
Net interest income ..................................... $ 12,514 $ 18,838
======== ========
Interest income decreased $10.7 million to $167.6 million for the year ended
December 31, 2002 compared to $178.4 million for the year ended December 31,
2001. This reflects an 89 basis point decrease in the overall yield on
interest-earning assets from 7.34% for 2001 to 6.45% for 2002. This primarily
resulted from the lower interest rate environment in 2002, 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 reduced by management's strategic decision
to invest excess funds in lower yielding short-term investments with minimal
extension risk or potential market value fluctuations in anticipation of rising
interest rates. The decreased rate earned on interest-earning assets was
partially offset by an increase in average interest-earning asset balances to
$2.60 billion for 2002 from $2.43 billion for 2001 as a result of increased
funding from deposits.
Interest expense decreased to $76.1 million for the year ended December 31, 2002
compared to $99.4 million for the year ended December 31, 2001. This $23.2
million decline is primarily due to the 120 basis point decrease in the rate
paid on interest-bearing liabilities from 4.35% to 3.15% due to the lower
interest rate environment in 2002 as compared to 2001. This decreased rate paid
on interest-bearing liabilities was partially offset by an increase in the
average balance of interest-bearing liabilities to $2.41 billion for 2002 from
$2.28 billion for 2001. More specifically, the average balance of interest
bearing deposits increased $140.7 million when comparing 2002 to 2001, while the
average balance of borrowed funds decreased $11.5 million for the same period.
35
Provision for Credit Losses
The following table sets forth the analysis of the allowance for credit losses,
including charge-off and recovery data, for the years indicated.
For the year ended December 31,
-------------------------------------------------------
2002 2001 2000 1999 1998
------- -------- ------- ------- -------
(Dollars in thousands)
Balance at beginning of year .......... $18,727 $17,746 $ 9,862 $ 8,010 $ 6,921
Charge-offs:
Real estate:
One- to four- family ............ 370 382 175 101 14
Home equity ..................... -- 158 28 35 --
Multi-family .................... -- -- 53 84 177
Commercial ...................... 390 901 78 62 581
Consumer ........................... 2,572 1,571 534 447 428
Commercial business ................ 2,472 1,059 204 6 52
------- ------- ------- ------- -------
Total ........................ 5,804 4,071 1,072 735 1,252
------- ------- ------- ------- -------
Recoveries:
Real estate:
One- to four- family ............ 107 30 22 -- --
Home equity ..................... -- -- 13 -- --
Multi-family .................... -- -- 30 37 --
Commercial ...................... 270 268 1 4 155
Consumer ........................... 536 425 224 80 98
Commercial business ................ 213 169 47 -- 4
------- ------- ------- ------- -------
Total ........................ 1,126 892 337 121 257
------- ------- ------- ------- -------
Net charge-offs ....................... 4,678 3,179 735 614 995
Provision for credit losses ........... 6,824 4,160 2,258 2,466 2,084
Allowance obtained through acquisitions -- -- 6,361 -- --
------- ------- ------- ------- -------
Balance at end of year ................ $20,873 $18,727 $17,746 $ 9,862 $ 8,010
======= ======= ======= ======= =======
Ratio of net charge-offs to average
loans outstanding during the year . 0.24% 0.17% 0.06% 0.07% 0.15%
======= ======= ======= ======= =======
Ratio of allowance for credit losses
to total loans .................... 1.05% 1.00% 0.96% 0.99% 1.06%
======= ======= ======= ======= =======
Ratio of allowance for credit losses
to non-accruing loans ............. 279.13% 163.13% 273.73% 511.25% 243.02%
======= ======= ======= ======= =======
Net charge-offs for 2002 amounted to $4.7 million compared to $3.2 million in
2001. This $1.5 million increase was primarily a result of having an increased
amount of higher-risk commercial business loans as a percentage of total loans
and the downturn in the economy. Additionally, consumer loan net charge-offs
increased $890 thousand when comparing 2002 to 2001, as a result of the
Company's overdraft protection service, initiated in the fourth quarter of 2001,
whose balances have a higher rate of charge-off than other consumer loans. Even
though this service results in higher net-charge-offs, the revenues received,
recorded in non-interest income, are in excess of the losses incurred. As a
percentage of average loans outstanding, net charge-offs increased to 0.24% for
2002 from 0.17% in 2001. As a result of the increased level of historical net
charge-offs the Company has experienced over the last two years, as well as the
increase in the aggregate balance of unseasoned higher risk commercial loans in
the Company's loan portfolio and the weaker economic conditions in 2002, the
Company increased the provision for credit losses to $6.8 million in 2002 from
$4.2 million in 2001. The provision for credit losses 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 loan composition and
inherent risk within the loan portfolio, the level of non-accruing loans and
charge-offs, as well as both current and historic economic conditions. The
Company establishes the provision for credit losses in order to maintain the
allowance for credit losses at a level which covers all known and inherent
losses in the loan portfolio that are both probable and reasonable to estimate.
36
Noninterest Income
For 2002 the Company had $49.7 million in noninterest income, an increase of 18%
over the $42.1 million for 2001. This increase was primarily due to the sale of
the Lacona Banking Center, which resulted in a $2.4 million pre-tax gain,
increased banking service charges and fee income, as well as increased revenue
from the Company's financial services subsidiaries. The primary driver for the
increased banking service charges and fee income for 2002 was the Company's
overdraft protection service, initiated in the fourth quarter of 2001, which
helped non-sufficient funds fees to increase $4.0 million. During 2002, the
Company benefited from strong annuity and insurance markets, which caused
financial services revenue to increase $2.5 million. These increases were
partially offset by a $1.1 million decrease in covered call option premium
income, as a result of the Company's decision to exit this program in 2002, and
increased losses incurred on investment securities of $961 thousand, which were
primarily due to weak equity markets. Noninterest income continues to be a
stable source of earnings for the Company, as it represented 35% of net revenue
for 2002.
Noninterest Expenses
Noninterest expenses totaled $84.4 million for the year ended December 31, 2002
representing a $1.4 million increase over the 2001 total of $83.0 million.
Adjusting 2001 amounts for the change in accounting for goodwill, noninterest
expense for 2002 increased $6.2 million. This increase is mainly attributable to
higher salaries and benefits expense of $4.2 million, higher technology and
communications expense of $1.5 million and increased marketing and advertising
costs of $490 thousand. During 2002, the Company incurred approximately $500
thousand of severance, $200 thousand of technology costs, $250 thousand in
marketing expenses and $375 thousand of professional fees and other costs in
connection with the consolidation of its three banks and the new "First Niagara"
branding campaign. These consolidation and branding costs are comparable to the
$700 thousand in expenses recorded in 2001 related to final integration costs
from the Company's acquisitions and severance from various reorganization
initiatives. In addition to the severance charges, the increase in salaries and
benefits from 2001 to 2002 was primarily due to internal growth and a $545
thousand increase in stock based compensation expense, primarily as a result of
the rise in the Company's stock price. These increases in salaries and benefits
were partially offset by a $998 thousand curtailment gain realized in 2002 from
the freezing of the Company's defined benefit pension plan. The increase in
technology and communications expense is mainly due to the consolidation related
costs mentioned above, internal growth and the upgrading of systems. Even with
the increase in noninterest expenses, the Company's efficiency ratio improved to
59.4% for 2002 from 64.6% for 2001, adjusted for goodwill.
Income Taxes
The effective tax rate increased to 38.3% for 2002 compared to 32.9% for 2001,
adjusted for goodwill amortization. Excluding the $1.8 million New York State
bad debt tax expense recapture charge, the effective tax rate for 2002 increased
to 34.8% as First Niagara Bank 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.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2001 AND DECEMBER 31,
2000
Net Income
For the year ended December 31, 2001, net income increased 9% to $21.2 million,
or $0.85 per diluted share as compared to $19.5 million, or $0.79 per diluted
share for 2000. Net income represented a return on average assets in 2001 of
0.79% compared to 0.98% in 2000 and a return on average equity in 2001 of 8.30%
compared to 8.38% in 2000.
Net Interest Income
Net interest income rose 31%, to $79.0 million for 2001 from $60.2 million for
2000. However, the Company's net interest margin decreased slightly to 3.25% for
2001 from 3.26% for 2000. The narrowing of the net interest margin resulted
primarily from a $30.2 million decline in average net earning assets to $144.6
million in 2001, as funds previously available for investment were utilized to
fund the Company's acquisition activity in 2000. This decrease in average net
earning assets was almost entirely offset by a 17 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. Additionally, the Company's net interest margin benefited in 2001 from the
redeployment of funds from lower yielding residential mortgages into higher
yielding commercial loans and the 92% increase in average noninterest bearing
deposits due to increased commercial business relationships and the popularity
of the Company's bi-weekly mortgage product.
37
Interest income rose to $178.4 million in 2001 from $137.0 million in 2000. This
$41.3 million, or 30%, increase was a result of growth in the Company's average
interest-earning assets of $582.3 million partially offset by a decrease in the
interest rate earned on those assets during 2001 of 8 basis points. Interest
income on loans increased $42.4 million to $144.3 million for 2001 from $101.8
million for 2000. This increase resulted from a $556.8 million increase in
average loans outstanding during 2001, due to the bank acquisitions in 2000 and
growth in commercial loans. Offsetting this increase was an 8 basis point
decrease in the average yield earned on loans caused by the lower interest rate
environment in 2001 partially offset by the change in the Company's loan
portfolio composition to higher yielding commercial loans. Interest earned on
investment securities decreased $1.8 million during 2001 primarily due to the
prepayments received on mortgage backed securities and the sale of
mortgage-backed securities in the second half of 2000 to fund acquisitions,
which caused the average balance on those investments to decrease $49.0 million.
The 2000 bank acquisitions added approximately $42.3 million of additional
interest income in 2001 compared to 2000, primarily from loans acquired and
internal growth.
Interest expense increased to $99.4 million for 2001 from $76.9 million for
2000. This $22.5 million, or 29%, increase is primarily attributable to the
increase in average interest-bearing liabilities of $612.5 million partially
offset by a decrease in the interest rate paid on those liabilities of 25 basis
points in 2001. Interest expense on deposits increased $18.1 million to $74.4
million for 2001 from $56.3 million for 2000. This resulted from a $534.9
million increase in average interest bearing deposits outstanding during 2001,
mainly due to the bank acquisitions in 2000 and internal growth, partially
offset by a decrease in the average rate paid on those deposits over the same
period. Interest expense on borrowed funds increased to $24.9 million for the
year ended December 31, 2001, compared to $20.6 million for the same period in
2000. This was a result of an increase in the average balance of borrowed funds
of $77.6 million in 2001 resulting from the bank acquisitions in 2000, partially
offset by a 6 basis point decrease in the average rate paid on those borrowings
over the same period. The decline in the rates paid on deposits and borrowings
can be attributed to the lower interest rate environment during 2001. Overall,
the 2000 bank acquisitions added approximately $22.4 million of additional
interest expense in 2001 compared to 2000.
Provision for Credit Losses
Net charge-offs for 2001 amounted to $3.2 million compared to $735 thousand in
2000. This $2.4 million increase was primarily a result of having a full year of
the Cayuga, Cortland and Albion acquisitions in 2001 versus a partial year in
2000. Additionally, net charge-offs increased due to an increase in commercial
loans as a percentage of total loans and the downturn in the economy. As a
percentage of average loans outstanding, net charge-offs increased to 0.17% for
2001 from 0.06% in 2000. Given the increase in non-accrual and delinquent loans,
the Company increased the provision for credit losses to $4.2 million for the
year ending December 31, 2001, from $2.3 million in 2000. Of this $1.9 million
increase, approximately $1.6 million related to Cortland and Cayuga which were
acquired in 2000.
Noninterest Income
Noninterest income increased $8.0 million, or 23%, to $42.1 million in 2001 from
$34.1 million in 2000. Revenue associated with the acquisitions resulted in $5.4
million of additional noninterest income for 2001, of which $3.1 million related
to bank service charges and fees and lending and leasing income from the banks
acquired and $1.1 million related to the acquisition of Allied. Other factors
that contributed to the overall increase in noninterest income included an
increase in gains on sales of mortgages of $1.0 million, due to the Company's
decision to sell the majority of fixed rate mortgage loans originated in 2001,
and an increase of $1.2 million in non-sufficient funds fee income primarily due
to the Company's new overdraft protection service. Noninterest income continues
to be a stable source of earnings for the Company, and represented 35% of total
revenue during 2001.
Noninterest Expenses
Noninterest expenses totaled $83.0 million for the year ended December 31, 2001
reflecting a $21.5 million, or 35%, increase over the 2000 total of $61.5
million. Approximately $19.2 million of this increase was attributable to the
acquisitions and was primarily in salaries and employee benefits and the
amortization of goodwill. Overall, salaries and employee benefits were $46.0
million in 2001 compared with $34.2 million in 2000. During 2001, the Company's
noninterest expense was impacted by the increased amortization of goodwill and
other intangibles associated with its acquisitions, which increased $2.7 million
when compared to 2000. Other increases in noninterest expenses related to
internal growth, which included the ongoing upgrades of technology and
communications systems that will facilitate future expansion and $700 thousand
of costs which were related to final integration costs from the Company's
acquisitions and severance from various reorganization initiatives.
38
Income Taxes
The effective tax rate increased to 37.4% in 2001 from 36.0% in 2000, primarily
due to the nondeductible amortization of goodwill and other intangibles related
to the acquisitions.
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 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 2002,
loan originations totaled $764.9 million compared to $534.3 million and $419.5
million for 2001 and 2000, respectively, while purchases of investment
securities totaled $756.7 million, $434.6 million and $37.1 million for the same
years. The increase in investment security purchases during 2002 is primarily
due to the reinvestment of funds received from the high level of loan and
mortgage-backed security prepayments, as well as from the sale of investment
securities, as a result of management's decision to restructure this portfolio
in 2002.
The sales, maturity and principal payments received on investment securities, as
well as deposit growth and existing liquid assets were used to fund the above
investing activities. During 2002 cash flow provided by the sale, maturity and
principal payments received on securities available for sale amounted to $816.3
million compared to $245.4 million and $241.2 million in 2001 and 2000. Deposit
growth, primarily the Company's savings and non-interest bearing accounts,
provided $165.0 million, $84.5 million and $60.4 million of funding for the
years ending December 31, 2002, 2001 and 2000, respectively. Borrowings,
excluding the repayment of $140.0 million used to fund the purchase of U.S.
Treasury securities in late 2001, decreased slightly from the end of 2001 as the
increase in deposits and sales, maturity and principal payments received on
investment securities were more than adequate to meet the funding needs of the
Company.
Maturity Schedule of Certificates of Deposit. The following table indicates the
funding obligations of the Company relating to certificates of deposit by time
remaining until maturity.
At December 31, 2002
-------------------------------------------------------
3 months Over 3 to 6 Over 6 to 12 Over 12
or less months months months Total
------- ------ ------ ------ -----
(In thousands)
Certificates of deposit less than $100,000 ....... $138,207 $138,484 $228,396 $204,208 $709,295
Certificates of deposit of $100,000 or more ...... 30,674 34,583 60,243 44,451 169,951
-------- -------- -------- -------- --------
Total certificates of deposit ............ $168,881 $173,067 $288,639 $248,659 $879,246
======== ======== ======== ======== ========
In addition to the funding requirements of certificates of deposit illustrated
above, the Company has repayment obligations related to its borrowings as
follows: $69.3 million in 2003; $42.3 million in 2004; $58.9 million in 2005;
$43.3 million in 2006; $27.3 million in 2007; and $156.0 million in years
thereafter. However, certain advances and reverse repurchase agreements have
call provisions that could accelerate their maturity if interest rates were to
rise significantly from current levels as follows: $98.0 million in 2003; $23.0
million in 2004; $0 in 2005; and $27.1 million in 2006.
Loan Commitments. In the ordinary course of business the Company extends
commitments to originate one- to-four family mortgages, commercial loans and
consumer loans. As of December 31, 2002, the Company had outstanding commitments
to originate loans of approximately $124.6 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 $5.0
million at December 31, 2002.
39
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 $167.4 million at December 31, 2002
and generally have an expiration period of less than one year. In addition to
the above, the Company issues standby letters of credit to third parties which
guarantees payments on behalf of commercial customers in the event that the
customer fails to perform under the terms of the contract between the customer
and the third-party. Standby letters of credit amounted to $12.1 million at
December 31, 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's 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.
Security Yields, Maturities and Repricing Schedule. The following table sets
forth certain information regarding the carrying value, weighted average yields
and estimated maturities, including prepayment assumptions, of the Company's
available for sale securities portfolio as of December 31, 2002. Adjustable-rate
securities are included in the period in which interest rates are next scheduled
to adjust and fixed-rate securities are included based upon the weighted average
life date. No tax equivalent adjustments were made to the weighted average
yields. Amounts are shown at fair value.
At December 31, 2002
------------------------------------------------------------------------------------------------
More than one More than five
One year or less year to five years years to ten years After ten years Total
----------------- ------------------ ------------------ ----------------- ------------------
Weighted Weighted Weighted Weighted Weighted
carrying Average carrying Average carrying Average carrying Average carrying Average
value yield value yield value yield value yield value yield
----------------- ------------------- ------------------ ------------------ ------------------
(Dollars in thousands)
Mortgage-backed securities:
CMO's ..................... $172,643 1.05% $ 90,357 2.94% $ -- --% $ -- --% $263,000 1.70%
FHLMC ..................... 3,403 6.47 45,892 4.90 -- -- 3,665 6.96 52,960 5.15
GNMA ...................... 706 2.54 6,708 6.41 1,692 8.23 1,463 7.87 10,569 6.65
FNMA ...................... 468 5.73 13,061 6.18 -- -- 261 5.58 13,790 6.15
------- -------- ------ ------ -------
Total mortgage-backed
securities ....... 177,220 1.17 156,018 3.94 1,692 8.23 5,389 7.14 340,319 2.57
------- -------- ------ ------ -------
Debt securities:
U.S. Treasury ............. 140,038 1.11 16 5.25 -- -- -- -- 140,054 1.11
U.S. Government agencies .. 27,307 3.49 63,222 2.54 -- -- -- -- 90,529 2.83
States and political
subdivisions ........... 6,221 1.80 21,081 3.36 7,206 4.79 58 4.60 34,566 3.38
Corporate ................. 2,016 4.46 9,800 4.19 886 2.72 1,861 3.25 14,563 4.02
------- -------- ------ ------ -------
Total debt securities .... 175,582 1.54 94,119 2.90 8,092 4.56 1,919 3.29 279,712 2.10
------- -------- ------ ------ -------
Common stock (1) ............ -- -- -- -- -- -- -- -- 3,497 --
Asset-backed securities ..... -- -- 503 6.14 2,189 2.28 1,145 2.03 3,837 2.71
Other securities (1) ........ -- -- -- -- -- -- -- -- 4,999 2.68
------- -------- ------ ------ -------
Total securities available
for sale ................. $352,802 1.36% $250,640 3.55% $11,973 4.66% $8,453 5.57% $632,364 2.36%
======= ======= ====== ====== ========
(1) Estimated maturities do not include common stock or other securities
available for sale.
40
Loan Maturity and Repricing Schedule. The following table sets forth certain
information as of December 31, 2002, regarding the amount of loans maturing or
repricing in the Company's portfolio. Demand loans having no stated schedule of
repayment and no stated maturity and overdrafts are reported as due in one year
or less. Adjustable- and floating-rate loans are included in the period in which
interest rates are next scheduled to adjust rather than the period in which they
contractually mature, and fixed-rate loans (including bi-weekly loans) are
included in the period in which the final contractual repayment is due. No
adjustments have been made for amortization or prepayment of principal.
One
Within through After
one five five
year years years Total
-------- -------- -------- ----------
(In thousands)
Real estate loans:
One- to four-family ................... $240,276 $498,273 $188,904 $ 927,453
Home equity ............................ 80,936 43,388 12,662 136,986
Commercial and multi-family ............ 131,578 248,433 93,482 473,493
Construction ........................... 80,627 18,281 8,292 107,200
-------- -------- -------- ----------
Total real estate loans ............ 533,417 808,375 303,340 1,645,132
-------- -------- -------- ----------
Consumer loans .............................. 91,161 72,817 5,177 169,155
Commercial business loans ................... 101,934 65,562 11,059 178,555
-------- -------- -------- ----------
Total loans ........................ $726,512 $946,754 $319,576 $1,992,842
======== ======== ======== ==========
Fixed- and Adjustable-Rate Loan Schedule. The following table sets forth at
December 31, 2002, the dollar amount of all fixed-rate and adjustable-rate loans
due after December 31, 2003.
Due after December 31, 2003
----------------------------------
Fixed Adjustable Total
-------- ---------- ----------
(In thousands)
Real estate loans:
One- to four-family ....... $591,373 $ 95,804 $ 687,177
Home equity ............... 56,050 -- 56,050
Commercial and multi-family 114,582 227,333 341,915
Construction .............. -- 26,573 26,573
-------- -------- ----------
Total real estate loans 762,005 349,710 1,111,715
-------- -------- ----------
Consumer loans ................. 77,994 -- 77,994
Commercial business loans ...... 76,621 -- 76,621
-------- -------- ----------
Total loans ........... $916,620 $349,710 $1,266,330
======== ======== ==========
The Company has lines of credit with the FHLB and FRB that provide secondary
funding sources for lending, liquidity, and asset/liability management. At
December 31, 2002, the FHLB line of credit totaled $732.9 million under which
$236.0 million was utilized. The FRB line of credit totaled $4.3 million, under
which there were no borrowings outstanding as of December 31, 2002.
Cash, interest-bearing demand accounts at correspondent banks, federal funds
sold, and other short-term investments are the Company's most liquid assets. The
level of these assets are monitored daily and are dependent on operating,
financing, lending and investing activities during any given period. Excess
short-term liquidity is usually invested in overnight federal funds sold. In the
event that funds beyond those generated internally are required as a result of
higher than expected loan commitment fundings, deposit outflows or the amount of
debt being called, additional sources of funds are available through the use of
reverse repurchase agreements, the sale of loans or investments or the Company's
various lines of credit. As of December 31, 2002, the total of cash,
interest-bearing demand accounts, federal funds sold and other short-term
investments was $90.5 million, or 3.1% of total assets.
41
FOURTH QUARTER RESULTS
Net income for the quarter ended December 31, 2002 increased 45% to $8.4
million, or $0.33 per diluted share from $5.8 million, or $0.23 per diluted
share for the same period of 2001. Adjusting fourth quarter 2001 results to
exclude the effects of goodwill amortization, similar to the 2002 fourth
quarter, net income for the current quarter increased $1.4 million or 20%.
Net interest income increased 12% to $23.6 million for the fourth quarter of
2002 from $21.1 million for the same period in 2001 as the Company continued to
benefit from the lower interest rate environment and its ongoing focus on higher
yielding commercial loans. As a result, the net interest rate spread improved 22
basis points to 3.39% for the quarter ended December 31, 2002 compared to 3.17%
for the fourth quarter of 2001. Total loans increased to $1.99 billion at
December 31, 2002, when compared to the quarter ended September 30, 2002 balance
of $1.96 billion. This $35.0 million increase is almost exclusively attributable
to commercial loans, which increased $34.9 million during that period.
Overall, deposits remained consistent from September 30, 2002 to December 31,
2002 at $2.1 billion. However, during the fourth quarter of 2002, noninterest
bearing deposits increased 5% to $134.2 million from $127.6 million at September
30, 2002. As a result of this and the increase in net interest rate spread
discussed above, the net interest margin increased to 3.60% for the quarter
ended December 31, 2002, from 3.42% for the same period in 2001.
For the fourth quarter of 2002, the Company had $13.9 million in noninterest
income, an increase of 25% over the $11.1 million for the same period in 2001.
This increase was primarily due to the sale of the Lacona Banking Center, which
resulted in a $2.4 million pre-tax gain. Additionally, noninterest income was
positively impacted by the popularity of the Company's overdraft protection
service, prepayment penalties received from increased commercial real estate
loan refinancing, as well as strong annuity and insurance markets. These
increases were partially offset by a decrease in covered call option premium
income, as a result of the Company's decision to exit this program in 2002, and
lower income from investment advisory services, fiduciary services and losses
incurred on investment securities, due to weak equity markets.
Noninterest expense for the three months ended December 31, 2002 was $22.4
million as compared to $21.8 million for the comparable period of 2001.
Adjusting the final quarter of 2001 for the change in accounting for goodwill,
noninterest expense for the current 2002 quarter increased $1.8 million,
primarily due to higher salaries and benefits expense. This increase was mainly
a result of internal growth and the rise in the Company's stock price, which was
reflected in higher stock based compensation expense. In the fourth quarter of
2002, the Company incurred approximately $850 thousand of expenses related to
the consolidation of its three banks and the new "First Niagara" branding
campaign. This amount is comparable to the $700 thousand in expenses incurred in
the fourth quarter of 2001 related to final integration costs from the Company's
acquisitions and severance from various reorganization initiatives.
CRITICAL ACCOUNTING ESTIMATES
Pursuant to recent SEC guidance, management of the Company is encouraged to
evaluate and disclose those accounting estimates that are judged to be critical
- - those most important to the portrayal of the Company's financial condition and
results, and that require management's most difficult, subjective and complex
judgements. Management considers the accounting estimates relating to the
allowance for credit losses and goodwill to be critical given the inherent
uncertainty in evaluating the levels of the allowance required to cover credit
losses in the portfolio and assessing whether or not goodwill is impaired. The
judgments made regarding the allowance for credit losses and goodwill can have a
material effect on the results of operations of the Company. A more detailed
description of the Company's methodology for calculating the allowance for
credit losses and assumptions made is included within the "Lending Activities"
section filed herewith in Part I, Item 1, "Business."
Goodwill is not subject to amortization but must be tested for possible
impairment at least annually or more frequently if events or changes in
circumstances indicate that the asset might be impaired. Impairment testing
requires that the fair value of each reporting unit be compared to its carrying
amount, including goodwill. Reporting units were identified based upon an
analysis of each of the Company's individual operating segments. A reporting
unit is defined as any distinct, separately identifiable component of an
operating segment for which complete, discrete financial information is
available that management regularly reviews. Goodwill was allocated to the
carrying value of each reporting unit based on its relative fair value at the
time it was acquired.
42
Determining the fair value of a reporting unit requires a high degree of
subjective management assumption. Discounted cash flow valuation models are
utilized that incorporate such variables as revenue growth rates, expense
trends, interest rates and terminal values. Based upon an evaluation of key data
and market factors, management selects from a range the specific variables to be
incorporated into the valuation model. Future changes in the economic
environment or the operations of the reporting units could cause changes to
these variables.
The Company has established November 1 of each year as the date for conducting
its annual goodwill impairment assessment. The variables are selected as of that
date and the valuation models are run to determine the fair value of each
reporting unit. At January 1, 2002 and November 1, 2002, the Company did not
identify any individual reporting unit where fair value was less than carrying
value, including goodwill.
IMPACT OF NEW ACCOUNTING STANDARDS
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This statement requires entities to record the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred if a reasonable estimate of fair value can be made. When the liability
is initially recorded, the entity capitalizes the asset retirement cost by
increasing the carrying amount of the related long-lived asset. The liability is
accreted to its present value each period and the capitalized cost is
depreciated over the useful life of the related asset. Upon settlement of the
liability, an entity either settles the obligation for its recorded amount or
incurs a gain or loss. The provisions of SFAS No. 143 are effective for fiscal
years beginning after June 15, 2002 and are not expected to have a material
impact on the Company's consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which supercedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
and the provisions for the disposal of a segment of a business in APB Opinion
No. 30, "Reporting the Results of Operations -- Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." This statement requires that long-lived
assets to be disposed of by sale be measured at the lower of its carrying amount
or fair value less cost to sell, and recognition of impairment losses on
long-lived assets to be held if the carrying amount of the long-lived asset is
not recoverable from its undiscounted cash flows and exceeds its fair value.
Additionally, SFAS No. 144 resolved various implementation issues related to
SFAS No. 121. The provisions of SFAS No. 144 were adopted on January 1, 2002 and
had no effect on the Company's consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
This statement eliminates SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt" as amended by SFAS No. 64, "Extinguishments of Debt Made
to Satisfy Sinking-Fund Requirements." As a result, gains and losses from
extinguishment of debt can only be classified as extraordinary items if they
meet the definition of unusual and infrequent as prescribed in APB Opinion No.
30. Additionally, SFAS No. 145 amends SFAS No. 13 "Accounting for Leases" to
require that lease modifications that have economic effects similar to
sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. SFAS No. 145 addresses a number of additional
issues that were not substantive in nature. The provisions of this statement are
effective at various dates in 2002 and 2003 and are not expected to have a
material impact on the Company's consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." This statement nullifies Emerging Issues Task
Force Issue No. 94-3 "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)" and requires that a liability for costs associated with an
exit or disposal activity be recognized when the liability is probable and
represents obligations to transfer assets or provide services as a result of
past transactions. The provisions of this statement are effective for exit or
disposal activities that are initiated after December 31, 2002.
43
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions - an Amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9." This statement removes acquisitions of financial
institutions from the scope of both SFAS No. 72 and Interpretation No. 9 and
requires that those transactions be accounted for in accordance with SFAS No.
141 "Business Combinations" and No. 142 "Goodwill and Other Intangible Assets."
As a result, the requirement in paragraph 5 of SFAS No. 72 to recognize (and
subsequently amortize) any excess of the fair value of liabilities assumed over
the fair value of tangible and identifiable intangible assets acquired as an
unidentifiable intangible asset (SFAS No. 72 goodwill) no longer applies to
acquisitions within the scope of the Statement. The provisions of this statement
were effective October 1, 2002 and did not have a material impact on the
Company's consolidated financial statements as the Company did not have any SFAS
No. 72 goodwill.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." This Interpretation enhances the disclosures to be made
by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also requires a
guarantor to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of Interpretation No. 45 are applicable
on a prospective basis to guarantees issued or modified after December 31, 2002.
The disclosure requirements are effective for financial statements of interim
and annual periods ending after December 15, 2002. The Company has made the
applicable transition disclosures required by Interpretation No. 45 in this
annual report on Form 10-K. The Company is required to adopt the recognition and
measurement provisions of Interpretation No. 45 effective January 1, 2003, which
is not expected to have a material impact on the Company's consolidated
financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - An Amendment of FASB Statement No.
123." This statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide three alternative methods for a voluntary change to
the fair value based method of accounting for stock-based compensation and
requires prominent disclosures in both interim and annual financial statements
about the method of accounting for stock-based compensation and its effect on
reported results. The provisions of this statement were effective for fiscal
years ending after December 15, 2002 and interim periods beginning after
December 15, 2002. The Company has made the applicable disclosures required by
SFAS No. 148 in this annual report on Form 10-K.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," which clarifies the application of Accounting
Research Bulletin No. 51, "Consolidated Financial Statements." More
specifically, the Interpretation explains how to identify variable interest
entities and how to determine whether or not those entities should be
consolidated. The Interpretation requires the primary beneficiaries of variable
interest entities to consolidate the variable interest entities if they are
subject to a majority of the risk of loss or are entitled to receive a majority
of the residual returns. It also requires that both the primary beneficiary and
all other enterprises with a significant variable interest in a variable
interest entity make certain disclosures. Interpretation No. 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year or interim period beginning after June
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The provisions of this
Interpretation are not expected to have a material impact on the Company's
consolidated financial statements.
44
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The principal objective of the Company's interest rate risk management is to
evaluate the interest rate risk inherent in certain assets and liabilities,
determine the appropriate level of risk given the Company's business strategy,
operating environment, capital and liquidity requirements and performance
objectives, and manage the risk consistent with the Board's approved guidelines
to reduce the vulnerability of operations to changes in interest rates. The
asset/liability committee ("ALCO") is comprised of senior management and
selected banking officers who are 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.
The Company utilizes the following strategies to manage interest rate risk: (1)
emphasizing the origination and retention of residential monthly and bi-weekly
fixed-rate mortgage loans having terms to maturity of not more than twenty
years, residential and commercial adjustable-rate mortgage loans, and home
equity loans; (2) selling substantially all newly originated 20-30 year monthly
and 25-30 year bi-weekly fixed-rate, residential mortgage loans into the
secondary market without recourse and on a servicing retained basis; and (3)
investing in shorter term securities which generally bear lower yields as
compared to longer term investments, but which better position the Company for
increases in market interest rates. Shortening the maturities of the Company's
interest-earning assets by increasing shorter term investments better matches
the maturities of the Company's deposit accounts, in particular its certificates
of deposits that mature in one year or less. During 1999 and 2000 the Company
entered into interest rate swap agreements in order to manage the interest rate
risk related to the repricing of its money market deposit accounts. Under the
agreements the Company paid an annual fixed rate of interest and received a
floating three-month U.S. Dollar LIBOR rate over a two-year period. The last of
the Company's interest rate swap agreements expired in December 2002. The
Company intends to continue to analyze the future utilization of swap agreements
as part of its overall asset/liability management process.
Gap Analysis. The matching of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities are "interest rate
sensitive" and by monitoring a Company's interest rate sensitivity "gap." An
asset or liability is said to be interest rate sensitive within a specific time
period if it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
same time period. At December 31, 2002, the Company's one-year gap position, the
difference between the amount of interest-earning assets maturing or repricing
within one year and interest-bearing liabilities maturing or repricing within
one year, was a negative 6.28%. A gap is considered positive when the amount of
interest rate sensitive assets exceeds the amount of interest rate sensitive
liabilities. A gap is considered negative when the amount of interest rate
sensitive liabilities exceeds the amount of interest rate sensitive assets.
Accordingly, during a period of rising interest rates, an institution with a
negative gap position is likely to experience a decline in net interest income
as the cost of its interest-bearing liabilities increase at a rate faster than
its yield on interest-earning assets. In comparison, an institution with a
positive gap is likely to realize an increase in its net interest income in a
rising interest rate environment. Given the Company's existing liquidity
position, its ability to sell investment securities and the results of the
Company's net interest income simulation modeling analysis discussed below,
which management believes is a better indicator of the Company's interest rate
risk exposure, management believes that its negative gap position will not have
a material adverse effect on its operating results or liquidity position.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 2002, which are
anticipated by the Company, based upon certain assumptions, to reprice or mature
in each of the future time periods shown (the "Gap table"). Except as stated
below, the amount of assets and liabilities shown which reprice or mature during
a particular period were determined in accordance with the earlier of the
repricing date or the contractual maturity of the asset or liability. The table
sets forth an approximation of the projected repricing of assets and liabilities
at December 31, 2002, on the basis of contractual maturities, anticipated
prepayments, and scheduled rate adjustments within the selected time intervals.
One- to four-family residential and commercial real estate loans were projected
to repay at rates between 4% and 31% annually, while mortgage-backed securities
were projected to prepay at rates between 26% and 50% annually. Savings and
negotiable order of withdrawal ("NOW") accounts were assumed to decay, or
run-off, at 18% annually. While the Company believes such assumptions to be
reasonable, there can be no assurance that assumed prepayment rates and decay
rates will approximate actual future loan prepayment and deposit withdrawal
activity.
45
Amounts maturing or repricing as of December 31, 2002
---------------------------------------------------------------------------------------
Less than 3-6 6 months Over 10
3 months months to 1 year 1-3 years 3-5 years 5-10 years years
--------- --------- --------- -------- -------- -------- ---------
(Dollars in thousands)
Interest-earning assets:
Federal funds sold and other
short-term investments .............. $ 45,167 $ -- $ -- $ -- $ -- $ -- $ --
Mortgage-backed securities (1) ......... 51,103 38,446 45,067 96,089 61,376 43,633 --
Investment securities (1) .............. 154,450 15,231 17,094 74,980 3,933 11,191 12,731
Loans (2) .............................. 349,976 120,723 250,223 568,683 375,327 305,544 13,464
Other (1)(3) ........................... -- -- -- -- -- -- 21,763
--------- --------- --------- -------- -------- -------- ---------
Total interest-earning assets .... 600,696 174,400 312,384 739,752 440,636 360,368 47,958
--------- --------- --------- -------- -------- -------- ---------
Interest-bearing liabilities:
Savings accounts ....................... 81,853 27,968 55,936 49,172 49,172 122,930 245,863
NOW and money market accounts .......... 283,543 9,993 19,985 35,860 13,902 34,756 69,511
Certificates of deposit ................ 168,881 173,067 288,639 215,871 30,137 2,447 204
Mortgagors' payments held in escrow .... 3,105 3,105 6,209 -- -- -- 3,200
Stock offering subscription proceeds ... 75,952 -- -- -- -- -- --
Other borrowed funds ................... 33,666 10,582 29,302 100,616 65,437 126,779 30,753
--------- --------- --------- -------- -------- -------- ---------
Total interest-bearing liabilities 647,000 224,715 400,071 401,519 158,648 286,912 349,531
--------- --------- --------- -------- -------- -------- ---------
Interest rate sensitivity gap ............. ($ 46,304) ($ 50,315) ($ 87,687) $338,233 $281,988 $ 73,456 ($301,573)
========= ========= ========= ======== ======== ======== =========
Cumulative interest rate sensitivity gap .. ($ 46,304) ($ 96,619) ($184,306) $153,927 $435,915 $509,371 $ 207,798
========= ========= ========= ======== ======== ======== =========
Ratio of interest-earning assets to
interest-bearing liabilities ........... 92.84% 77.61% 78.08% 184.24% 277.74% 125.60% 13.72%
Ratio of cumulative gap to total assets ... (1.58%) (3.29%) (6.28%) 5.24% 14.85% 17.36% 7.08%
Amounts maturing or
repricing as of
December 31, 2002
-------------------
Total
----------
Interest-earning assets:
Federal funds sold and other
short-term investments .............. $ 45,167
Mortgage-backed securities (1) ......... 335,714
Investment securities (1) .............. 289,610
Loans (2) .............................. 1,983,940
Other (1)(3) ........................... 21,763
----------
Total interest-earning assets .... 2,676,194
Interest-bearing liabilities:
Savings accounts ....................... 632,894
NOW and money market accounts .......... 467,550
Certificates of deposit ................ 879,246
Mortgagors' payments held in escrow .... 15,619
Stock offering subscription proceeds ... 75,952
Other borrowed funds ................... 397,135
----------
Total interest-bearing liabilities 2,468,396
----------
Interest rate sensitivity gap ............. $ 207,798
Cumulative interest rate sensitivity gap ..
Ratio of interest-earning assets to
interest-bearing liabilities ........... 108.42%
Ratio of cumulative gap to total assets ...
(1) Amounts shown are at amortized cost.
(2) Amounts shown include principal balance net of deferred costs, unearned
discounts, negative balance deposits reclassified to loans and
non-accruing loans.
(3) Primarily includes FHLB stock.
Certain shortcomings are inherent in the method of analysis presented in the gap
table. For example, although certain assets and liabilities may have similar
maturities or periods to repricing, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate loans, have
features, which restrict changes in interest rates, both on a short-term basis
and over the life of the asset. Further, in the event of changes in interest
rates, prepayment and early withdrawal levels would likely deviate significantly
from those assumed in calculating the table. Finally, the ability of many
borrowers to service their adjustable-rate loans may decrease in the event of an
interest rate increase.
As a result of these shortcomings, the Company focuses more attention on
simulation modeling, such as the net interest income, analysis discussed below,
rather than gap analysis. Even though the gap analysis reflects a ratio of
cumulative gap to total assets within the Company's targeted range of acceptable
limits, the net interest income simulation modeling is considered by management
to be more informative in forecasting future income.
46
Net Interest Income Analysis. The accompanying table as of December 31, 2002 and
2001 sets forth the estimated impact on the Company's net interest income
resulting from changes in interest rates during the next twelve months. These
estimates require making certain assumptions including loan and mortgage-related
investment prepayment speeds, reinvestment rates, and deposit maturities and
decay rates similar to the gap analysis. These assumptions are inherently
uncertain and, as a result, the Company cannot precisely predict the impact of
changes in interest rates on net interest income. Actual results may differ
significantly due to timing, magnitude and frequency of interest rate changes
and changes in market conditions. During 2002, management of the Company has
continued to restructure the loan, investment securities and borrowing
portfolios as part of their asset liability management process. This strategy
included selling long-term fixed rate residential mortgages originated, an
increased emphasis on variable rate commercial loans, replacing long-term
investment securities with shorter-term investment securities, and replacing
short-term borrowings with long-term borrowings, in order to make the Company
less liability sensitive. These initiatives have impacted the Company's interest
rate sensitivity position since December 31, 2001, which should benefit the
Company during periods of higher interest rates, as follows.
Calculated increase (decrease) at
------------------------------------------------------------------------------------------
December 31, 2002 December 31, 2001
------------------------------------------- -----------------------------------------
Changes in Net interest Net interest
interest rates income % Change income % Change
- --------------------------- ------------------- ------------------ ----------------- -------------------
(In thousands)
+200 basis points $ 64 0.07% $ (670) (0.76)%
+100 basis points 97 0.10 (155) (0.18)
- -100 basis points (1,014) (1.09) (22) (0.03)
As is the case with the gap table, certain shortcomings are inherent in the
methodology used in the above interest rate risk measurements. Modeling changes
in net interest income requires the making of certain assumptions that may or
may not reflect the manner in which actual yields and costs respond to changes
in market interest rates. In this regard, the net interest income table
presented assumes that the composition of the Company's interest sensitive
assets and liabilities existing at the beginning of a period remains constant
over the period being measured and also assumes that a particular change in
interest rates is reflected uniformly across the yield curve regardless of the
duration to maturity or repricing of specific assets and liabilities.
Accordingly, although the net interest income table provides an indication of
the Company's interest rate risk exposure at a particular point in time, such
measurements are not intended to and do not provide a precise forecast of the
effect of changes in market interest rates on the Company's net interest income
and will differ from actual results.
47
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Independent Auditors' Report
The Board of Directors
First Niagara Financial Group, Inc.:
We have audited the accompanying consolidated statements of condition of First
Niagara Financial Group, Inc. and subsidiaries (the Company) as of December 31,
2002 and 2001, and the related consolidated statements of income, comprehensive
income, stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 2002. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2002 and 2001, and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 1, the Company adopted prospectively the provisions of
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, in 2002.
/S/ KPMG LLP
January 24, 2003
Buffalo, New York
48
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Consolidated Statements of Condition
December 31, 2002 and 2001
(In thousands except share and per share amounts)
Assets 2002 2001
----------- -----------
Cash and cash equivalents:
Cash and due from banks $ 45,358 52,423
Federal funds sold and other short-term investments 45,167 22,231
----------- -----------
Total cash and cash equivalents 90,525 74,654
Securities available for sale 632,364 693,897
Loans, net 1,974,560 1,853,141
Premises and equipment, net 40,445 40,233
Goodwill, net 74,101 74,213
Amortizing intangible assets, net 6,392 6,797
Other assets 116,408 115,011
----------- -----------
Total assets $ 2,934,795 2,857,946
=========== ===========
Liabilities and Stockholders' Equity
Liabilities:
Deposits $ 2,129,469 1,990,830
Stock offering subscription proceeds 75,952 --
Short-term borrowings 69,312 212,992
Long-term borrowings 327,823 346,048
Other liabilities 48,543 47,459
----------- -----------
Total liabilities 2,651,099 2,597,329
----------- -----------
Commitments and contingencies (see note 5, 6, 9, 10, 11 and 17) -- --
Stockholders' equity:
Preferred stock, $0.01 par value, 5,000,000 shares authorized,
none issued -- --
Common stock, $0.01 par value, 45,000,000 shares
authorized, 29,756,250 shares issued 298 298
Additional paid-in capital 137,624 135,917
Retained earnings 196,074 176,073
Accumulated other comprehensive income 2,074 2,561
Common stock held by ESOP, 832,747 shares in 2002 and
878,533 shares in 2001 (11,024) (11,630)
Treasury stock, at cost, 3,918,978 shares in 2002 and
4,075,498 shares in 2001 (41,350) (42,602)
----------- -----------
Total stockholders' equity 283,696 260,617
----------- -----------
Total liabilities and stockholders' equity $ 2,934,795 2,857,946
=========== ===========
See accompanying notes to consolidated financial statements
49
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Consolidated Statements of Income
Years ended December 31, 2002, 2001 and 2000
(In thousands except per share amounts)
2002 2001 2000
--------- --------- ---------
Interest income:
Real estate loans $ 115,795 119,203 85,213
Other loans 24,664 25,071 16,612
Investment securities 7,496 10,888 8,804
Mortgage-backed securities 16,100 20,138 24,045
Federal funds sold and other short-term investments 2,446 1,503 771
Other 1,136 1,565 1,595
--------- --------- ---------
Total interest income 167,637 178,368 137,040
Interest expense:
Deposits 53,611 74,409 56,272
Borrowings 22,496 24,943 20,590
--------- --------- ---------
Total interest expense 76,107 99,352 76,862
--------- --------- ---------
Net interest income 91,530 79,016 60,178
Provision for credit losses 6,824 4,160 2,258
--------- --------- ---------
Net interest income after provision
for credit losses 84,706 74,856 57,920
--------- --------- ---------
Noninterest income:
Banking service charges and fees 14,226 10,222 7,257
Lending and leasing income 5,523 4,310 3,105
Insurance services and fees 20,514 18,456 16,685
Bank-owned life insurance income 2,706 2,507 2,070
Annuity and mutual fund commissions 2,585 1,750 1,348
Investment and fiduciary services income 1,112 1,456 965
Net realized losses on securities available for sale (1,044) (83) (339)
Gain on sale of banking center 2,429 -- --
Other 1,640 3,454 2,999
--------- --------- ---------
Total noninterest income 49,691 42,072 34,090
--------- --------- ---------
Noninterest expense:
Salaries and employee benefits 50,181 45,989 34,224
Occupancy and equipment 7,897 7,664 5,735
Technology and communications 9,125 7,642 5,733
Marketing and advertising 2,616 2,126 2,603
Amortization of goodwill -- 4,742 2,114
Amortization of other intangibles 873 969 937
Other 13,756 13,873 10,172
--------- --------- ---------
Total noninterest expense 84,448 83,005 61,518
--------- --------- ---------
Income before income taxes 49,949 33,923 30,492
Income tax expense:
Federal and state 17,370 12,703 10,973
New York State bad debt tax expense recapture 1,784 -- --
--------- --------- ---------
Total income tax expense 19,154 12,703 10,973
--------- --------- ---------
Net income $ 30,795 21,220 19,519
========= ========= =========
Adjusted net income (see note 7) $ 30,795 25,962 21,633
========= ========= =========
Basic earnings per common share (see note 2 and 15):
Net income $ 1.24 0.86 0.79
Adjusted net income (see note 7) 1.24 1.05 0.87
Diluted earnings per common share (see note 2 and 15):
Net income $ 1.21 0.85 0.79
Adjusted net income (see note 7) 1.21 1.04 0.87
Weighted average common shares outstanding (see note 2):
Basic 24,913 24,728 24,847
Diluted 25,469 25,010 24,858
See accompanying notes to consolidated financial statements.
50
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2002, 2001 and 2000
(In thousands)
2002 2001 2000
-------- -------- --------
Net income $ 30,795 21,220 19,519
-------- -------- --------
Other comprehensive income (loss), net of income taxes:
Securities available for sale:
Net unrealized gains arising during the year 836 2,381 9,025
Reclassification adjustment for realized losses
included in net income 627 50 204
-------- -------- --------
1,463 2,431 9,229
-------- -------- --------
Cash flow hedges:
Net unrealized losses arising during the year (105) (503) --
Reclassification adjustment for realized losses
included in net income 311 392 --
-------- -------- --------
206 (111) --
-------- -------- --------
Defined benefit pension plan:
Minimum pension liability arising during the year (2,156) -- --
-------- -------- --------
Total other comprehensive (loss) income before
cumulative effect of change in accounting principle (487) 2,320 9,229
Cumulative effect of change in accounting principle
for derivatives, net of tax -- (95) --
-------- -------- --------
Total other comprehensive (loss) income (487) 2,225 9,229
-------- -------- --------
Total comprehensive income $ 30,308 23,445 28,748
======== ======== ========
See accompanying notes to consolidated financial statements.
51
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
Years Ended December 31, 2002, 2001 and 2000
(In thousands except share and per share amounts)
Accumulated Common
Additional other stock
Common paid-in Retained comprehensive held by Treasury
stock capital earnings income (loss) ESOP stock Total
-------- -------- -------- ------------- -------- -------- --------
Balances at January 1, 2000 $ 298 135,964 151,341 (8,893) (13,076) (33,018) 232,616
Net income -- -- 19,519 -- -- -- 19,519
Unrealized gain on securities available for
sale, net of taxes and reclassification
adjustment -- -- -- 9,229 -- -- 9,229
Purchase of treasury stock
(1,098,300 shares) -- -- -- -- -- (10,871) (10,871)
ESOP shares released
(52,727 shares) -- (204) -- -- 698 -- 494
Vested restricted stock plan awards
(54,970 shares) -- 16 -- -- -- 561 577
Common stock dividends of $0.28 per share -- -- (7,024) -- -- -- (7,024)
-------- -------- -------- -------- -------- -------- --------
Balances at December 31, 2000 $ 298 135,776 163,836 336 (12,378) (43,328) 244,540
Net income -- -- 21,220 -- -- -- 21,220
Unrealized gain on securities available for
sale, net of taxes and reclassification
adjustment -- -- -- 2,431 -- -- 2,431
Unrealized loss on interest rate swaps, net
of taxes and reclassification adjustment -- -- -- (111) -- -- (111)
Cumulative effect of change in accounting
principle for derivatives -- -- -- (95) -- -- (95)
Exercise of stock options (39,700 shares) -- 99 -- -- -- 381 480
ESOP shares released
(56,550 shares) -- 55 -- -- 748 -- 803
Vested restricted stock plan awards
(38,982 shares) -- (13) -- -- -- 345 332
Common stock dividends of $0.36 per share -- -- (8,983) -- -- -- (8,983)
-------- -------- -------- -------- -------- -------- --------
Balances at December 31, 2001 $ 298 135,917 176,073 2,561 (11,630) (42,602) 260,617
Net income -- -- 30,795 -- -- -- 30,795
Unrealized gain on securities available for
sale, net of taxes and reclassification
adjustment -- -- -- 1,463 -- -- 1,463
Unrealized gain on interest rate swaps, net
of taxes and reclassification adjustment -- -- -- 206 -- -- 206
Minimum pension liability adjustment, net
of taxes -- -- -- (2,156) -- -- (2,156)
Exercise of stock options (90,350 shares) -- 533 -- -- -- 886 1,419
ESOP shares released
(45,786 shares) -- 547 -- -- 606 -- 1,153
Vested restricted stock plan awards
(66,170 shares) -- 627 -- -- -- 366 993
Common stock dividends of $0.43 per share -- -- (10,794) -- -- -- (10,794)
-------- -------- -------- -------- -------- -------- --------
Balances at December 31, 2002 $ 298 137,624 196,074 2,074 (11,024) (41,350) 283,696
======== ======== ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
52
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended December 31, 2002, 2001 and 2000
(In thousands)
2002 2001 2000
--------- --------- ---------
Cash flows from operating activities:
Net income $ 30,795 21,220 19,519
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization (accretion) of fees and discounts, net 3,853 (124) (271)
Depreciation of premises and equipment 5,286 4,763 3,665
Provision for credit losses 6,824 4,160 2,258
Amortization of goodwill and other intangibles 873 5,711 3,051
Net (increase) decrease in loans held for sale (1,004) 1,560 (1,751)
Net realized losses on securities available for sale 1,044 83 339
Gain on curtailment of defined benefit pension plan (998) -- --
Gain on sale of banking center (2,429) -- --
ESOP compensation expense 1,153 803 494
Deferred income tax expense 1,096 829 420
(Increase) decrease in other assets (1,834) 1,094 8,589
Increase (decrease) in other liabilities 674 3,529 (4,120)
--------- --------- ---------
Net cash provided by operating activities 45,333 43,628 32,193
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sales of securities available for sale 449,110 76,751 135,556
Proceeds from maturities of securities available for sale 196,961 65,388 32,595
Principal payments received on securities available for sale 170,181 103,301 73,044
Purchases of securities available for sale (756,685) (434,582) (37,116)
Net increase in loans (128,740) (35,834) (152,589)
Purchase of bank-owned life insurance -- (4,000) --
Acquisitions, net of cash acquired (605) (980) (90,865)
Net cash distributed for banking center sale (21,566) -- --
Other, net (7,246) (6,965) (5,018)
--------- --------- ---------
Net cash used in investing activities (98,590) (236,921) (44,393)
--------- --------- ---------
Cash flows from financing activities:
Net increase in deposits 165,038 84,479 60,381
Proceeds from stock offering subscription 75,952 -- --
(Repayments of) proceeds from short-term borrowings (175,492) 59,209 (41,850)
Proceeds from long-term borrowings 30,000 88,100 42,900
Repayments of long-term borrowings (16,518) (18,079) (10,470)
Proceeds from exercise of stock options 942 406 --
Purchase of treasury stock -- -- (10,871)
Dividends paid on common stock (10,794) (8,983) (7,024)
--------- --------- ---------
Net cash provided by financing activities 69,128 205,132 33,066
--------- --------- ---------
Net increase in cash and cash equivalents 15,871 11,839 20,866
Cash and cash equivalents at beginning of year 74,654 62,815 41,949
--------- --------- ---------
Cash and cash equivalents at end of year $ 90,525 74,654 62,815
========= ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $ 16,970 10,050 9,661
Interest expense 76,684 100,121 75,886
========= ========= =========
Acquisition of banks and financial services companies:
Assets acquired (noncash) $ -- 141 872,460
Liabilities assumed -- 67 854,230
Purchase price payable -- 656 1,120
========= ========= =========
Sale of banking center
Assets sold (noncash) $ 2,403 -- --
Liabilities sold 26,399 -- --
========= ========= =========
See accompanying notes to consolidated financial statements.
53
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
1) Summary of Significant Accounting Policies
First Niagara Financial Group, Inc. ("FNFG") is a Delaware corporation,
which holds all of the capital stock of First Niagara Bank ("First
Niagara"), a federally chartered savings bank. FNFG and First Niagara are
hereinafter referred to collectively as "the Company." First Niagara was
originally organized in 1870 as a New York State chartered mutual savings
bank. FNFG was organized in April 1998 by First Niagara in connection with
its conversion to a New York State chartered stock savings bank and the
reorganization to a two-tiered mutual holding company. On July 21, 2002,
the Boards of Directors of First Niagara Financial Group, MHC ("the MHC"),
FNFG and First Niagara adopted a plan of conversion and reorganization to
convert the MHC from mutual to stock form ("the Conversion"). In
connection with the Conversion, which was completed on January 17, 2003,
the 61% of outstanding shares of FNFG common stock owned by the MHC were
sold to depositors of First Niagara and the public ("the Offering"). As a
result of the Conversion and Offering the MHC ceased to exist, and FNFG
became a fully public Company. See note 2 for additional information.
The Company provides financial services to individuals and businesses in
upstate New York. The Company's business is primarily accepting deposits
from customers through its banking centers and investing those deposits,
together with funds generated from operations and borrowings, in one- to
four-family residential, multi-family residential and commercial real
estate loans, commercial business loans and leases, consumer loans, and
investment securities. Additionally, the Company offers insurance products
and services, as well as trust and investment services.
The accounting and reporting policies of the Company conform to general
practices within the banking industry and to accounting principles
generally accepted in the United States of America. Certain
reclassification adjustments were made to the 2001 and 2000 financial
statements to conform them to the 2002 presentation.
The following is a description of the Company's significant accounting
policies:
(a) Principles of Consolidation
The consolidated financial statements include the accounts of FNFG
and its subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
(b) Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, cash items in the
process of collection, amounts due from banks, federal funds sold,
money market accounts and other short-term investments, which mature
within three months or less.
(c) Investment Securities
All debt and marketable equity securities are classified as
available for sale. The securities are carried at fair value, with
unrealized gains and losses, net of the related deferred income tax
effect, reported as a component of accumulated other comprehensive
income. Realized gains and losses are included in the consolidated
statement of income and are determined using the specific
identification method. A decline in the fair value of any available
for sale security below cost that is deemed other than temporary is
charged to earnings, resulting in the establishment of a new cost
basis. Premiums and discounts on investment securities are
amortized/accreted to interest income utilizing the interest method.
54
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(d) Loans
Loans are stated at the principal amount outstanding, adjusted for
net unamortized deferred fees, costs, discounts and premiums that
are amortized to income by the interest method. Accrual of interest
income on loans is generally discontinued after payments become more
than ninety days delinquent, unless the status of a particular loan
clearly indicates earlier discontinuance is more appropriate. All
uncollected interest income previously recognized on non-accrual
loans is reversed and subsequently recognized only to the extent
payments are received. In those instances where there is doubt as to
the collectibility of principal, interest payments are applied to
principal. Loans are generally returned to accrual status when
principal and interest payments are current, full collectibility of
principal and interest is reasonably assured and a consistent record
of performance, generally six months, has been demonstrated.
(e) Direct Financing Leases
The Company accounts for its direct financing leases in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 13,
"Accounting for Leases." At lease inception, the present values of
future rentals and the residual are recorded as a net investment in
direct financing leases. Unearned interest income and sales
commissions and other direct costs incurred are capitalized and are
amortized to interest income over the lease term utilizing the
interest method.
(f) Real Estate Owned
Real estate owned consists of property acquired in settlement of
loans which are initially valued at the lower of the carrying amount
of the loan or fair value, based on appraisals at foreclosure, less
the estimated cost to sell the property ("net realizable value").
These properties are periodically adjusted to the lower of adjusted
cost or net realizable value throughout the holding period.
(g) Allowance for Credit Losses
The allowance for credit losses is established through charges to
earnings through the provision for credit losses. Loan and lease
losses are charged and recoveries are credited to the allowance for
credit losses. Management's evaluation of the allowance is based on
a continuing review of the loan portfolio. The methodology for
determining the amount of the allowance for credit losses consists
of several elements. Larger balance nonaccruing, impaired and
delinquent loans are reviewed individually and the value of any
underlying collateral is considered in determining estimates of
losses associated with those loans and the need, if any, for a
specific reserve. Another element involves estimating losses
inherent in categories of smaller balance homogeneous loans based
primarily on historical experience, industry trends and trends in
the real estate market and the current economic environment in the
Company's market areas. The unallocated portion of the allowance for
credit losses is based on management's evaluation of various
conditions, and involves a higher degree of uncertainty because this
component of the allowance is not identified with specific problem
credits or portfolio segments. The conditions evaluated in
connection with this element include the following: industry and
regional conditions; seasoning of the loan portfolio and changes in
the composition of and growth in the loan portfolio; the strength
and duration of the current business cycle; existing general
economic and business conditions in the lending areas; credit
quality trends, including trends in nonaccruing loans; historical
loan charge-off experience; and the results of bank regulatory
examinations.
55
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect
all amounts of principal and interest under the original terms of
the agreement. Such loans are measured based on the present value of
expected future cash flows discounted at the loan's effective
interest rate or, as a practical expedient, the loan's observable
market price or the fair value of the underlying collateral if the
loan is collateral dependent. The Company collectively evaluates
smaller-balance homogeneous loans for impairment, including one- to
four-family residential mortgage loans, student loans and consumer
loans, other than those modified in a troubled debt restructuring.
(h) Premises and Equipment
Premises and equipment are carried at cost, net of accumulated
depreciation and amortization. Depreciation is computed on the
straight-line method over the estimated useful lives of the assets.
Leasehold improvements are amortized on the straight-line method
over the lesser of the life of the improvements or the lease term.
The Company generally amortizes buildings over a period of 20 to 39
years, furniture and equipment over a period of 3 to 10 years, and
capital leases over the respective lease term. Impairment losses on
premises and equipment are realized if the carrying amount is not
recoverable from its undiscounted cash flows and exceeds its fair
value.
(i) Goodwill and Intangible Assets
The excess of the cost of acquired entities over the fair value of
identifiable tangible and intangible assets acquired, less
liabilities assumed, is recorded as goodwill. Acquired intangible
assets (other than goodwill) are amortized over their useful
economic life. Effective with the Company's adoption of SFAS No.
142, "Goodwill and Other Intangible Assets" on January 1, 2002, the
Company no longer is permitted to amortize goodwill and any acquired
intangible assets with an indefinite useful economic life, but is
required to review these assets for impairment annually based upon
guidelines specified by the Statement. The Company has established
November 1 of each year as the date for conducting its annual
goodwill impairment assessment. Impairment testing requires that the
fair value of the Company's reporting units be compared to their
carrying amount, including goodwill. Reporting units are identified
based upon an analysis of each of the Company's individual operating
segments. A reporting unit is defined as any distinct, separately
identifiable component of an operating segment for which complete,
discrete financial information is available that management
regularly reviews. Discounted cash flow valuation models that
incorporate such variables as revenue growth rates, expense trends,
interest rates and terminal values are utilized to determine the
fair value of the Company's reporting units.
Prior to January 1, 2002, the Company amortized goodwill on a
straight-line basis over periods of ten to twenty years and
periodically assessed whether events or changes in circumstances
indicated that the carrying amount of goodwill might be impaired.
56
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(j) Derivative Instruments
Effective January 1, 2001, the Company adopted the provisions of
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" as amended by SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities - An Amendment
of FASB Statement No. 133." SFAS No. 133 and SFAS No. 138 establish
accounting and reporting standards for derivative instruments,
including certain derivatives embedded in other contracts, and for
hedging activities. These statements require that an entity
recognize all derivatives as either assets or liabilities in the
statement of condition and measures those instruments at fair value.
Changes in the fair value of the derivatives are recorded each
period in current earnings or other comprehensive income, depending
on whether the derivative is used in a qualifying hedge strategy
and, if so, whether the hedge is a cash flow or fair value hedge.
In order to qualify as a hedge, the Company must document the
hedging strategy at its inception, including the nature of the risk
being hedged and how the effectiveness of the hedge will be
measured. The Company accounted for the interest rate swap
agreements that it used to hedge a portion of its Money Market
Demand Accounts ("MMDA") as cash flow hedges. The Company recognized
the portion of the change in fair value of the interest rate swaps
that is considered effective in hedging cash flows as a direct
charge or credit to accumulated other comprehensive income (equity),
net of tax. The ineffective portion of the change in fair value, if
any, was recorded to earnings. Amounts recorded in accumulated other
comprehensive income were periodically reclassified to interest
expense on deposits to offset interest expense on the hedged MMDA
accounts resulting from fluctuations in interest rates.
Prior to January 1, 2001, interest income or expense on the swaps
was recognized as an adjustment to interest expense on deposits as
accrued. The fair value of interest rate swaps as of January 1,
2001, net of the related deferred income tax effect, was recorded as
a cumulative effect of a change in accounting principle in
accumulated other comprehensive income.
Commitments to originate residential real estate loans that the
Company intends to sell, forward commitments to sell residential
real estate loans, and residential real estate loans held for sale
are generally recorded in the consolidated statement of condition at
fair value, with the corresponding unrealized gain or loss being
included in other noninterest income. Prior to January 1, 2001 these
financial instruments were recorded at the lower of aggregate cost
or market value.
(k) Employee Benefits
The Company maintains a non-contributory, qualified, defined benefit
pension plan ("the pension plan") that covers substantially all
employees who meet certain age and service requirements. The
actuarially determined pension benefit in the form of a life annuity
is based on the employee's combined years of service, age and
compensation. The Company's policy is to fund the minimum amount
required by government regulations. Effective February 1, 2002, the
Company froze all benefit accruals and participation in the pension
plan.
Additionally, in 2002, 2001 and 2000, the Company maintained several
defined contribution 401(k) plans related to the companies acquired
in 1999 and 2000. The Company accrues contributions due under these
plans as earned by employees.
57
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
The Company also provides certain post-retirement benefits,
principally health care and group life insurance ("the
post-retirement plan"), to employees who meet certain age and
service requirements and their beneficiaries and dependents. The
expected cost of providing these post-retirement benefits are
accrued during an employee's active years of service. Effective
January 19, 2001, the Company modified its post-retirement plan so
that participation was closed to those employees who did not meet
the retirement eligibility by December 31, 2001.
(l) Stock-Based Compensation
The Company maintains various long-term incentive stock benefit
plans under which fixed award stock options and restricted stock
awards may be granted to certain officers, directors, key employees
and other persons providing services to the Company. SFAS No. 123,
"Accounting for Stock-Based Compensation," established accounting
and disclosure requirements using a fair value-based method of
accounting for stock-based employee compensation plans. As allowed
under SFAS No. 123, the Company has elected to continue to apply the
intrinsic value-based method of accounting prescribed by Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees," and has only adopted the disclosure
requirements of SFAS No. 123, as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure
- An Amendment of FASB Statement No. 123." As such, compensation
expense is recorded on the date the options are granted only if the
current market price of the underlying stock exceeded the exercise
price. Compensation expense equal to the market value of FNFG's
stock on the grant date is accrued ratably over the vesting period
for shares of restricted stock granted.
Had the Company determined compensation cost based on the fair value
method under SFAS No. 123, the Company's net income would have been
reduced to the pro forma amounts indicated below. These amounts may
not be representative of the effects on reported net income for
future years due to changes in market conditions and the number of
options outstanding:
2002 2001 2000
---------- ---------- ----------
(in thousands except per share amounts)
Net Income
As reported $ 30,795 21,220 19,519
Add: Stock-based employee compensation
expense included in net income, net of
related tax effects 556 420 398
Deduct: Stock-based employee compensation
expense determined under the fair-value
based method, net of related tax effects (1,172) (996) (1,011)
---------- ---------- ----------
Pro forma $ 30,179 20,644 18,906
========== ========== ==========
Basic earnings per share
As reported $ 1.24 0.86 0.79
Pro forma 1.21 0.83 0.76
Diluted earnings per share
As reported $ 1.21 0.85 0.79
Pro forma 1.18 0.83 0.76
58
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
The per share weighted-average fair value of stock options granted
for 2002, 2001 and 2000 were $10.22, $4.19 and $2.89 on the date of
grant, respectively, using the Black Scholes option-pricing model.
The following weighted-average assumptions were utilized: 2002, 2001
and 2000 expected dividend yield of 1.51%, 2.79% and 3.13%;
risk-free interest rate of 3.91%, 5.02% and 6.44%; expected life of
6.5 years for 2002 and 7.5 years for 2001 and 2000; and expected
volatility of 33.71%, 32.30% and 30.13%, respectively. The Company
also deducted 10% in each year to reflect an estimate of the
probability of forfeiture prior to vesting.
(m) Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the periods in which the
deferred tax assets or liabilities are expected to be realized or
settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through income tax expense.
(n) Earnings Per Share
Basic earnings per share ("EPS") is computed by dividing income
available to common stockholders by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts
to issue common stock were exercised or converted into common stock
or resulted in the issuance of common stock that then shared in the
earnings of the Company.
(o) Investment and Fiduciary Services
Assets held in fiduciary or agency capacity for customers are not
included in the accompanying consolidated statements of condition,
since such assets are not assets of the Company. Fee income is
recognized on the accrual method based on the fair value of assets
administered.
(p) New Accounting Standards
In June 2001, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 143, "Accounting for Asset Retirement Obligations."
This statement requires entities to record the fair value of a
liability for an asset retirement obligation in the period in which
it is incurred if a reasonable estimate of fair value can be made.
When the liability is initially recorded, the entity capitalizes the
asset retirement cost by increasing the carrying amount of the
related long-lived asset. The liability is accreted to its present
value each period and the capitalized cost is depreciated over the
useful life of the related asset. Upon settlement of the liability,
an entity either settles the obligation for its recorded amount or
incurs a gain or loss. The provisions of SFAS No. 143 are effective
for fiscal years beginning after June 15, 2002 and are not expected
to have a material impact on the Company's consolidated financial
statements.
59
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which supercedes SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of" and the provisions for the
disposal of a segment of a business in APB Opinion No. 30,
"Reporting the Results of Operations -- Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." This statement
requires that long-lived assets to be disposed of by sale be
measured at the lower of its carrying amount or fair value less cost
to sell, and recognition of impairment losses on long-lived assets
to be held if the carrying amount of the long-lived asset is not
recoverable from its undiscounted cash flows and exceeds its fair
value. Additionally, SFAS No. 144 resolved various implementation
issues related to SFAS No. 121. The provisions of SFAS No. 144 were
adopted on January 1, 2002 and had no effect on the Company's
consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." This statement eliminates SFAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt" as amended
by SFAS No. 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements." As a result, gains and losses from
extinguishment of debt can only be classified as extraordinary items
if they meet the definition of unusual and infrequent as prescribed
in APB Opinion No. 30. Additionally, SFAS No. 145 amends SFAS No. 13
"Accounting for Leases" to require that lease modifications that
have economic effects similar to sale-leaseback transactions be
accounted for in the same manner as sale-leaseback transactions.
SFAS No. 145 addresses a number of additional issues that were not
substantive in nature. The provisions of this statement are
effective at various dates in 2002 and 2003 and are not expected to
have a material impact on the Company's consolidated financial
statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This statement
nullifies Emerging Issues Task Force Issue No. 94-3 "Liability
Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)" and requires that a liability for costs associated
with an exit or disposal activity be recognized when the liability
is probable and represents obligations to transfer assets or provide
services as a result of past transactions. The provisions of this
statement are effective for exit or disposal activities that are
initiated after December 31, 2002.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of
Certain Financial Institutions - an Amendment of FASB Statements No.
72 and 144 and FASB Interpretation No. 9." This statement removes
acquisitions of financial institutions from the scope of both SFAS
No. 72 and Interpretation No. 9 and requires that those transactions
be accounted for in accordance with SFAS No. 141 "Business
Combinations" and No. 142 "Goodwill and Other Intangible Assets." As
a result, the requirement in paragraph 5 of SFAS No. 72 to recognize
(and subsequently amortize) any excess of the fair value of
liabilities assumed over the fair value of tangible and identifiable
intangible assets acquired as an unidentifiable intangible asset
("SFAS No. 72 goodwill") no longer applies to acquisitions within
the scope of the Statement. The provisions of this statement were
effective October 1, 2002 and did not have a material impact on the
Company's consolidated financial statements as the Company did not
have any SFAS No. 72 goodwill.
60
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
In November 2002, the FASB issued Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." This
Interpretation enhances the disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations
under certain guarantees that it has issued. It also requires a
guarantor to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and measurement provisions of
Interpretation No. 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002. The
disclosure requirements are effective for financial statements of
interim and annual periods ending after December 15, 2002. The
Company has made the applicable transition disclosures required by
Interpretation No. 45 in this annual report on Form 10-K. The
Company is required to adopt the recognition and measurement
provisions of Interpretation No. 45 effective January 1, 2003, which
is not expected to have a material impact on the Company's
consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - An Amendment
of FASB Statement No. 123." This statement amends FASB Statement No.
123, "Accounting for Stock-Based Compensation," to provide three
alternative methods for a voluntary change to the fair value based
method of accounting for stock-based compensation and requires
prominent disclosures in both interim and annual financial
statements about the method of accounting for stock-based
compensation and its effect on reported results. The provisions of
this statement were effective for fiscal years ending after December
15, 2002 and interim periods beginning after December 15, 2002. The
Company has made the applicable disclosures required by SFAS No. 148
in this annual report on Form 10-K.
In January 2003, the FASB issued Interpretation No. 46,
"Consolidation of Variable Interest Entities," which clarifies the
application of Accounting Research Bulletin No. 51, "Consolidated
Financial Statements." More specifically, the Interpretation
explains how to identify variable interest entities and how to
determine whether or not those entities should be consolidated. The
Interpretation requires the primary beneficiaries of variable
interest entities to consolidate the variable interest entities if
they are subject to a majority of the risk of loss or are entitled
to receive a majority of the residual returns. It also requires that
both the primary beneficiary and all other enterprises with a
significant variable interest in a variable interest entity make
certain disclosures. Interpretation No. 46 applies immediately to
variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an
interest after that date. It applies in the first fiscal year or
interim period beginning after June 15, 2003, to variable interest
entities in which an enterprise holds a variable interest that it
acquired before February 1, 2003. The provisions of this
Interpretation are not expected to have a material impact on the
Company's consolidated financial statements.
(q) Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and
disclosure of contingent assets and liabilities to prepare these
financial statements in conformity with accounting principles
generally accepted in the United States of America. Actual results
could differ from those estimates.
61
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(2) Corporate Structure and Stock Offering
First Niagara was organized in 1870 as a New York State chartered mutual
savings bank. In April 1998 First Niagara reorganized into the mutual
holding company structure as the wholly-owned subsidiary of FNFG, which
simultaneously conducted an initial public offering. Under this structure,
at least 51% of FNFG's voting shares were required to be owned by the MHC.
The Company utilized the proceeds raised in its initial offering to make
three bank and five non-bank acquisitions between 1999 and 2001. In July
2000, FNFG acquired CNY Financial Corporation, the holding company for
Cortland Savings Bank ("Cortland"). In November 2000, FNFG acquired all of
the common stock of Iroquois Bancorp, Inc., the holding company of Cayuga
Bank ("Cayuga") and The Homestead Savings, FA. Following completion of
this transaction, The Homestead Savings was merged into Cayuga. Initially,
Cortland and Cayuga were operated as wholly owned subsidiaries of FNFG. In
June 2002, FNFG announced its decision to convert to a federal charter
subject to Office of Thrift Supervision ("OTS") regulation, and to merge
Cortland and Cayuga into First Niagara. The mergers of Cortland and Cayuga
into First Niagara, as well as the conversion to federal charters for
First Niagara and the MHC were approved by the OTS and were effective
November 8, 2002. The conversion of FNFG to a federal charter was approved
by stockholders' of the Company on January 9, 2003 and was effective
January 17, 2003.
On July 21, 2002, the Boards of Directors of the MHC, FNFG and First
Niagara adopted a plan of conversion and reorganization to convert the MHC
from mutual to stock form. In connection with the Conversion the 61%
ownership interest of the MHC in FNFG was sold to depositors of First
Niagara and the public. Completion of the Conversion and Offering, which
was effective on January 17, 2003, resulted in the issuance of 67.4
million shares of common stock. A total of 41.0 million shares were sold
in subscription, community and syndicated offerings, at $10.00 per share,
and an additional 26.4 million shares were issued to the former public
stockholders of FNFG based upon an exchange ratio of 2.58681 new shares
for each share of FNFG held as of the close of business on January 17,
2003. Cash was paid in lieu of fractional shares. As a result of the
Conversion and Offering, current and prior year share and per share
amounts will be restated to give retroactive recognition to the exchange
ratio applied in the conversion. On a restated basis, diluted EPS for
2002, 2001 and 2000 was $0.47, $0.33 and $0.30, respectively.
Costs related to the Offering, primarily marketing fees paid to the
Company's investment banking firm, professional fees, registration fees
and printing and mailing costs, were approximately $19 million and
accordingly, net offering proceeds were approximately $391 million. As a
result of the Conversion and Offering, FNFG was succeeded by a new, fully
public, Delaware corporation with the same name and the MHC ceased to
exist. At December 31, 2002 stock subscription proceeds received,
exclusive of $13.2 million of funds authorized for withdrawal from deposit
accounts, amounted to $76.0 million.
Upon the completion of the reorganization, the Company established a
special "liquidation account" for the benefit of certain depositors of
First Niagara of $128.1 million which is equal to the amount of the
retained earnings of First Niagara at the time it reorganized into the MHC
in 1998. Under the rules of the OTS, First Niagara is not be permitted to
pay dividends on its capital stock to FNFG, its sole stockholder, if First
Niagara's stockholder's equity would be reduced below the amount of the
liquidation account.
62
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(3) Acquisitions and Dispositions of Assets
On January 17, 2003, in conjunction with the Conversion and Offering, the
Company acquired Finger Lakes Bancorp, Inc. ("FLBC") the holding company
of Savings Bank of the Finger Lakes ("SBFL"), headquartered in Geneva, New
York. SBFL operated seven branch locations and had assets of $379.0
million and deposits of $259.8 million at December 31, 2002. Subsequent to
the acquisition, SBFL was merged into First Niagara. Under the terms of
the agreement, the Company paid $20.00 per share, in an equal combination
of cash and stock from the Offering, for all of the outstanding shares and
options of FLBC for an aggregate purchase price of $67.1 million. As a
result, 3.4 million shares of FNFG stock were issued and cash payments
totaling $33.6 million were made. This acquisition was accounted for under
the purchase method of accounting.
On October 25, 2002, the Company sold its Lacona Banking Center. In
connection with this transaction, $2.6 million of assets and $26.4 million
of deposits were sold, which resulted in a pre-tax gain of $2.4 million.
In 2002 First Niagara Risk Management, Inc. ("FNRM"), First Niagara's
wholly owned insurance subsidiary, acquired the customer lists of a
property and casualty insurance agency and an insurance adjustment firm,
both located in western New York. In connection with these purchases, $468
thousand of customer lists were recorded and are being amortized on a
straight-line basis over a period of three to five years.
63
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(4) Securities Available for Sale
The amortized cost, gross unrealized gains and losses and approximate fair
value of securities available for sale at December 31, 2002 are summarized
as follows (in thousands):
Amortized Unrealized Unrealized Fair
cost gains losses value
-------- ---------- ---------- -------
Debt securities:
U.S. Treasury $140,060 1 (7) 140,054
U.S. Government agencies 89,522 1,007 -- 90,529
Corporate 14,665 137 (239) 14,563
States and political subdivisions 32,957 1,609 -- 34,566
-------- ----- ------ -------
Total debt securities 277,204 2,754 (246) 279,712
-------- ----- ------ -------
Mortgage-backed securities:
Collateralized mortgage obligations:
Federal Home Loan Mortgage Corporation 142,008 529 (182) 142,355
Government National Mortgage
Association 14,999 32 (6) 15,025
Federal National Mortgage Association 52,611 303 (65) 52,849
Privately issued 52,543 316 (88) 52,771
-------- ----- ------ -------
Total collateralized mortgage obligations 262,161 1,180 (341) 263,000
-------- ----- ------ -------
Other mortgage-backed securities:
Federal Home Loan Mortgage Corporation 51,024 1,936 -- 52,960
Government National Mortgage
Association 9,910 659 -- 10,569
Federal National Mortgage Association 12,619 1,171 -- 13,790
-------- ----- ------ -------
Total other mortgage-backed securities 73,553 3,766 -- 77,319
-------- ----- ------ -------
Total mortgage-backed securities 335,714 4,946 (341) 340,319
-------- ----- ------ -------
Asset-backed securities:
Non-U.S. government agencies 500 3 -- 503
U.S. government agencies 3,276 60 (2) 3,334
-------- ----- ------ -------
Total asset-backed securities 3,776 63 (2) 3,837
-------- ----- ------ -------
Equity securities - common stock 3,677 550 (730) 3,497
Other 4,953 46 -- 4,999
-------- ----- ------ -------
Total investment securities $625,324 8,359 (1,319) 632,364
======== ===== ====== =======
64
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
The amortized cost, gross unrealized gains and losses and approximate fair value
of securities available for sale at December 31, 2001 are summarized as follows
(in thousands):
Amortized Unrealized Unrealized Fair
cost gains losses value
-------- ------ ------ -------
Debt securities:
U.S. Treasury $164,992 128 -- 165,120
U.S. Government agencies 79,419 1,647 (50) 81,016
Corporate 27,264 176 (414) 27,026
States and political subdivisions 26,696 575 (63) 27,208
-------- ------ ------ -------
Total debt securities 298,371 2,526 (527) 300,370
-------- ------ ------ -------
Mortgage-backed securities:
Collateralized mortgage obligations:
Federal Home Loan Mortgage Corporation 100,646 526 (599) 100,573
Government National Mortgage
Association 4,927 -- (193) 4,734
Federal National Mortgage Association 33,482 145 (501) 33,126
Privately issued 126,434 1,512 (805) 127,141
-------- ------ ------ -------
Total collateralized mortgage obligations 265,489 2,183 (2,098) 265,574
-------- ------ ------ -------
Other mortgage-backed securities:
Federal Home Loan Mortgage Corporation 37,081 1,258 -- 38,339
Government National Mortgage
Association 16,094 705 -- 16,799
Federal National Mortgage Association 18,213 956 -- 19,169
-------- ------ ------ -------
Total other mortgage-backed securities 71,388 2,919 -- 74,307
-------- ------ ------ -------
Total mortgage-backed securities 336,877 5,102 (2,098) 339,881
-------- ------ ------ -------
Asset-backed securities:
Non-U.S. government agencies 23,380 735 -- 24,115
U.S. government agencies 4,682 55 (2) 4,735
-------- ------ ------ -------
Total asset-backed securities 28,062 790 (2) 28,850
-------- ------ ------ -------
Equity securities - common stock 21,530 3,318 (4,523) 20,325
Other 4,453 18 -- 4,471
-------- ------ ------ -------
Total investment securities $689,293 11,754 (7,150) 693,897
======== ====== ====== =======
65
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Scheduled contractual maturities of certain investment securities owned by the
Company at December 31, 2002 are as follows (in thousands):
Amortized Fair
cost value
-------- -------
Debt securities:
Within one year $173,607 173,943
After one year through five years 79,440 80,796
After five years through ten years 9,589 10,454
After ten years 14,568 14,519
-------- -------
277,204 279,712
Mortgage-backed securities 335,714 340,319
Asset-backed securities 3,776 3,837
-------- -------
$616,694 623,868
======== =======
The contractual maturities of mortgage and asset-backed securities available for
sale generally exceed ten years. However, the effective lives are expected to be
shorter due to anticipated prepayments.
Gross realized gains and losses on securities available for sale in 2002, 2001
and 2000 are summarized as follows (in thousands):
2002 2001 2000
------- ----- -----
Gross realized gains $ 8,924 2,080 1,295
Gross realized losses (9,968) (2,163) (1,634)
------- ----- -----
Net realized gains (losses) $(1,044) (83) (339)
======= ===== =====
At December 31, 2002, $228.7 million of securities were pledged to secure
borrowings and lines of credit from the Federal Home Loan Bank ("FHLB") and
Federal Reserve Bank ("FRB"), repurchase agreements and deposits. At December
31, 2002, no investments in securities of a single non-U.S. Government or
government agency issuer exceeded 10% of stockholders' equity
66
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(5) Loans
Loans receivable at December 31, 2002 and 2001 consist of the following
(in thousands):
2002 2001
----------- ----------
Real estate:
One-to four-family $ 927,453 980,638
Home equity 136,986 114,443
Commercial and multi-family 473,493 392,896
Construction:
Commercial 101,633 56,394
Residential 5,567 8,108
----------- ---------
Total real estate loans 1,645,132 1,552,479
Consumer loans 169,155 182,126
Commercial business loans 178,555 135,621
----------- ---------
Total loans 1,992,842 1,870,226
Net deferred costs and unearned discounts 2,591 1,642
Allowance for credit losses (20,873) (18,727)
----------- ---------
Total loans, net $ 1,974,560 1,853,141
=========== =========
Included in commercial business loans are $41.5 million and $18.4 million
of direct financing leases at December 31, 2002 and 2001, respectively.
Under direct financing leases, the Company leases equipment to small
businesses with terms ranging from two to five years. During 2002, $34.6
million of equipment leases were originated by the Company, of which $2.6
million were sold to outside investors. The remainder of the leases
originated were retained by the Company.
Non-accrual loans amounted to $7.5 million, $11.5 million and $6.5 million
at December 31, 2002, 2001 and 2000, respectively, representing 0.38%,
0.61% and 0.35% of total loans, respectively. Interest income that would
have been recorded if the loans had been performing in accordance with
their original terms amounted to $182 thousand, $604 thousand and $273
thousand for 2002, 2001 and 2000, respectively. At December 31, 2002 and
2001, the balance of impaired loans amounted to $4.2 million and $5.3
million, respectively, and $897 thousand and $1.3 million, respectively,
was included within the allowance for credit losses to specifically
reserve for losses relating to those loans. Residential real estate owned,
net of related allowances of $0 and $363 thousand, at December 31, 2002
and December 31, 2001, respectively, was $1.4 million and $665 thousand,
respectively.
Residential mortgage loans held for sale were $4.3 million and $3.3
million at December 31, 2002 and December 31, 2001, respectively, and are
included in one-to four-family real estate loans. Mortgages serviced for
others by the Company amounted to $242.9 million, $252.3 million and
$190.1 million at December 31, 2002, 2001 and 2000, respectively. Mortgage
loans sold amounted to $55.5 million, $105.5 million and $56.3 million for
2002, 2001 and 2000, respectively. Gains on the sale of loans amounted to
$1.0 million, $1.4 million and $378 thousand for 2002, 2001 and 2000,
respectively.
67
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Changes in the Company's capitalized mortgage servicing assets,
classified within other assets in the consolidated statements of
condition for 2002, 2001 and 2000 are summarized as follows (in
thousands):
2002 2001 2000
------- ------- -------
Balance, beginning of year $ 1,265 519 122
Originations 482 952 417
Amortization (339) (206) (20)
------- ------- -------
Balance, end of year $ 1,408 1,265 519
======= ======= =======
The Company had outstanding commitments to originate loans of
approximately $124.6 million and $81.3 million at December 31, 2002 and
2001, respectively. These commitments have fixed expiration dates and are
at market rates. 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 $5.0
million and $2.6 million at December 31, 2002 and 2001, respectively.
Unused lines of credit and outstanding letters of credit amounted to
$179.5 million and $140.5 million at December 31, 2002 and 2001,
respectively. Since the majority of unused lines of credit and
outstanding letters of credit expire without being funded, the Company's
obligation to fund the above commitment amounts is substantially less
than the amounts reported.
Changes in the allowance for credit losses for 2002, 2001 and 2000 are
summarized as follows (in thousands):
2002 2001 2000
-------- ------ ------
Balance, beginning of year $ 18,727 17,746 9,862
Provision for credit losses 6,824 4,160 2,258
Allowance obtained through
acquisitions -- -- 6,361
Charge-offs (5,804) (4,071) (1,072)
Recoveries 1,126 892 337
-------- ------ ------
Balance, end of year $ 20,873 18,727 17,746
======== ====== ======
Virtually all of the Company's mortgage and consumer loans are to
customers located in Upstate New York. Accordingly, the ultimate
collectibility of the Company's loan portfolio is susceptible to changes
in market conditions in this market area. Loans due from certain officers
and directors of the Company and affiliates amounted to $1.5 million and
$5.9 million at December 31, 2002 and 2001, respectively.
68
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(6) Premises and Equipment
A summary of premises and equipment at December 31, 2002 and 2001 follows
(in thousands):
2002 2001
-------- -----
Land $ 3,511 3,531
Buildings and improvements 31,190 30,742
Furniture and equipment 33,670 31,065
Property under capital leases 1,365 1,365
-------- -----
69,736 66,703
Accumulated depreciation and amortization (29,291) (26,470)
-------- -----
Premises and equipment, net $ 40,445 40,233
======== ======
Future minimum rental commitments for premises and equipment under
noncancellable operating leases at December 31, 2002 were $1.7 million in
2003; $1.6 million in 2004; $1.6 million in 2005; $1.5 million in 2006;
$1.4 million in 2007; and $6.7 million in years thereafter through 2021.
Real estate taxes, insurance and maintenance expenses related to these
leases are obligations of the Company. Rent expense was $1.8 million, $1.5
million and $1.3 million for 2002, 2001 and 2000, respectively, and is
included in occupancy and equipment expense.
(7) Goodwill and Intangible Assets
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, 2000 (in thousands except per share amounts):
2002 2001 2000
---------- ---------- ----------
Net income:
As reported $ 30,795 21,220 19,519
Add back: Goodwill amortization -- 4,742 2,114
---------- ---------- ----------
Adjusted net income $ 30,795 25,962 21,633
========== ========== ==========
Basic earnings per share:
As reported $ 1.24 0.86 0.79
Add back: Goodwill amortization -- 0.19 0.08
---------- ---------- ----------
Adjusted basic earnings per share $ 1.24 1.05 0.87
========== ========== ==========
Diluted earnings per share:
As reported $ 1.21 0.85 0.79
Add back: Goodwill amortization -- 0.19 0.08
---------- ---------- ----------
Adjusted diluted earnings per share $ 1.21 1.04 0.87
========== ========== ==========
69
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
The following tables set forth information regarding the Company's
amortizing intangible assets (in thousands):
2002 2001
-------- --------
Customer lists:
Gross carrying amount $ 10,113 9,645
Accumulated amortization (3,721) (2,848)
-------- --------
Net carrying amount $ 6,392 6,797
======== ========
Estimated future intangible asset amortization expense:
2003 $896
2004 896
2005 873
2006 818
2007 728
In 2002 FNRM acquired the customer lists of a property and casualty
insurance agency and an insurance adjustment firm, both located in western
New York. In connection with these purchases, $468 thousand of customer
lists were recorded and are being amortized on a straight-line basis over
a period of three to five years, based upon management's evaluation of
their useful economic life.
The following table sets forth information regarding the Company's
goodwill for 2002, 2001 and 2000 (in thousands):
Financial Consolidated
Banking segment services segment total
--------------- ----------------- ----------------
Balances at January 1, 2000 $ -- 4,977 4,977
Acquired 71,857 2,782 74,639
Amortization (1,400) (714) (2,114)
Contingent earn-out adjustments -- (31) (31)
-------- -------- --------
Balances at December 31, 2000 70,457 7,014 77,471
Acquired -- 1,279 1,279
Amortization (3,787) (955) (4,742)
Purchase accounting adjustment 205 -- 205
-------- -------- --------
Balances at December 31, 2001 66,875 7,338 74,213
Contingent earn-out adjustments -- (112) (112)
-------- -------- --------
Balances at December 31, 2002 $ 66,875 7,226 74,101
======== ======== ========
The Company has performed the required transitional and annual goodwill
impairment tests as of January 1, 2002 and November 1, 2002, respectively.
Based upon the results of these tests, the Company has determined that
goodwill was not impaired as of either date.
70
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(8) Other Assets
A summary of other assets at December 31, 2002 and 2001 follows (in
thousands):
2002 2001
-------- -------
Cash surrender value of bank-
owned life insurance $ 54,082 51,357
FHLB stock 20,863 24,865
Net deferred tax assets (see note 14) 9,188 9,961
Accrued interest receivable 12,093 13,203
Other receivables and prepaid assets 7,975 3,499
Other 12,207 12,126
-------- -------
$116,408 115,011
======== =======
(9) Deposits
Deposits consist of the following at December 31, 2002 and 2001 (in
thousands):
2002 2001
--------------------- -----------------------
Weighted Weighted
average average
Balance rate Balance rate
---------- -------- ---------- -------
Savings accounts $ 632,894 1.49% $ 450,762 2.56%
Certificates of deposit maturing:
Within one year 630,587 3.15 674,637 4.41
After one year, through two years 195,372 3.24 148,965 4.23
After two years, through three years 20,499 4.68 19,996 5.20
After three years, through four years 25,231 4.50 10,771 5.81
After four years, through five years 4,906 4.17 6,662 5.10
After five years 2,651 4.72 2,686 5.14
---------- ----------
879,246 3.26 863,717 4.43
---------- ----------
Checking accounts:
Non-interest bearing 134,160 -- 109,895 --
Interest-bearing:
NOW accounts 161,063 0.68 157,886 0.94
Money market accounts 306,487 1.44 391,420 2.14
---------- ----------
601,710 659,201
---------- ----------
Mortgagors' payments held in escrow 15,619 2.00 17,150 2.00
---------- ----------
$2,129,469 2.06% $1,990,830 3.01%
========== ==========
Included within deposits is approximately $13.2 million of funds
authorized for withdrawal in connection with the Company's second step
stock offering. These funds were withdrawn from their respective deposit
accounts and credited to stockholders' equity upon completion of the
offering on January 17, 2003.
71
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Interest expense on deposits for 2002, 2001 and 2000 is summarized as
follows (in thousands):
2002 2001 2000
------- ------- -------
Certificates of deposit $32,774 47,284 30,593
Money market accounts 6,437 14,334 14,848
Savings accounts 12,750 10,919 9,380
NOW accounts 1,354 1,544 1,190
Mortgagors' payments
held in escrow 296 328 261
------- ------- -------
$53,611 74,409 56,272
======= ======= =======
Certificates of deposit issued in amounts over $100 thousand amounted to
$170.0 million, $157.8 million and $162.4 million at December 31, 2002,
2001 and 2000, respectively. Interest expense thereon approximated $6.3
million, $9.3 million and $4.8 million in 2002, 2001 and 2000,
respectively. The Federal Deposit Insurance Corporation does not insure
deposit amounts that are in excess of $100 thousand. Interest rates on
certificates of deposit range from 1.34% to 7.03% at December 31, 2002.
First Niagara is required to maintain reserves against certain deposit
accounts. At December 31, 2002, $600 thousand of the Company's cash and
due from banks is restricted from withdrawal to meet these reserve
requirements.
The carrying value of investment securities pledged as collateral for
deposits at December 31, 2002 was $21.2 million. The aggregate amount of
deposits that have been reclassified as loans at December 31, 2002 due to
such deposits being in an overdraft position was $1.4 million.
(10) Other Borrowed Funds
Information relating to outstanding borrowings at December 31, 2002 and
2001 is summarized as follows (in thousands):
2002 2001
-------- --------
Short-term borrowings:
FHLB advances $ 48,180 99,368
Reverse repurchase agreements 15,132 105,124
Loan payable to First Niagara
Financial Group, MHC 6,000 6,000
Commercial bank loan -- 2,500
-------- --------
$ 69,312 212,992
======== ========
Long-term borrowings:
FHLB advances $187,823 216,048
Reverse repurchase agreements 140,000 130,000
-------- --------
$327,823 346,048
======== ========
FHLB advances generally bear fixed interest rates ranging from 1.84% to
7.71% at December 31, 2002. Reverse repurchase agreements generally bear
fixed interest rates ranging from 1.50% to 6.53% at December 31, 2002. At
December 31, 2001, FNFG had a $2.5 million loan with a commercial bank
that was repaid on January 28, 2002 and had an interest rate equal to the
LIBOR rate plus 150 basis points.
72
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Interest expense on borrowings for 2002, 2001 and 2000 is summarized as
follows (in thousands):
2002 2001 2000
------- ------- -------
FHLB advances $14,081 16,514 13,099
Reverse repurchase agreements 8,256 7,669 7,253
Loan payable to First Niagara
Financial Group, MHC 153 394 90
Commercial bank loan 6 366 148
------- ------- -------
$22,496 24,943 20,590
======= ======= =======
The Company has a line of credit with the FHLB and FRB that provides a
secondary funding source for lending, liquidity, and asset/liability
management. At December 31, 2002, the FHLB line of credit totaled $732.9
million under which $236.0 million was utilized. The FRB line of credit
totaled $4.3 million, under which there were no borrowings outstanding as
of December 31, 2002. The Company is required to pledge loans or
investment securities as collateral for these borrowing facilities.
Approximately $259.7 million of residential mortgage and multifamily loans
were pledged to secure the amount outstanding under the FHLB line of
credit at December 31, 2002.
The Company pledged to the FHLB and to broker-dealers, available for sale
securities with a carrying value of $147.6 million at December 31, 2002.
These are treated as financing transactions and the obligations to
repurchase are reflected as a liability in the consolidated financial
statements. The dollar amount of securities underlying the agreements are
included in securities available for sale in the consolidated statements
of condition. However, the securities are delivered to the dealer with
whom each transaction is executed. The dealers may sell, loan or otherwise
dispose of such securities to other parties in the normal course of their
business, but agree to resell to the Company the same securities at the
maturities of the agreements. The Company also retains the right of
substitution of collateral throughout the terms of the agreements. At
December 31, 2002, there were no amounts at risk under reverse repurchase
agreements with any individual counterparty or group of related
counterparties that exceeded 10% of stockholders' equity. The amount at
risk is equal to the excess of the carrying value (or market value if
greater) of the securities sold under agreements to repurchase over the
amount of the repurchase liability.
The aggregate maturities of long-term borrowings at December 31, 2002 are
as follows (in thousands):
2004 $ 42,316
2005 58,878
2006 43,323
2007 27,271
Thereafter 156,035
--------
$327,823
========
(11) Capital
As discussed further in note 2, effective November 8, 2002, Cortland and
Cayuga merged into First Niagara, and First Niagara converted to a federal
charter subject to OTS regulation. OTS regulations require savings
institutions to maintain a minimum ratio of tangible capital to total
adjusted assets of 1.5%, a minimum ratio of Tier 1 (core) capital to total
adjusted assets of 4.0%, and a minimum ratio of total (core and
supplementary) capital to risk-weighted assets of 8.0%.
73
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Under its prompt corrective action regulations, the OTS is required to
take certain supervisory actions (and may take additional discretionary
actions) with respect to an undercapitalized institution. Such actions
could have a direct material effect on the institution's financial
statements. The regulations establish a framework for the classification
of savings institutions into five categories -- well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized,
and critically undercapitalized. Generally, an institution is considered
well capitalized if it has a Tier 1 (core) capital ratio of at least 5.0%,
a Tier 1 risk-based capital ratio of at least 6.0%, and a total risk-based
capital ratio of at least 10.0%.
The foregoing capital ratios are based in part on specific quantitative
measures of assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. Capital amounts and
classifications are also subject to qualitative judgments by the OTS about
capital components, risk weightings and other factors. These capital
requirements apply only to First Niagara, and do not consider additional
capital retained by FNFG. Prior to converting to federal charters, FNFG
and First Niagara were required to maintain minimum capital ratios
calculated in a similar manner to, but not entirely the same as, the
framework of the OTS.
Management believes that as of December 31, 2002, First Niagara met all
capital adequacy requirements to which it was subject. Further, the most
recent Federal Deposit Insurance Corporation notification categorized
First Niagara as a well-capitalized institution under the prompt
corrective action regulations. Management is unaware of any conditions or
events since the latest notification from federal regulators that have
changed the capital adequacy category of First Niagara.
The actual capital amounts and ratios for First Niagara at December 31,
2002 and 2001 are presented in the following table. For comparative
purposes, prior year amounts and ratios have been recomputed to conform to
OTS regulations to illustrate the effect of the consolidation of Cortland
and Cayuga into First Niagara as if it occurred on December 31, 2001 (in
thousands):
To be well capitalized
Minimum under prompt corrective
Actual capital adequacy action provisions
-------------------- ------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------ -------- ----- -------- ------
December 31, 2002:
Tangible capital $186,218 6.54% 42,699 1.50% N/A N/A%
Tier 1 (core) capital 186,218 6.54 113,863 4.00 142,328 5.00
Tier 1 risk-based capital 186,218 10.27 N/A N/A 108,743 6.00
Total risk-based capital 205,508 11.34 144,990 8.00 181,238 10.00
December 31, 2001:
Tangible capital $165,805 5.99% 41,517 1.50% N/A N/A%
Tier 1 (core) capital 165,805 5.99 110,711 4.00 138,389 5.00
Tier 1 risk-based capital 165,805 9.78 N/A N/A 101,677 6.00
Total risk-based capital 166,083 9.80 135,569 8.00 169,462 10.00
74
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
The following is a reconciliation of stockholders' equity under generally
accepted accounting principles ("GAAP") to regulatory capital for First
Niagara as of December 31, 2002 an 2001 (in thousands):
2002 2001
--------- ---------
First Niagara
GAAP stockholders' equity $ 270,946 250,021
Capital adjustments:
Goodwill and other intangibles (80,493) (81,010)
Unrealized losses on equity securities
available for sale (net of tax) (408) (928)
Fair value adjustment included in stockholders' equity (3,930) (2,391)
Disallowed portion of mortgage servicing rights (140) (126)
Minority interest 243 239
--------- ---------
Tier 1 capital 186,218 165,805
Allowable portion of allowance for credit losses 20,873 18,727
Fair value of equity securities (1,583) (18,449)
--------- ---------
Total capital $ 205,508 166,083
========= =========
FNFG's ability to pay dividends is primarily dependent upon the ability of
First Niagara to pay dividends to FNFG. The payment of dividends by
subsidiary banks is subject to continued compliance with minimum
regulatory capital requirements. In addition, regulatory approval is
required prior to a subsidiary bank declaring dividends in excess of net
income for that year plus net income retained in the preceding two years.
First Niagara established a liquidation account at the time of conversion
to a New York State chartered stock savings bank in an amount equal to its
net worth as of the date of the latest consolidated statement of financial
condition appearing in the final prospectus. In the event of a complete
liquidation of First Niagara, each eligible account holder will be
entitled, under New York State Law, to receive a distribution from the
liquidation account in an amount equal to their current adjusted account
balance for all such depositors then holding qualifying deposits in First
Niagara. Accordingly, retained earnings of the Company are deemed to be
restricted up to the balances of the liquidation accounts at December 31,
2002 and 2001. The liquidation account is maintained for the benefit of
eligible pre-conversion account holders who continue to maintain their
accounts at First Niagara after the date of conversion. The liquidation
account, which is reduced annually to the extent that eligible account
holders have reduced their qualifying deposits as of each anniversary
date, totaled $30.4 million at December 31, 2002 and $36.0 million at
December 31, 2001. Similarly, a liquidation account is also maintained for
depositors acquired from Cortland in connection with its reorganization
into a New York State chartered stock savings bank. This liquidation
account totaled $8.2 million at December 31, 2002 and $9.4 million at
December 31, 2001.
(12) Derivative and Hedging Activities
During 1999 and 2000 the Company entered into interest rate swap
agreements in order to manage the interest rate risk related to the
repricing of its Money Market Deposit Accounts ("MMDA"). Under the
agreements the Company paid an annual fixed rate of interest and received
a floating three-month U.S. Dollar LIBOR rate over a two-year period. The
last of the Company's interest rate swap agreements expired in December
2002. Since the swap agreements qualified as cash flow hedges under the
provisions of SFAS No. 133, the Company recognized the portion of the
change in fair value of the interest rate swaps that was considered
effective in
75
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
hedging cash flows as a direct charge or credit to other comprehensive
income, net of tax, each period. With the adoption of SFAS No. 133 on
January 1, 2001 a negative fair value adjustment of $95 thousand was
recorded in other comprehensive income, net of income taxes of $63
thousand, as a cumulative effect of a change in accounting principle, as
required by the Statement. The Company intends to continue to analyze the
future utilization of swap agreements as part of its overall
asset/liability management process.
The following table illustrates the effect of interest rate swaps on
other comprehensive income for 2002 and 2001 (in thousands):
Before-tax Income Net-of-tax
amount taxes amount
---------- ------ ----------
Year ended December 31, 2002:
Net unrealized losses arising during 2002 $(175) 70 (105)
Reclassification adjustment for realized
losses included in net income 518 (207) 311
----- ----- -----
Net gains included in other
comprehensive income $ 343 (137) 206
===== ===== =====
Year ended December 31, 2001:
Net unrealized losses arising during 2001 $(837) 334 (503)
Reclassification adjustment for realized
losses included in net income 652 (260) 392
----- ----- -----
Net losses included in other
comprehensive income $(185) 74 (111)
===== ===== =====
For 2002, interest expense on deposits was reduced by $117 thousand for
the portion of the change in fair value of swaps that was determined to be
ineffective. For 2001, interest expense on deposits was increased by $117
thousand for the portion of the change in fair value of swaps that was
determined to be ineffective. Amounts included in other comprehensive
income relating to the unrealized losses on swaps was reclassified to
interest expense on deposit accounts as interest expense on the hedged
MMDA accounts increased or decreased, based upon fluctuations in the U.S.
Dollar LIBOR rate.
During 2000, $94 thousand of net interest income relating to interest rate
swaps was reflected in interest expense on the hedged MMDA accounts. Prior
to January 1, 2001 the net interest income or expense on these instruments
was recognized in income or expense over the lives of the respective
contracts as accrued.
(13) Stock Based Compensation
The Company has two stock based compensation plans pursuant to which
options may be granted to officers, directors and key employees. The 1999
Stock Option Plan authorizes grants of options to purchase up to 1,390,660
shares of common stock. In 2002, the Board of Directors and stockholders
of FNFG adopted a long-term incentive stock benefit plan. This plan
authorizes the issuance of up to 834,396 shares of common stock pursuant
to grants of stock options, stock appreciation rights, accelerated
ownership option rights or stock awards. During 2002, only stock options
were granted under this plan. Stock options are granted with an exercise
price equal to the stock's market value on the date of grant. All options
have a 10-year term and become fully vested and exercisable over a period
of 4 to 5 years from the grant date. At December 31, 2002, there were
options for 1,326,743 shares outstanding and 717,513 additional shares
available for grant under the plans.
76
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
The following is a summary of stock option activity for 2002, 2001 and
2000:
Number of Weighted average
shares exercise price
--------- ----------------
Balance at January 1, 2000 783,250 $10.75
Granted 471,500 9.07
Exercised -- --
Forfeited (15,600) 10.05
---------
Balance at December 31, 2000 1,239,150 10.12
Granted 173,375 13.06
Exercised (39,700) 10.22
Forfeited (120,600) 10.23
---------
Balance at December 31, 2001 1,252,225 10.51
Granted 164,868 29.38
Exercised (90,350) 10.43
Forfeited -- --
---------
Balance at December 31, 2002 1,326,743 $12.86
=========
The following is a summary of stock options outstanding at December 31,
2002 and 2001:
Weighted Weighted Weighted
average average average
Options exercise remaining Options exercise
Exercise price outstanding price life (years) exercisable price
-------------------------- -------------- ------------ ------------- ------------- -------------
December 31, 2002:
$9.03 - $12.60 1,135,375 $10.41 6.99 544,495 $10.37
$13.80 - $16.86 26,500 $15.48 8.73 5,125 $15.67
$25.35 - $31.54 164,868 $29.38 9.62 -- --
-------------- -------------
Total 1,326,743 $12.86 7.35 549,620 $10.42
============== =============
December 31, 2001:
$9.03 - $12.60 1,224,725 $10.40 7.97 348,500 $10.35
$13.80 - $16.86 27,500 $15.47 9.73 -- --
-------------- -------------
Total 1,252,225 $10.51 8.01 348,500 $10.35
============== =============
During 1999, the Company allocated 556,264 shares for issuance under a
Restricted Stock Plan. The plan grants shares of FNFG's stock to executive
management and members of the Board of Directors. The restricted stock
generally becomes fully vested over five years from the grant date.
Compensation expense equal to the market value of FNFG's stock on the
grant date is accrued ratably over the service period for shares granted.
At December 31, 2002, there were 203,675 unvested shares outstanding and
160,399 additional shares available for grant under the plan. Unearned
compensation expense related to granted but unvested restricted stock
amounted to $2.5 million and $2.2 million at December 31, 2002 and 2001,
respectively. Shares of restricted stock are issued from treasury stock as
they vest.
77
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Shares granted under the Restricted Stock Plan during 2002, 2001 and 2000
totaled 45,315, 51,500 and 139,250, respectively, and had a weighted
average market value on the date of grant of $26.99, $13.51 and $9.06,
respectively. Compensation expense related to this plan amounted to $927
thousand, $648 thousand and $663 thousand for 2002, 2001 and 2000,
respectively.
(14) Income Taxes
Total income taxes for 2002, 2001 and 2000 were allocated as follows (in
thousands):
2002 2001 2000
-------- -------- --------
Income from operations $ 19,154 12,703 10,973
Stockholders' equity (1,345) (1,403) 6,404
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
Company's decision to combine its three banks, First Niagara can no longer
make this assertion and accordingly, recorded a $1.8 million deferred
income tax liability in the second quarter of 2002. As anticipated, as of
December 31, 2002, First Niagara did not maintain the required percentage
of qualified assets. 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.
The components of income taxes attributable to income from operations for
2002, 2001 and 2000 are as follows (in thousands):
2002 2001 2000
-------- -------- --------
Current:
Federal $ 16,507 11,402 10,207
State 1,551 472 346
-------- -------- --------
18,058 11,874 10,553
-------- -------- --------
Deferred:
Federal (553) 809 166
State 1,649 20 254
-------- -------- --------
1,096 829 420
-------- -------- --------
$ 19,154 12,703 10,973
======== ======== ========
78
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
The Company's effective tax rate for 2002, 2001 and 2000 were 38.3%, 37.4%
and 36.0%, respectively. Income tax expense attributable to income from
operations for 2002, 2001 and 2000 differs from the expected tax expense
(computed by applying the Federal corporate tax rate of 35% to income
before income taxes) as follows (in thousands):
2002 2001 2000
-------- -------- --------
Expected tax expense $ 17,482 11,873 10,672
Increase (decrease) attributable to:
State income taxes, net of Federal
benefit and deferred state tax 873 326 479
New York State bad debt tax expense
recapture, net of Federal benefit 1,784 -- --
Bank-owned life insurance income (930) (877) (724)
Municipal interest (430) (537) (126)
Amortization of goodwill and other
intangibles 302 1,936 1,016
Decrease in federal valuation allowance
for deferred tax assets -- (292) (542)
Other 73 274 198
-------- -------- --------
$ 19,154 12,703 10,973
======== ======== ========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 2002 and 2001 are presented below (in thousands):
2002 2001
-------- --------
Deferred tax assets:
Financial reporting allowance for credit losses $ 8,328 7,472
Net purchase discount on acquired companies 1,738 1,705
Deferred compensation 2,144 2,081
Post-retirement benefit obligation 1,403 1,450
Losses on investments in affiliates -- 418
Acquired intangibles 696 779
Pension obligation 1,135 --
Other 528 1,058
-------- --------
Total gross deferred tax assets 15,972 14,963
Valuation allowance -- --
-------- --------
Net deferred tax assets 15,972 14,963
-------- --------
Deferred tax liabilities:
Tax allowance for credit losses, in excess
of base year amount (2,266) (820)
Unrealized gain on securities available for sale (2,808) (2,879)
Excess of tax depreciation over financial
reporting depreciation (1,078) (694)
Other (632) (609)
-------- --------
Total gross deferred tax liabilities (6,784) (5,002)
-------- --------
Net deferred tax asset $ 9,188 9,961
======== ========
79
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, availability of operating loss carrybacks, projected future
taxable income, and tax planning strategies in making this assessment.
Based upon the level of historical taxable income, the opportunity for net
operating loss carrybacks, and projections for future taxable income over
the periods which deferred tax assets are deductible, management believes
it is more likely than not the Company will realize the benefits of these
deductible differences at December 31, 2002.
(15) Earnings Per Share
The computation of basic and diluted earnings per share for 2002, 2001 and
2000 are as follows (in thousands except per share amounts):
2002 2001 2000
-------- -------- --------
Net income available to common stockholders $ 30,795 21,220 19,519
======== ======== ========
Weighted average shares outstanding basic and diluted
Total shares issued 29,756 29,756 29,756
Unallocated ESOP shares (861) (914) (968)
Treasury shares (3,982) (4,114) (3,941)
-------- -------- --------
Total basic weighted average shares outstanding 24,913 24,728 24,847
Incremental shares from assumed exercise of
stock options 473 220 9
Incremental shares from assumed vesting of
restricted stock awards 83 62 2
-------- -------- --------
Total diluted weighted average shares outstanding $ 25,469 25,010 24,858
======== ======== ========
Basic earnings per share $ 1.24 0.86 0.79
======== ======== ========
Diluted earnings per share $ 1.21 0.85 0.79
======== ======== ========
80
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(16) Benefit Plans
Pension Plan
The reconciliation of the change in the projected benefit obligation, the
fair value of plan assets and the funded status of the Company's pension
plan as of December 31, 2002 and 2001 are as follows (in thousands):
2002 2001
-------- -----
Change in projected benefit obligation:
Projected benefit obligation at beginning
of year $ 11,874 8,339
Service cost 288 676
Interest cost 751 739
Actuarial loss 1,290 783
Benefits paid (331) (299)
Settlements (23) (9)
Plan amendments 119 1,645
Curtailment (2,795) --
-------- ------
Projected benefit obligation at end of year 11,173 11,874
-------- ------
Change in fair value of plan assets:
Fair value of plan assets at beginning of year 9,763 11,753
Actual loss on plan assets (1,223) (1,682)
Benefits paid (331) (299)
Settlements (23) (9)
-------- ------
Fair value of plan assets at end of year 8,186 9,763
-------- ------
Projected benefit obligation in excess of plan
assets at end of year (2,987) (2,111)
Unrecognized actuarial loss 3,587 393
Unrecognized actuarial prior service cost -- 1,524
-------- ------
Prepaid (accrued) pension costs $ 600 (194)
======== ======
Amounts recognized in the consolidated balance sheet consist of:
Accrued pension liability $(2,987) (194)
Accumulated other comprehensive loss 3,587 --
-------- ------
Net amount recognized $ 600 (194)
======== ======
81
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Net pension cost for the years 2002, 2001 and 2000 is comprised of the
following (in thousands):
2002 2001 2000
------ ------ ------
Service cost $ 288 676 408
Interest cost 751 739 621
Expected return on plan assets (892) (1,026) (862)
Amortization of unrecognized gain -- (152) (76)
Amortization of unrecognized prior service
liability 58 121 1
Curtailment credit (998) -- --
------ ------ -----
Net periodic pension (gain) cost $ (793) 358 92
====== ====== =====
The principal actuarial assumptions used in 2002, 2001 and 2000 were as
follows:
2002 2001 2000
------ ------ -----
Discount rate 6.50% 7.25% 8.00%
Expected long-term rate of return on plan assets 8.50% 9.00% 9.00%
Assumed rate of future
compensation increase N/A 4.50% 5.00%
====== ====== =====
The plan assets are in mutual funds consisting primarily of listed stocks
and bonds, government securities and cash equivalents. Effective February
1, 2002, the Company froze all benefit accruals and participation in the
pension plan. Accordingly, subsequent to that date, no employees will be
permitted to commence participation in the plan and future salary
increases and years of credited service will not be considered when
computing an employee's benefits under the plan. As a result, the Company
recognized a one-time pension curtailment gain of $998 thousand in 2002.
As of October 1, 2002, the latest measurement date, the accumulated
benefit obligation of the pension plan exceeded the fair value of its
assets. Accordingly, the Company was required to record a $3.6 million
(gross) additional minimum pension liability, included as a reduction of
stockholders' equity net of taxes of $1.4 million. As of December 31,
2002, the Company has met all ERISA minimum funding requirements.
82
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Other Post-retirement Benefits
A reconciliation of the change in the benefit obligation and the accrued
benefit cost of the Company's post-retirement plan as of December 31, 2002
and 2001 are as follows (in thousands):
2002 2001
------- -----
Change in accumulated post-retirement benefit obligation:
Accumulated post-retirement benefit
obligation at beginning of year $ 3,284 3,256
Service cost -- 47
Interest cost 230 208
Actuarial loss 792 924
Benefits paid (295) (210)
Plan amendments -- (930)
Curtailment credit -- (11)
------- -----
Accumulated post-retirement benefit obligation at end of year 4,011 3,284
------- -----
Fair value of plan assets at end of year -- --
------- -----
Post-retirement benefit obligation in excess
of plan assets at end of year (4,011) (3,284)
Unrecognized actuarial loss 1,313 535
Unrecognized prior service credit (819) (884)
------- -----
Accrued post-retirement benefit cost
at end of year $(3,517) (3,633)
======= ======
The components of net periodic post-retirement benefit cost for 2002, 2001
and 2000 are as follows (in thousands):
2002 2001 2000
----- --- ---
Service cost $ -- 47 95
Interest cost 230 208 140
Amortization of unrecognized loss (gain) 13 1 (12)
Amortization of unrecognized prior service credit (64) (46) --
Curtailment credit -- (11) --
----- --- ---
Total periodic cost $ 179 199 223
===== === ===
The post-retirement benefit obligation was determined using a discount
rate of 6.50% for 2002, 7.25% for 2001 and 8.00% for 2000 and an assumed
rate of future compensation increases of 4.00% for 2002, 4.50% for 2001
and 5.00% for 2000. The assumed health care cost trend rate used in
measuring the accumulated post-retirement benefit obligation was 9.00% for
2003, and gradually decreased to 4.50% in the year 2008 and thereafter,
over the projected payout of benefits. The health care cost trend rate
assumption can have a significant effect on the amounts reported. If the
health care cost trend rate were increased one percent, the accumulated
post-retirement benefit obligation as of December 31, 2002 would have
increased by 7.8% and the aggregate of service and interest cost would
have increased by 5.8%. If the health care cost trend rate were decreased
one percent, the accumulated post-retirement benefit obligation as of
December 31, 2002 would have decreased by 6.7% and the aggregate of
service and interest cost would have decreased by 5.1%.
83
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Effective January 19, 2001, the Company modified all of its
post-retirement health care and life insurance plans. Participation in the
plans was closed to those employees who did not meet the retirement
eligibility requirements as of December 31, 2001.
401(k) Plan
All full-time and part-time employees of the Company that meet certain age
and service requirements are eligible to participate in the Company
sponsored 401(k) plan. Under the plan, participants may make
contributions, in the form of salary reductions, up to the maximum
Internal Revenue Code limit. The Company contributes an amount to the plan
equal to 100% of the first 2% of employee contributions plus 75% of
employee contributions between 3% and 6%. The Company's contribution to
these plans amounted to $1.3 million, $1.2 million and $524 thousand for
2002, 2001 and 2000, respectively.
Employee Stock Ownership Plan ("ESOP")
The Company's ESOP plan is accounted for in accordance with Statement of
Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans."
All full-time and part-time employees of the Company that meet certain age
and service requirements are eligible to participate. The ESOP holds
shares of FNFG common stock that were purchased in the 1998 initial public
offering and in the open market. The purchased shares were funded by a
loan from FNFG payable in equal quarterly installments over 30 years
bearing an interest rate that is adjustable with the prime rate. Loan
payments are funded by cash contributions from First Niagara and dividends
on FNFG stock held by the ESOP. The loan can be prepaid without penalty.
Shares purchased by the ESOP are maintained in a suspense account and held
for allocation among the participants. As quarterly loan payments are
made, shares are committed to be released and subsequently allocated to
employee accounts at each calendar year end. Compensation expense is
recognized in an amount equal to the average market price of the committed
to be released shares during the respective quarterly period. Compensation
expense of $1.2 million, $803 thousand and $494 thousand was recognized
for 2002, 2001 and 2000, respectively, in connection with the 45,786,
56,550 and 52,727 shares allocated to participants during those respective
years. The fair value of unallocated ESOP shares was $21.8 million at
December 31, 2002 and $14.8 million at December 31, 2001.
Other Plans
The Company also sponsors various non-qualified compensation plans for
officers and employees. Awards are payable if certain earnings and
performance objectives are met. Awards under these plans amounted to $2.7
million, $2.5 million and $1.3 million for 2002, 2001 and 2000,
respectively. The Company also maintains supplemental benefit plans for
certain executive officers.
84
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(17) Fair Value of Financial Instruments
The carrying value and estimated fair value of the Company's financial
instruments at December 31, 2002 and 2001 are as follows (in thousands):
Carrying Estimated fair
value value
----------- --------------
December 31, 2002:
Financial assets:
Cash and cash equivalents $ 90,525 90,525
Securities available for sale 632,364 632,364
Loans, net 1,974,560 2,073,157
Other assets 87,038 87,593
Financial liabilities:
Deposits $ 2,129,469 2,136,427
Borrowings 397,135 427,572
Stock offering subscription proceeds 75,952 75,952
Other liabilities 2,380 2,380
December 31, 2001:
Financial assets:
Cash and cash equivalents $ 74,654 74,654
Securities available for sale 693,897 693,897
Loans, net 1,853,141 1,915,712
Other assets 89,425 89,534
Financial liabilities:
Deposits $ 1,990,830 1,996,810
Borrowings 559,040 574,642
Other liabilities 2,957 2,957
Interest rate swaps (460) (460)
Fair value estimates are based on existing on and off balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that
are not considered financial instruments. In addition, the tax
ramifications related to the realization of the unrealized gains and
losses can have a significant effect on fair value estimates and have not
been considered in these estimates. Fair value estimates, methods, and
assumptions are set forth below for each type of financial instrument.
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial
instruments, including judgments regarding future expected loss
experience, current economic conditions, risk characteristics of various
financial instruments, and other factors. These estimates are subjective
in nature and involve uncertainties and matters of significant judgment
and therefore cannot be determined with precision. Changes in assumptions
could significantly affect the estimates.
Cash and Cash Equivalents
The carrying value approximates the fair value because the instruments
have original maturities of three months or less.
85
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Securities
The carrying value and fair value are estimated based on quoted market
prices. See note 4 for the amortized cost of securities available for
sale.
Loans
Residential revolving home equity and personal and commercial open ended
lines of credit reprice as the prime rate changes. Therefore, the carrying
value of such loans approximates their fair value.
The fair value of fixed-rate performing loans is calculated by discounting
scheduled cash flows through estimated maturity using current origination
rates. The estimate of maturity is based on the contractual cash flows
adjusted for prepayment estimates based on current economic and lending
conditions. Fair value for significant nonaccruing loans is based on
carrying value, which does not exceed recent external appraisals of any
underlying collateral.
Deposits
The fair value of deposits with no stated maturity, such as savings, money
market, checking, as well as mortgagors' payments held in escrow, is equal
to the amount payable on demand. The fair value of certificates of deposit
is based on the discounted value of contractual cash flows, using rates
currently offered for deposits of similar remaining maturities.
Borrowings
The fair value of borrowings is calculated by discounting scheduled cash
flows through the estimated maturity using current market rates.
Stock Offering Subscription Proceeds
The fair value of stock offering subscription proceeds is equal to its
carrying value similar to other deposit accounts with no stated maturity.
Other Assets and Liabilities
The fair value of accrued interest receivable on loans and investments and
accrued interest payable on deposits and borrowings approximates the
carrying value because all interest is receivable or payable in 90 to 120
days. The fair value of bank-owned life insurance is calculated by
discounting scheduled cash flows through the estimated maturity using
current market rates. FHLB stock carrying value approximates fair value.
Interest Rate Swaps
The fair value of interest rate swaps is calculated by discounting
expected future cash flows through maturity using current market rates.
Commitments
The fair value of commitments to extend credit, standby letters of credit
and financial guarantees are not included in the above table as the
carrying value generally approximates fair value. These instruments
generate fees that approximate those currently charged to originate
similar commitments.
86
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(18) 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, its
banking activities and its financial services activities. Financial
services activities consist of the results of the Company's insurance and
investment advisory subsidiaries, as well as First Niagara's trust
department, which were organized under one Financial Services Group in
2001. Banking activities consists of the results of FNFG's banking
subsidiaries excluding financial services activities. Transactions between
the banking and financial services segments are primarily related to
interest income and expense from intercompany deposit accounts, which are
eliminated in consolidation and are accounted for under the accrual method
of accounting.
Information about the Company's segments at or for the years ended
December 31, 2002, 2001 and 2000 is presented in the following table (in
thousands):
Financial
Banking services Consolidated
At or for the year ended: activities activities Eliminations total
---------- ---------- ------------ ------------
December 31, 2002
Interest income $ 167,637 105 (105) 167,637
Interest expense 76,212 -- (105) 76,107
---------- ---------- ---------- ----------
Net interest income 91,425 105 -- 91,530
Provision for credit losses 6,824 -- -- 6,824
---------- ---------- ---------- ----------
Net interest income after
provision for credit losses 84,601 105 -- 84,706
Noninterest income 25,500 24,276 (85) 49,691
Amortization of other
intangibles -- 873 -- 873
Other noninterest expense 63,873 19,787 (85) 83,575
---------- ---------- ---------- ----------
Income before income taxes 46,228 3,721 -- 49,949
Income tax expense 17,236 1,918 -- 19,154
---------- ---------- ---------- ----------
Net income $ 28,992 1,803 -- 30,795
========== ========== ========== ==========
Total assets $2,914,242 28,726 (8,173) 2,934,795
========== ========== ========== ==========
87
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Financial
Banking services Consolidated
At or for the year ended: activities activities Eliminations total
---------- ---------- ------------ ------------
December 31, 2001
Interest income $ 178,368 149 (149) 178,368
Interest expense 99,501 -- (149) 99,352
---------- ---------- ---------- ----------
Net interest income 78,867 149 -- 79,016
Provision for credit losses 4,160 -- -- 4,160
---------- ---------- ---------- ----------
Net interest income after
provision for credit losses 74,707 149 -- 74,856
Noninterest income 20,433 21,662 (23) 42,072
Amortization of goodwill and
other intangibles 3,787 1,924 -- 5,711
Other noninterest expense 59,668 17,649 (23) 77,294
---------- ---------- ---------- ----------
Income before income taxes 31,685 2,238 -- 33,923
Income tax expense 11,148 1,555 -- 12,703
---------- ---------- ---------- ----------
Net income $ 20,537 683 -- 21,220
========== ========== ========== ==========
Total assets $2,837,552 27,767 (7,373) 2,857,946
========== ========== ========== ==========
December 31, 2000
Interest income $ 137,040 117 (117) 137,040
Interest expense 76,969 10 (117) 76,862
---------- ---------- ---------- ----------
Net interest income 60,071 107 -- 60,178
Provision for credit losses 2,258 -- -- 2,258
---------- ---------- ---------- ----------
Net interest income after
provision for credit losses 57,813 107 -- 57,920
Noninterest income 15,101 18,998 (9) 34,090
Amortization of goodwill and
other intangibles 1,401 1,650 -- 3,051
Other noninterest expense 43,716 14,760 (9) 58,467
---------- ---------- ---------- ----------
Income before income taxes 27,797 2,695 -- 30,492
Income tax expense 9,336 1,637 -- 10,973
---------- ---------- ---------- ----------
Net income $ 18,461 1,058 -- 19,519
========== ========== ========== ==========
Total assets $2,605,507 24,724 (5,545) 2,624,686
========== ========== ========== ==========
88
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
(19) Condensed Parent Company Only Financial Statements
The following condensed statements of condition as of December 31, 2002
and 2001 and the condensed statements of income and cash flows for 2002,
2001 and 2000 should be read in conjunction with the consolidated
financial statements and related notes (in thousands):
2002 2001
-------- --------
Condensed Statements of Condition
Assets:
Cash and cash equivalents $ 3,724 3,106
Securities available for sale 1,915 5,094
Loan receivable from ESOP 12,034 12,511
Investment in subsidiaries 270,946 250,021
Other assets 1,938 578
-------- --------
Total assets $290,557 271,310
======== ========
Liabilities:
Accounts payable and other liabilities $ 861 193
Short-term borrowings -- 4,500
Short-term loan payable to related parties 6,000 6,000
Stockholders' equity 283,696 260,617
-------- --------
Total liabilities and stockholders' equity $290,557 271,310
======== ========
2002 2001 2000
-------- -------- --------
Condensed Statements of Income
Interest income $ 736 1,482 3,538
Dividends received from subsidiaries 10,900 16,000 95,000
-------- -------- --------
Interest income 11,636 17,482 98,538
Interest expense 166 924 415
-------- -------- --------
Net interest income 11,470 16,558 98,123
Net gain (loss) on securities available
for sale 397 98 (422)
Noninterest expenses 1,817 1,674 1,244
-------- -------- --------
Income before income taxes and
undisbursed (overdisbursed)
income of subsidiaries 10,050 14,982 96,457
Income tax (benefit) expense (355) (425) 587
-------- -------- --------
Income before undisbursed
(overdisbursed) income
of subsidiaries 10,405 15,407 95,870
Undisbursed (overdisbursed) income
of subsidiaries 20,390 5,813 (76,351)
-------- -------- --------
Net income $ 30,795 21,220 19,519
======== ======== ========
89
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001 and 2000
Condensed Statements of Cash Flows 2002 2001 2000
---------- ---------- ----------
Cash flows from operating activities:
Net income $ 30,795 21,220 19,519
Adjustments to reconcile net income to
net cash provided by operating activities:
Accretion of fees and discounts, net (16) (17) (18)
(Undisbursed) overdisbursed income
of subsidiaries (20,390) (5,813) 76,351
Net (gain) loss on securities
available for sale (397) (98) 422
Deferred income taxes 36 678 767
(Increase) decrease in other assets (460) 2,711 2,869
Increase (decrease) in liabilities 1,116 (60) (3,468)
---------- ---------- ----------
Net cash provided by operating
activities 10,684 18,621 96,442
---------- ---------- ----------
Cash flow from investing activities:
Proceeds from sales of securities available for sale 986 195 25,085
Purchases of securities available for sale (582) (125) (841)
Principal payments on securities available for sale 3,405 2,353 5,105
Acquisitions, net of cash acquired -- (322) (120,713)
Repayment of ESOP loan receivable 477 477 476
---------- ---------- ----------
Net cash provided by (used in)
investing activities 4,286 2,578 (90,888)
---------- ---------- ----------
Cash flows from financing activities:
Purchase of treasury stock -- -- (10,871)
Repayment of loans from related parties -- -- (5,408)
(Repayment) proceeds of short-term borrowings (4,500) (10,709) 15,209
Proceeds from exercise of stock options 942 406 --
Dividends paid on common stock (10,794) (8,983) (7,024)
---------- ---------- ----------
Net cash used in financing activities (14,352) (19,286) (8,094)
---------- ---------- ----------
Net increase (decrease) in cash
and cash equivalents 618 1,913 (2,540)
Cash and cash equivalents at beginning
of year 3,106 1,193 3,733
---------- ---------- ----------
Cash and cash equivalents at end of year $ 3,724 3,106 1,193
========== ========== ==========
90
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers of FNFG in
the Proxy Statement for the 2003 Annual Meeting of Stockholders is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation in the Proxy Statement
for the 2003 Annual Meeting of Stockholders is incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial
owners of FNFG management in the Proxy Statement for the 2003 Annual
Meeting of Stockholders is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions
in the Proxy Statement for the 2003 Annual Meeting of Stockholders
is incorporated herein by reference.
ITEM 14. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer,
we evaluated the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-14(c) and
15d-14(c) under the Exchange Act) as of a date (the "Evaluation
Date") within 90 days prior to the filing date of this report. Based
upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the Evaluation Date, our
disclosure controls and procedures are effective to ensure that
information required to be disclosed in the reports that the Company
files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission's rules
and forms. There have been no significant changes in the Company's
internal controls or in other factors that could significantly
affect these controls subsequent to the Evaluation Date.
91
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial statements are filed as part of this Annual Report on Form
10-K. See Part II, Item 8. "Financial Statements and Supplementary
Data."
(b) Reports on Form 8-K
On November 13, 2002, the Company filed a Current Report on Form 8-K
which disclosed that First Niagara and the MHC have completed their
conversions from New York chartered institutions to federally
chartered institutions. The Company also disclosed that Cayuga and
Cortland, formerly operated as wholly owned subsidiaries, have been
merged into First Niagara. Such Current Report, as an Item 7 exhibit
included the Company's press release dated November 12, 2002.
On November 18, 2002, the Company filed a Current Report on Form 8-K
which disclosed that First Niagara, has received approval from the
OTS for the second step conversion of the MHC. Additionally, the
Company reported information regarding the conversion, offering and
stock information center. Such Current Report, as an Item 7 exhibit
included the Company's press release dated November 15, 2002.
On December 19, 2002, the Company filed a Current Report on Form 8-K
which disclosed that FNFG received OTS approval for the acquisition
of FLBC and its wholly owned subsidiary, SBFL, and that the merger
remained subject to the approval of the shareholders of FLBC, which
had a special meeting scheduled for December 30, 2002. Such Current
Report, as an Item 7 exhibit included the Company's press release
dated December 13, 2002.
On December 30, 2002, the Company filed a Current Report on Form 8-K
which disclosed that orders for approximately 11,000,000 shares of
common stock had been received in the subscription and community
offering portion of its second step conversion offering, which
concluded on December 23, 2002. In addition, the Company disclosed
that Ryan Beck & Co., Inc. had been authorized to proceed with a
syndicated community offering of unsold shares of common stock,
which is expected to commence on or about January 6, 2003. Finally,
the Company disclosed that, subject to market conditions and
regulatory approval, it anticipated completing the offering at no
more than the midpoint of the offering range. Such Current Report,
as an Item 7 exhibit included the Company's press release dated
December 27, 2002.
92
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (Con't)
(c) Exhibits
The exhibits listed below are filed herewith or are incorporated by
reference to other filings.
Exhibit Index to Form 10-K
--------------------------
Exhibit 3.3 Certificate of Incorporation (1)
Exhibit 3.4 Bylaws (1)
Exhibit 10.1 Form of Employment Agreement with the Named Executive Officers (2)
Exhibit 10.2 First Niagara Bank Deferred Compensation Plan (3)
Exhibit 10.3 First Niagara Financial Group, Inc. 1999 Stock Option Plan (4)
Exhibit 10.4 First Niagara Financial Group, Inc. 1999 Recognition and Retention Plan(4)
Exhibit 10.5 First Niagara Financial Group, Inc. 2002 Long-Term Incentive Stock
Benefit Plan(5)
Exhibit 11 Calculations of Basic Earnings Per Share and Diluted Earnings Per Share
(See Note 15 to Notes to Consolidated Financial Statements)
Exhibit 21 Subsidiaries of First Niagara Financial Group, Inc. (See Part I, Item 1
of Form 10-K)
Exhibit 23 Consent of Independent Auditors'
Exhibit 99.1 Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1, originally filed with the Securities and Exchange Commission on
September 18, 2002.
(2) Incorporated by reference to the Company's Pre-effective Amendment No. 1
to the Registration Statement on Form S-1, filed with the Securities and
Exchange Commission on November 14, 2002.
(3) Incorporated by reference to the Company's Registration Statement on Form
S-1, originally filed with the Securities and Exchange Commission on
December 22, 1997.
(4) Incorporated by reference to the Company's Proxy Statement for the 1999
Annual Meeting of Stockholders filed with the Securities and Exchange
Commission on March 31, 1999.
(5) Incorporated by reference to the Company's Proxy Statement for the 2002
Annual Meeting of Stockholders filed with the Securities and Exchange
Commission on March 27, 2002.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FIRST NIAGARA FINANCIAL GROUP, INC.
Date: March 24, 2003 By: /s/ William E. Swan
--------------------------------------
William E. Swan
Chairman, President and
Chief Executive Officer
93
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/ William E. Swan Chairman, President and Chief Executive March 24, 2003
- ----------------------------- Officer
William E. Swan
/s/ Paul J. Kolkmeyer Executive Vice President, Chief Operating March 24, 2003
- ----------------------------- Officer and Chief Financial Officer
Paul J. Kolkmeyer
/s/ Gordon P. Assad Director March 24, 2003
- -----------------------------
Gordon P. Assad
/s/ John J. Bisgrove, Jr. Director March 24, 2003
- -----------------------------
John J. Bisgrove, Jr.
/s/ G. Thomas Bowers Director March 24, 2003
- -----------------------------
G. Thomas Bowers
/s/ James W. Currie Director March 24, 2003
- -----------------------------
James W. Currie
/s/ Daniel W. Judge Director March 24, 2003
- -----------------------------
Daniel W. Judge
/s/ B. Thomas Mancuso Director March 24, 2003
- -----------------------------
B. Thomas Mancuso
/s/ James Miklinski Director March 24, 2003
- -----------------------------
James Miklinski
/s/ Sharon D. Randaccio Director March 24, 2003
- -----------------------------
Sharon D. Randaccio
/s/ Robert G. Weber Director March 24, 2003
- -----------------------------
Robert G. Weber
/s/ Louise Woerner Director March 24, 2003
- -----------------------------
Louise Woerner
/s/ David M. Zebro Director March 24, 2003
- -----------------------------
David M. Zebro
94
Certification of Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, William E. Swan, Chairman, President and Chief Executive Officer, certify
that:
1. I have reviewed this annual report on Form 10-K of First Niagara Financial
Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the years covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the years presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the year in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the Audit
Committee of registrant's Board of Directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 24, 2003 /s/ William E. Swan
----------------------------------------
William E. Swan
Chairman, President and
Chief Executive Officer
95
Certification of Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Paul J. Kolkmeyer, Executive Vice President, Chief Operating Officer and
Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of First Niagara Financial
Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the years covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the years presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the year in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the Audit
Committee of registrant's Board of Directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 24, 2003 /s/ Paul J. Kolkmeyer
----------------------------------------
Paul J. Kolkmeyer
Executive Vice President, Chief
Operating Officer and Chief Financial
Officer
96