UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
Commission file number 0-15366
ALLIANCE FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
New York 16-1276885
(State or other jurisdiction of (IRS Employer I.D. #)
incorporation or organization)
65 Main Street, Cortland, New York 13045
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (607) 756-2831
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
The number of shares outstanding of the Registrant's common stock on August 14,
2002: Common Stock, $1.00 Par Value - 3,449,338 shares.
CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Condition as of June 30, 2002 (unaudited) and
December 31, 2001
Condensed Consolidated Statements of Income for the Three Months Ended
June 30, 2002 and 2001 and Six Months Ended June 30, 2002 and 2001
(unaudited)
Consolidated Statements of Changes in Shareholders' Equity for the Six
Months Ended June 30, 2002 (unaudited)
Consolidated Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (unaudited)
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ALLIANCE FINANCIAL CORPORATION
Consolidated Statements of Condition
(Dollars in Thousands)
June 30, 2002 December 31, 2001
(Unaudited)
ASSETS
Cash and due from banks $ 19,555 $ 21,626
Federal funds sold -- --
-------- --------
Total cash and cash equivalents 19,555 21,626
Held-to-maturity investment securities 6,786 7,371
Available-for-sale investment securities 300,375 265,319
-------- --------
Total investment securities (fair value
$307,937 & $273,477, respectively) 307,161 272,690
Total loans 408,890 375,842
Unearned income (53) (104)
Allowance for loan losses (4,885) (4,478)
-------- --------
Net loans 403,952 371,260
Bank premises, furniture, and equipment 10,472 10,621
Other assets 17,915 16,674
-------- --------
Total Assets $759,055 $692,871
======== ========
LIABILITIES
Non-interest-bearing deposits $ 53,326 $ 57,044
Interest-bearing deposits 490,259 442,248
-------- --------
Total deposits 543,585 499,292
Borrowings 148,368 132,425
Other liabilities 8,915 7,691
-------- --------
Total Liabilities 700,868 639,408
SHAREHOLDERS' EQUITY
Preferred stock (par value $25.00)
1,000,000 shares authorized, none issued
Common stock (par value $1.00)
10,000,000 shares authorized
3,820,430 and 3,815,305 shares issued;
3,446,338 and 3,447,213 shares
outstanding, respectively 3,820 3,815
Surplus 7,182 7,096
Undivided profits 51,059 49,086
Accumulated other comprehensive income 4,046 1,243
Treasury stock, at cost; 374,092 shares
and 368,092 shares, respectively (7,920) (7,777)
-------- --------
Total Shareholders' Equity 58,187 53,463
Total Liabilities & Shareholders' Equity $759,055 $692,871
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
ALLIANCE FINANCIAL CORPORATION
Condensed Consolidated Statements of Income
(Unaudited)
(Dollars in Thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
Interest Income:
Interest & fees on loans $ 6,997 $ 7,239 $13,938 $14,296
Interest on investment securities 3,787 3,190 7,285 6,432
Interest on federal funds sold 2 99 18 371
------- ------- ------- -------
Total Interest Income 10,786 10,528 21,241 21,099
Interest Expense:
Interest on deposits 2,834 4,381 5,503 9,234
Interest on borrowings 1,274 692 2,481 1,448
------- ------- ------- -------
Total Interest Expense 4,108 5,073 7,984 10,682
Net Interest Income 6,678 5,455 13,257 10,417
Provision for loan losses 534 490 1,095 1,080
------- ------- ------- -------
Net Interest Income After Provision
for Losses 6,144 4,965 12,162 9,337
Other Income 1,710 1,698 3,282 3,715
------- ------- ------- -------
Total Operating Income 7,854 6,663 15,444 13,052
Other Expenses 5,607 4,912 11,040 9,827
------- ------- ------- -------
Income Before Income Taxes 2,247 1,751 4,404 3,225
Provision for income taxes 554 391 1,089 700
------- ------- ------- -------
Net Income $ 1,693 $ 1,360 $ 3,315 $ 2,525
======= ======= ======= =======
Net Income per Common Share - Basic $ .49 $ .38 $ .96 $ .71
======= ======= ======= =======
Net Income per Common Share - Diluted $ .49 $ .38 $ .95 $ .71
======= ======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
ALLIANCE FINANCIAL CORPORATION
Consolidated Statements of Changes in Shareholders' Equity
For the Six Months Ended June 30, 2002
(Unaudited)
(Dollars in Thousands)
Accumulated
Issued Other
Common Common Undivided Comprehensive Treasury
Shares Stock Surplus Profits Income Stock Total
--------- ------ ------ ------- ------ -------- -------
Balance at December 31, 2001 3,815,305 $3,815 $7,096 $49,086 $1,243 $ (7,777) $53,463
Comprehensive income
Net Income 3,315 3,315
Other comprehensive income, net of taxes:
Unrealized appreciation in
Available for sale securities, net of
Reclassification adjustment 2,803 2,803
-------
Comprehensive income 6,118
Stock options exercised 5,125 5 86 91
Cash dividend, $.39 per share (1,342) (1,342)
Treasury stock purchased (143) (143)
Balance at June 30, 2002 3,820,430 $3,820 $7,182 $51,059 $4,046 $ (7,920) $58,187
========= ====== ====== ======= ====== ======== =======
The accompanying notes are an integral part of the financial statements.
ALLIANCE FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in Thousands)
Six Months Ended
June 30,
2002 2001
-------- ---------
OPERATING ACTIVITIES
Net Income $ 3,315 $ 2,525
Adjustments to reconcile net income to net cash provided
By operating activities:
Provision for loan losses 1,095 1,080
Provision for depreciation 723 669
Realized investment security gains (382) (963)
Realized gain on the sale of assets (20) --
Amortization (accretion) of investment security premiums and
discounts, net 291 (53)
Change in other assets and liabilities (1,334) (599)
-------- ---------
Net Cash Provided by Operating Activities 3,688 2,659
INVESTMENT ACTIVITIES
Proceeds from maturities of investment securities,
available-for-sale 24,274 37,676
Proceeds from maturities of investment securities,
held-to-maturity 1,644 4,401
Purchase of investment securities, available-for-sale (68,600) (103,083)
Purchase of investment securities, held-to-maturity (1,058) (3,515)
Proceeds from the sale of investment securities 14,032 35,211
Increase in surrender value of life insurance (240) (240)
Net increase in loans (39,660) (33,548)
Proceeds from the sale of loans 5,873 98
Purchase of premises and equipment, net (554) (670)
-------- ---------
Net Cash Used by Investing Activities (64,289) (63,670)
FINANCING ACTIVITIES
Net increase in demand deposits, NOW & savings accounts 17,299 26,770
Net increase (decrease) in time deposits 26,994 (10,108)
Net increase in short-term borrowings 30,943 34,529
Net (decrease) increase in long-term borrowings (15,000) 13,250
Proceeds from the exercise of stock options 91 --
Treasury Stock purchased (143) (1,619)
Cash dividends (1,654) (1,331)
-------- ---------
Net Cash Provided by Financing Activities 58,530 61,491
(Decrease) increase in Cash and Cash Equivalents (2,071) 480
Cash and cash equivalents at beginning of year 21,626 19,274
-------- ---------
Cash and Cash Equivalents at End of Period $ 19,555 $ 19,754
-------- ---------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest on deposits and borrowings $ 7,781 $ 11,160
Income taxes 1,565 890
Non-Cash Investing Activities:
Increase in net unrealized gains/losses on
available-for-sale securities (4,672) (1,874)
Non-Cash Financing Activities:
Dividend declared and unpaid 689 652
The accompanying notes are an integral part of the consolidated financial
statements.
ALLIANCE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Basis of Presentation
The accompanying unaudited financial statements were prepared in
accordance with the instructions for Form 10-Q and Regulation S-X and,
therefore, do not include information for footnotes necessary for a
complete presentation of financial condition, results of operations, and
cash flows in conformity with generally accepted accounting principles.
The following material under the heading "Management's Discussion and
Analysis of Financial Condition and Results of Operations" is written with
the presumption that the users of the interim financial statements have
read, or have access to, the latest audited financial statements and notes
thereto of the Company, together with Management's Discussion and Analysis
of Financial Condition and Results of Operations as of December 31, 2001
and for the three-year period then ended, included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2001. Accordingly,
only material changes in the results of operations and financial condition
are discussed in the remainder of Part I.
All adjustments which, in the opinion of management, are necessary for a
fair presentation of the financial statements have been included in the
results of operations for the three months and six months ended June 30,
2002 and 2001.
B. Earnings Per Share
Basic earnings per share has been computed by dividing net income by the
weighted average number of common shares outstanding throughout the three
months and six months ended June 30, 2002 and 2001, using 3,445,008 and
3,552,325 weighted average common shares outstanding for the three months
ended, and 3,444,785 and 3,574,533 weighted average common shares
outstanding for the six months ended, respectively. Diluted earnings per
share gives the effect to weighted average shares which would be
outstanding assuming the exercise of options using the treasury stock
method. Weighted average shares outstanding for the three months and six
months ended June 30, 2002 and 2001, adjusted for the effect of the
assumed exercise of stock options, were 3,481,867 and 3,557,946 for the
three months ended and 3,474,976 and 3,579,264 for the six months ended,
respectively.
C. Allowance for Loan Losses
The allowance for loan losses represents management's best estimate of
probable loan losses in the Company's loan portfolio. Management's
quarterly evaluation of the allowance for loan losses is a comprehensive
analysis that builds a total reserve by evaluating the risks within each
loan type, or pool, of similar loans. The Company uses a general
allocation methodology for all residential and consumer loan pools. This
methodology estimates a reserve for each pool based on the most recent
three-year loss rate, adjusted to reflect the expected impact that current
trends regarding loan growth, delinquency, losses, economic conditions,
and current interest rates are likely to have. For commercial loan pools,
the Company establishes a specific reserve allocation for all loans, which
have been risk rated under the Company's risk rating system, as
substandard, doubtful, or loss. The specific allocation is based on the
most recent valuation of the loan collateral and the customer's ability to
pay. For all other commercial loans, the Company uses the general
allocation methodology that establishes a reserve for each risk-rating
category. The general allocation methodology for commercial loans
considers the same factors that are considered when evaluating residential
mortgage and consumer loan pools. The combination of using both the
general and specific allocation methodologies reflects management's best
estimate of the probable loan losses in the Company's loan portfolio.
A loan is considered impaired, based on current information and events, if
it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual
terms of the loan agreement. The measurement of impaired loans is
generally discounted at the historical effective interest rate, except
that all collateral-dependent loans are measured for impairment based on
fair value of the collateral.
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
Throughout this analysis, the term "the Company" refers to the consolidated
entity of Alliance Financial Corporation, its wholly-owned banking subsidiary,
Alliance Bank, N.A. (the "Bank"), and the Bank's subsidiaries Alliance Preferred
Funding Corp. and Alliance Leasing, Inc.. The Company is a New York corporation,
which was formed in November 1998 as a result of the merger of Cortland First
Financial Corporation and Oneida Valley Bancshares, Inc.
The following discussion presents material changes in the Company's results of
operations and financial condition during the three and six months ended June
30, 2002, which are not otherwise apparent from the consolidated financial
statements included in this report.
This discussion and analysis contains certain forward-looking statements (within
the meaning of the Private Securities Litigation Reform Act of 1995) with
respect to the financial condition, results of operations and business of
Alliance Financial Corporation and its subsidiary. These forward-looking
statements involve certain risks and uncertainties. Factors that may cause
actual results to differ materially from those contemplated by such
forward-looking statements include, among others, the following possibilities:
(1) an increase in competitive pressures in the banking industry; (2) changes in
the interest rate environment that reduce margins; (3) changes in the regulatory
environment; (4) general economic conditions, either nationally or regionally,
that are less favorable than expected, resulting in, among other things, a
deterioration in credit quality; (5) changes in business conditions and
inflation; (6) changes in the securities markets; (7) changes occur in
technology used in the banking business; (8) possible inability to maintain and
increase market share and control expenses; and (9) other factors detailed from
time to time in the Company's SEC filings.
Operating results for the three and six months ended June 30, 2002 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2002.
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002
Net income was $1,693,000, or $0.49 per share, for the second quarter of 2002
compared to $1,360,000, or $0.38 per share, for the same period in 2001. Net
income increased $333,000, or 24.5%, while earnings per share were up $0.11, or
28.9%, over the comparable period. The return on average assets and return on
average shareholder's equity were 0.91% and 12.31%, respectively, for the three
months ended June 30, 2002, compared to 0.88% and 10.19%, respectively, for the
second quarter of 2001.
For the six months ended June 30, 2002, net income was $3,315,000, or $0.95 per
diluted share, compared to $2,525,000, or $0.71 per share, for the same period
in 2001. The $790,000 increase in net income is up 31.3% over the same period in
the previous year, while the earnings per share increase of $0.24 represents a
33.8% increase over the comparable period. The return on average assets
increased to 0.91% from 0.83%, while the return on average shareholder's equity
rose to 12.08% from 9.49%, when comparing the six months ended June 30, 2002 to
the comparable period in 2001.
Analysis of Net Interest Income and the Net Interest Margin
For the three months ended June 30, 2002 compared to the three months ended June
30, 2001, net interest income increased $1,223,000, or 22.4%, to $6,678,000. The
increase resulted from a $123,827,000 increase in average earning assets, as the
net interest margin at 4.02%, for the period ended June 30, 2002, remained
comparable with the 4.03% net interest margin reported for the prior year second
quarter. The increase in average earning assets is due to both strong growth
across all loan business lines, as well as significant increases in the
investment portfolio. The stability in the net interest margin for the
comparable periods resulted from both changes in the balance sheet mix and the
effect that lower market interest rates had on asset yields and the costs of
interest bearing liabilities.
Total interest income increased $258,000, or 2.5%, for the quarter ended June
30, 2002 compared to the quarter ended June 30, 2001. Loan income declined only
$242,000, or 3.3%, as the 145 basis point decline in the average loan yield was
nearly offset by the $56,682,000, or 16.6%, increase in average loans. There was
little change in the loan mix over the comparable periods. Investment income
increased $597,000, or 18.7%, for the comparable periods as a $75,741,000, or
33.5%, increase in average investments more than offset a 79 basis point decline
in the average portfolio yield. The growth in investments, which was funded by
shorter-term borrowings, reflected attractive buying opportunities over the past
twelve months, both as to yield and as a spread over borrowings, and represented
an earnings strategy intended to leverage the Company's strong capital position.
Interest expense declined $965,000, or 19%, to $4,108,000 for the quarter ended
June 30, 2002 when compared to the same period in 2001, as lower market interest
rates reduced the average rate paid on interest bearing liabilities by 139 basis
points. The decline in the average rate paid on interest bearing liabilities, by
far offset increased costs associated with a $121,657,000 increase in average
interest bearing liabilities. Although the average interest bearing deposits for
the comparable periods increased $26,450,000, or 5.8%, deposit expense declined
$1,547,000, as the average rate paid on deposits fell by 151 basis points. The
lower average rate paid was only slightly impacted by a change in the deposit
mix, as 1% of deposits moved from time deposits to the lower rate savings and
money market category. Interest expense on borrowings increased $582,000, or
84.1%, primarily the result of an increase of $95,207,000 in average borrowings.
The majority of the increase in borrowings funded the increase in the investment
portfolio. As a result of the significant increase in borrowings for the
comparable periods, non-interest bearing liabilities as a percentage of total
interest bearing liabilities declined from 10.1% to 8.5%. Average non-interest
bearing liabilities for the comparable periods grew $2,673,000, or 5.3%.
The following table sets forth information concerning average interest-earning
assets and interest-bearing liabilities and the average yields and rates thereon
for the periods indicated. Interest income and yield information is adjusted for
items exempt from federal income taxes and assumes a 34% tax rate. Nonaccrual
loans have been included in the average balances. Securities are shown at
average amortized cost.
THREE MONTHS ENDED JUNE 30, 2002 2001
------------------------------ ----------------------------
AVG. AVG.
YIELD/ YIELD/
AVG. AMT. OF RATE AVG. AMT. OF RATE
BALANCE INTEREST PAID BALANCE INTEREST PAID
-------- ------- ---- -------- ------- ----
(DOLLARS IN THOUSANDS)
Assets:
Interest-earning assets:
Federal funds sold $ 203 $ 1 1.97% $ 8,596 $ 99 4.61%
Taxable investment securities 246,111 3,145 5.11% 175,862 2,553 5.81%
Nontaxable investment securities 52,914 974 7.36% 47,625 965 8.11%
Loans (net of unearned discount) 398,552 6,997 7.02% 341,870 7,239 8.47%
-------- ------- ---- -------- ------- ----
Total interest-earning assets 697,780 11,117 6.37% 573,953 10,856 7.57%
Noninterest-earning assets:
Other assets 47,037 44,590
Less: Allowance for loan losses (4,836) (3,875)
Net unrealized gains/(losses) on
available-for-sale portfolio 2,526 2,323
-------- --------
Total $742,507 $616,991
-------- --------
Liabilities and Shareholders' Equity:
Interest-bearing liabilities:
Demand deposits $ 76,428 $ 113 0.59% $ 69,328 $ 196 1.13%
Savings and money
market deposits 181,476 666 1.47% 166,487 1,257 3.02%
Time deposits 221,569 2,055 3.71% 217,208 2,928 5.39%
Borrowings 148,179 1,274 3.44% 52,972 692 5.23%
-------- ------- ---- -------- ------- ----
Total interest-bearing liabilities 627,652 4,108 2.62% 505,995 5,073 4.01%
Noninterest-bearing liabilities:
Demand deposits 53,611 50,938
Other liabilities 6,252 6,658
Shareholders' equity 54,992 53,400
-------- ------- ---- -------- ------- ----
Total $742,507 $616,991
-------- ------- ---- -------- ------- ----
Net interest earnings $ 7,009 $ 5,783
------- ---- -------- ------- ----
Net yield on interest-earning assets 4.02% 4.03%
------- ---- -------- ------- ----
Federal tax exemption on non-taxable
investment securities included in interest income $ 331 $ 328
The following table sets forth the dollar volume of increase (decrease) in
interest income and interest expense resulting from changes in the volume of
earning assets and interest-bearing liabilities, and from changes in rates for
the periods indicated. Volume changes are computed by multiplying the volume
difference by the prior period's rate. Rate changes are computed by multiplying
the rate difference by the prior period's balance. The change in interest income
and expense due to both rate and volume has been allocated equally between the
volume and rate variances.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2002 COMPARED TO 2001 2002 COMPARED TO 2001
----------------------------- -----------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
VOLUME RATE NET CHG VOLUME RATE NET CHG
------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Interest earned on:
Federal funds sold $ (69) $ (29) $ (98) $ (213) $ (140) $ (353)
Taxable investment securities 960 (368) 592 1,895 (1,060) 835
Nontaxable investment securities 100 (94) 6 36 (18) 18
Loans (net of unearned discount) 1,099 (1,341) (242) 2,211 (2,569) (358)
------- ------- ------- ------- ------- -------
Total interest-earning assets $ 2,090 $(1,832) $ 258 $ 3,929 $(3,787) $ 142
======= ======= ======= ======= ======= =======
Interest paid on:
Interest-bearing demand deposits $ 15 $ (98) $ (83) $ 38 $ (245) $ (207)
Savings and money market deposits 84 (675) (591) 234 (1,455) (1,221)
Time deposits 49 (922) (873) (220) (2,083) (2,303)
Borrowings 1,032 (450) 582 2,090 (1,057) 1,033
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities $ 1,180 $(2,145) $ (965) $ 2,142 $(4,840) $(2,698)
======= ======= ======= ======= ======= =======
Net interest earnings (FTE) $ 910 $ 313 $ 1,223 $ 1,787 $ 1,053 $ 2,840
The following table sets forth information concerning average interest-earning
assets and interest-bearing liabilities and the yields and rates thereon for the
periods indicated. Interest income and yield information is adjusted for items
exempt from federal income taxes and assumes a 34% tax rate. Nonaccrual loans
have been included in the average balances. Securities are shown at average
amortized cost.
SIX MONTHS ENDED JUNE 30, 2002 2001
------------------------------ ----------------------------
AVG. AVG.
YIELD/ YIELD/
AVG. AMT. OF RATE AVG. AMT. OF RATE
BALANCE INTEREST PAID BALANCE INTEREST PAID
-------- ------- ---- -------- ------- ----
(DOLLARS IN THOUSANDS)
Assets:
Interest-earning assets:
Federal funds sold $ 2,015 $ 18 1.79% $ 14,145 $ 371 5.25%
Taxable investment securities 235,172 6,006 5.11% 167,839 5,171 6.16%
Nontaxable investment securities 53,306 1,938 7.27% 52,078 1,911 7.34%
Loans (net of unearned discount) 390,317 13,938 7.14% 334,029 14,296 8.56%
-------- ------- ---- -------- ------- ----
Total interest-earning assets 680,810 21,900 6.43% 568,091 21,749 7.66%
Noninterest-earning assets:
Other assets 47,129 44,526
Less: Allowance for loan losses (4,715) (3,747)
Net unrealized gains/(losses) on
available-for-sale portfolio 3,098 1,871
-------- --------
Total $726,322 $610,741
-------- --------
Liabilities and Shareholders' Equity:
Interest-bearing liabilities:
Demand deposits $ 77,128 $ 236 0.61% $ 69,150 $ 443 1.28%
Savings and money
market deposits 179,026 1,323 1.48% 158,962 2,544 3.20%
Time deposits 211,007 3,944 3.74% 220,277 6,247 5.67%
Borrowings 143,658 2,481 3.45% 51,512 1,448 5.62%
-------- ------- ---- -------- ------- ----
Total interest-bearing liabilities 610,819 7,984 2.61% 499,901 10,682 4.27%
Noninterest-bearing liabilities:
Demand deposits 53,908 50,980
Other liabilities 6,700 6,655
Shareholders' equity 54,895 53,205
-------- ------- ---- -------- ------- ----
Total $726,322 $610,741
-------- ------- ---- -------- ------- ----
Net interest earnings $13,916 $11,067
-------- ------- ---- -------- ------- ----
Net yield on interest-earning assets 4.09% 3.90%
-------- ------- ---- -------- ------- ----
Federal tax exemption on non-taxable
investment securities included in interest income $ 659 $ 650
For the six months ended June 30, 2002 compared to the six months ended June 30,
2001, net interest income increased $2,840,000, or 27.3%, to $13,257,000. The
increase resulted form a $112,719,000 increase in average earning assets, as
well as a 19 basis point increase in the net interest margin. The increase in
average earning assets for the comparable six-month periods reflected
significant growth in both loans and investments. The increase in the margin is
primarily due to lower market interest rates in 2002 impacting the costs of
liabilities more rapidly than yields on assets. Average earning asset yields for
the comparable periods declined 123 basis points while at the same time the
average cost of interest bearing liabilities declined 166 basis points.
Total interest income increased $142,000, or 0.7%, for the six months ended June
30, 2002 compared to the same period a year ago. An increase in investment
income of $853,000, or 13.3%, more than offset lower interest income from
short-term federal funds sold, and lower loan interest income. The increase in
investment income was attributable to a $68,561,000 increase in average
investments that more than offset a decline of 93 basis points in the average
yield on the portfolio for the comparable periods. With the lower market
interest rates in 2002, the Company significantly reduced its average short-term
federal funds sold position compared to the comparable prior year period,
resulting in a $353,000 reduction in interest income. Loan interest income
declined $358,000, or 2.5%, for the six month period ending June 30, 2002
compared to the same period last year, as a 142 basis point decline in the
average yield on loans negatively impacted loan interest income to a greater
degree than the positive impact resulting from the $56,288,000 increase in
average loans.
Interest expense declined $2,698,000, or 25.3%, for the six months ended June
30, 2002 compared to the six months ended June 30, 2001. The lower interest
expense results from the re-pricing of the majority of the Company's interest
bearing liabilities to lower market interest rates. Deposit expense for the
comparable periods declined $3,731,000, or 40.4%, primarily the result of a
decline of 176 basis points in the average rate paid on interest bearing
deposits. Average interest bearing deposits increased $18,772,000, or 4.2%, for
the comparable six month periods. Interest expense on borrowings increased
$1,033,000, or 71.3%, primarily on the $92,146,000 increase in average
borrowings. The majority of the increase in borrowings funded investment
purchases. With the majority of the new borrowings at the lower market interest
rates, the average rate paid on borrowings declined 217 basis points to 3.45%
for the six month period ended June 30, 2002.
Analysis of the Provision and Allowance for Loan Losses
For the three months ended June 30, 2002 and 2001, the provision for loan losses
was $534,000 and $490,000, respectively. Although the expense increased for the
comparable periods, the provision as an annualized percentage of average loans
for the respective periods declined from 0.58% to 0.54%. Although the growth of
16.6% in average loans over the past year created a need to increase the
allowance, improvement in loan portfolio quality indicators helped to minimize
the rate of increase in the provision expense at 9% for the comparable periods.
Net charge-offs for the quarter ended June 30, 2002 were $289,000, representing
0.29%, on an annualized basis, of average loans for the quarter, and compared
favorably to net charge offs in the amount of $385,000, representing 0.46%, on
an annualized basis, of average loans for the quarter ended June 30, 2001. The
level of the current quarter charge-offs also compares favorably with net charge
offs of $399,000, representing 0.41%, on an annualized basis, in the quarter
ended March 31, 2002. The reduction in charge offs almost entirely reflects
efforts over the past twelve months to improve both underwriting and collection
efforts in the indirect auto loan portfolio. For the quarters ended June 30,
2002 and June 30, 2001, the ratios of non-performing loans to total loans, and
the allowance for loan losses to non-performing loans remained stable, and at
levels that were considered strong. The Company also reported that delinquent
loans (over 30 days past due and non-accruing) as a percentage of total loans
averaged 0.97% for the second quarter of 2002, compared to a rate that averaged
1.70% throughout 2001.
The following tables present loan quality ratios for the periods indicated and a
summary of the changes in the allowance for loan losses arising from loans
charged-off and recoveries on loans previously charged-off and additions to the
allowance, which have been charged to expense for the periods indicated.
Three months ended June 30, Six months ended June 30,
2002 2001 2002 2001
------ ------ ------ ------
Net Loans Charged-off to Average Loans, Annualized 0.29% 0.46% 0.36% 0.39%
Provision for Loan Losses to Average Loans, Annualized 0.54% 0.58% 0.56% 0.65%
Allowance for Loan Losses to Period-end Loans 1.19% 1.09% 1.19% 1.09%
Allowance for Loan Losses to Nonperforming Loans 330.05% 335.98% 330.05% 335.98%
Nonperforming Loans to Period-end Loans 0.36% 0.33% 0.36% 0.33%
Nonperforming Assets to Period-end Assets 0.22% 0.21% 0.22% 0.21%
(Dollars in Thousands)
Three months ended June 30, Six months ended June 30,
2002 2001 2002 2001
------ ------ ------ ------
Allowance for Loan Losses, Beginning of Period $4,640 $3,705 $4,478 $3,370
Loans Charged-off (429) (483) (921) (798)
Recoveries of Loans Previously Charged-off 140 98 233 158
------ ------ ------ ------
Net Loans Charged-off (289) (385) (688) (640)
------ ------ ------ ------
Provision for Loan Losses 534 490 1,095 1,080
------ ------ ------ ------
Allowance for Loan Losses, End of Period $4,885 $3,810 $4,885 $3,810
------ ------ ------ ------
For the six months ended June 30, 2002 and 2001, the provision for loan losses
was $1,095,000 and $1,080,000, respectively. Similar to the quarterly results,
the provision as an annualized percentage of average loans declined based on
improvement in loan portfolio quality indicators. The slight improvement in the
ratio of net charge offs to average loans for the comparable periods reflected
the second quarter's decline in indirect auto loan losses. As a result of the
provision expense exceeding the net charge offs over the past twelve months, the
ratio of the allowance for loan losses to average loans increased to 1.19% from
1.09%.
Non-interest Income
The following table sets forth certain information on non-interest income for
the periods indicated:
(Dollars in Thousands)
Three Months ended June 30, Six Months ended June 30,
2002 2001 Change 2002 2001 Change
--------------- -------------- ------ ----- ---------------
Service charges on deposit accounts $ 563 $ 602 $(39) -6.48% $1,108 $1,182 $ (74) -6.26%
Trust & brokerage services 378 340 38 11.18% 742 688 54 7.85%
Other operating income 519 414 105 25.36% 1,050 882 168 19.05%
------ ------ ---- ------ ------ ----- ----- ------
Core non-interest income $1,460 $1,356 $104 7.67% $2,900 $2,752 $ 148 5.38%
Investment securities gains 250 342 (92) -26.90% 382 963 (581) -60.33%
------ ------ ---- ------ ------ ----- ----- ------
Total non-interest income $1,710 $1,698 $ 12 0.71% $3,282 $3,715 ($433) -11.66%
====== ====== ==== ====== ====== ===== ===== ======
Core non-interest income for the quarter ended June 30, 2002 increased $104,000,
or 7.7%, to $1,460,000 when compared to $1,356,000 for the quarter ended June
30, 2001. Total non-interest income that includes net securities gains for the
current quarter, was $1,710,000, comparable with that reported in the second
quarter of last year. The increase in core non-interest income was partially
attributable to an increase in trust and brokerage revenues, which increased as
a result of a growing customer base. Other non-interest income increases were
also derived from higher debit card usage and the related fees, as well as gains
from mortgage sales resulting from a higher volume of loan sales. The decline in
service charge income resulted from a lower volume of overdrafts and the
associated fees. Securities gains for the three months ended June 30, 2002 in
the amount of $250,000 resulted from the sale of equity investments that the
Company had made in other financial institutions.
For the six months ended June 30, 2002, core non-interest income increased
$148,000, or 5.4%, to $2,900,000, compared to the six months ended June 30,
2001. The reasons for the changes in core non-interest income for the comparable
periods were the same as those impacting second quarter results. Total
non-interest income for the comparable periods declined $433,000, or 11.7%, as a
result of a lower level of security gains taken in the first half of 2002
compared to the same period last year. Security gains of $382,000 for the six
months ended June 30, 2002, were $581,000 less than those taken in the prior
year period. Significant gains were taken in the first half of 2001 that related
to specific strategies designed to benefit from the falling interest rates at
that time.
Non-interest Expense
Non-interest expense for the three months ended June 30, 2002 increased $695,000
to $5,607,000 when compared to the quarter ended June 30, 2001. The 14.1%
increase was well below the 18.9% increase in the growth of average assets for
the comparable periods. Salary and employee benefit expenses increased 13.2% in
the second quarter of 2002 compared to the same period last year as a result of
year over year salary adjustments of approximately 3.5%, and a one-time
adjustment to non-officer salaries during the first quarter of 2002, following a
comprehensive market study designed to insure that the Company's compensation
program was competitive to attract and retain high performing employees.
Increased occupancy expense for the comparable periods reflects both higher
lease and depreciation costs associated with the third quarter 2001 opening of
the Company's new administrative offices, as well as increased costs supporting
further investment in data processing and communication systems. Increases in
other operating expenses related to higher marketing costs associated with a
market research study designed to identify customer satisfaction levels and
competitive advantages, increased telephone expense related to a bank-wide
upgrade to high speed data communications, and higher costs of stationary and
supplies relating to the growth in loans and deposits.
The following table sets forth certain information on non-interest expense for
the periods indicated:
(Dollars in Thousands)
Three Months ended June 30, Six Months ended June 30,
2002 2001 Change 2002 2001 Change
------ ------ ------------ ------- ------ --------------
Salaries, wages, and employee benefits $3,104 $2,742 $362 13.20% $ 6,151 $5,609 $ 542 9.66%
Building, occupancy, and equipment 884 769 115 14.95% 1,746 1,589 157 9.88%
Other operating expense 1,619 1,401 218 15.56% 3,143 2,629 514 19.55%
------ ------ ---- ----- ------- ------ ------ -----
Total non-interest expense $5,607 $4,912 $695 14.15% $11,040 $9,827 $1,213 12.34%
====== ====== ==== ===== ======= ====== ====== =====
Non-interest expense for the six months ended June 30, 2002 increased
$1,213,000, or 12.3%, compared to the same period last year. Salary and employee
benefit expenses increased 9.7% in the first half of 2002 compared to the same
period last year as a result of the year over year salary adjustments, and the
one-time adjustment to non-officer salaries that occurred during the first
quarter of 2002. The 9.9% increase in occupancy expense for the comparable
periods, reflects both lease and depreciation costs associated with the third
quarter 2001 opening of the Company's new administrative offices. Increases in
other operating expenses related to higher advertising and marketing costs,
associated with product promotions and the market research study, increased loan
administrative costs related to increased volume and improved collections, and
higher costs of stationary and supplies relating to the growth in both loans and
deposits.
Income taxes
The Company's effective tax rate increased to 24.7% for the three months and six
months ended June 30, 2002 compared to 22.3% for the three months ended and
21.7% for the six months ended June 30, 2001, respectively. The change is a
result of a decrease in non-taxable investment income as a percentage of pretax
income.
ANALYSIS OF THE FINANCIAL CONDITION
Total assets increased $66,184,000, or 19.2% on an annualized basis, from
$692,871,000 at December 31, 2001 to $759,055,000 at June 30, 2002. For the six
months ended June 30, 2002, total loans increased $33,048,000, or 17.6% on an
annualized basis, to $408,890,000. Growth occurred in all categories of the loan
portfolio during the first half of the year, while the loan mix reflected a 1.6%
contraction in the percentage of residential mortgage loans to total loans, and
slight increases in the percentage of all other loan categories. For the six
months ended June 30, 2002, commercial loans were up $14,144,000, or 22.4% on an
annualized basis, on growth in both new business relationships and increased
usage on lines of credit. Indirect auto loans increased $7,191,000, or 25.6% on
an annualized basis, as a result of offering competitively priced loans through
a
growing base of over 180 new and used car dealers. Consumer loans increased
$5,721,000, or 22.8% on an annualized basis, exclusively on the Company's focus
to build home equity lines of credit. Home equity lines were offered at a
discounted introductory rate for six months throughout the period. Residential
mortgage loan activity remained strong during the first six months of 2002, with
the Company balancing portfolio growth with sales to the secondary market.
During the period, the residential mortgage loan portfolio increased $5,992,000,
or 8.4% on an annualized basis, and $5,873,000 in loans were sold to Freddie
Mac.
The following table sets forth the composition of the Company's loan portfolio
at the dates indicated:
June 30, 2002 December 31, 2001 June 30, 2001
------------------ ------------------ ------------------
Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- -------
(Dollars in Thousands)
Commercial $140,945 34.9% $126,801 34.2% $123,921 35.9%
Real estate mortgage 148,299 36.7% 142,307 38.3% 127,082 36.9%
Indirect Auto 63,562 15.7% 56,371 15.2% 49,104 14.2%
Consumer 56,084 13.9% 50,363 13.6% 48,646 14.1%
-------- ----- -------- ----- -------- -----
Gross Loans 408,890 101.2% 375,842 101.2% 348,753 101.2%
Less:
Unearned Discount (53) (0.0%) (104) (0.0%) (195) (0.1%)
Allowance for Loan Losses (4,885) (1.2%) (4,478) (1.2%) (3,810) (1.1%)
-------- ----- -------- ----- -------- -----
Net Loans $403,952 100.0% $371,260 100.0% $344,748 100.0%
======== ===== ======== ===== ======== =====
The investment portfolio, as of June 30, 2002 in the amount of $307,161,000,
increased $34,471,000, or 25.2% on an annualized basis, since December 31, 2001.
The majority of the increase occurred in March, as the Company purchased
$25,000,000 in a combination of two and three-year government agency securities,
funded by short-term borrowings. The transaction represented an attractive
buying opportunity both as to yield and as a spread over borrowings. Since
December 31, 2001, falling market rates have increased the unrealized gain on
the portfolio by $4,672,000, to $6,743,000.
Deposits as of June 30, 2002 increased $44,293,000, or 17.8% on an annualized
basis, to $543,585,000 over the six month period. The Company's deposit growth
is primarily the result of growth in time deposits that increased $27,774,000,
or 27.4% on an annualized basis. The Company pursued a strategy during the first
six months of 2002 to extend the average maturity of deposits to better match
the average maturity of loans and reduce its risk to an expected increase in
interest rates. The growth was concentrated in two year certificates of
deposits. At June 30, 2002, time deposits represented 42.3% of total deposits
compared to 40.4% at December 31, 2001.
The Company's borrowings, consisting primarily of collateralized repurchase
agreements with brokers and advances from the Federal Home Loan Bank, increased
$15,943,000, or 24% on an annualized basis, during the first six months of 2002.
The increase provided funding for investment portfolio growth.
Liquidity
The Company's liquidity reflects its ability to provide funds to meet loan
requests, to accommodate possible outflows in deposits, and to take advantage of
market interest rate opportunities. Funding of loan requests, providing for
liability outflows, and management of interest rate fluctuations requires
continuous analysis in order to match the maturities of specific categories of
short-term loans and investments with specific types of deposits and borrowings.
Liquidity is normally considered in terms of the nature and mix of the Bank's
sources and uses of funds. The Asset Liability Committee of the Bank is
responsible for implementing the policies and guidelines for the maintenance of
prudent levels of liquidity. Management believes, as of June 30, 2002, that
liquidity as measured by the Company is in compliance with its policy
guidelines.
The Bank's principal sources of funds for operations are cash flows generated
from earnings, deposits, loan repayments, borrowings from the Federal Home Loan
Bank of New York (FHLB), and securities sold under repurchase agreements.
Brokered deposits in the amount of $10,000,000 were utilized during the six
month period ended June 30, 2002. During the six months ended June 30, 2002,
cash and cash equivalents decreased by $2,071,000, as net cash used by investing
activities of $64,289,000, exceeded the net cash provided by operating
activities and financing activities of $62,218,000. Net cash provided by
financing activities reflects a net increase in deposits of $44,293,000, and a
net increase in borrowings of $15,943,000. Net cash used in investing activities
reflects a net increase in loans of $33,787,000, and a net increase in
investment securities of $29,708,000.
As a member of the Federal Home Loan Bank of New York, the Bank is eligible to
borrow up to an established credit limit against certain residential mortgage
loans that have been pledged as collateral. As of June 30, 2002, the Bank's
credit limit with the FHLB was $106 million. The Bank's outstanding borrowings
on that date were $58.6 million.
Capital Resources
During the six months ended June 30, 2002, shareholders equity increased
$4,724,000 to $58,187,000, and book value per share increased $1.37 to $16.88.
The increase in shareholders' equity resulted from net income of $3,315,000,
unrealized appreciation in available for sale securities (net of taxes) of
$2,803,000, stock option exercise proceeds of $91,000, offset by treasury stock
purchases of $143,000, and dividend payments of $1,342,000.
Capital requirements for the Company and the Bank are established by the Federal
Reserve Board and the Office of the Comptroller of the Currency. Quantitative
measures established by regulation to ensure capital adequacy require the
maintenance of minimum amounts and ratios of Total and Tier 1 capital to risk
weighted assets, and of Tier 1 capital to average assets. The following table
compares the Company's actual capital amounts and ratios to the "well
capitalized" category, which is the highest capital category as defined in the
regulations.
(Dollars in Thousands)
To be Well
Capitalized Under
Actual Prompt Corrective
Action Provisions
--------------- ------------------
Amount Ratio Amount Ratio
------- ----- ------- --------
As of June 30, 2002
Total Capital (to Risk-Weighted Assets) $59,026 12.51% $47,187 >/= 10.00%
Tier I Capital (to Risk-Weighted Assets) 54,141 11.47% 28,312 >/= 6.00%
Tier I Capital (to Average Assets) 54,141 7.29% 37,125 >/= 5.00%
As of December 31, 2001
Total Capital (to Risk-Weighted Assets) $56,698 13.08% $43,553 >/= 10.00%
Tier I Capital (to Risk-Weighted Assets) 52,220 12.05% 26,132 >/= 6.00%
Tier I Capital (to Average Assets) 52,220 7.53% 32,433 >/= 5.00%
On June 25, 2002, the Company's Board of Directors authorized the repurchase of
up to 100,000 shares, or approximately 3 percent, of the Company's outstanding
common stock during the period from July 18, 2002 through January 17, 2003. The
repurchase plan replaces the Company's previously authorized 300,000 share
annual repurchase plan that expired July 18, 2002. Under this expired plan, the
Company repurchased a total of 60,950 shares of its common stock.
Other Information
In December of 1998, the Oneida Indian Nation ("The Nation") and the U.S.
Justice Department filed a motion to amend a long-standing land claim against
the State of New York to include a class of 20,000 unnamed defendants who own
real property in Madison County and Oneida County. An additional motion sought
to include the Company as a representative of a class of landowners. On
September 25, 2000, the United States District Court of Northern New York
rendered a decision denying the motion to include the landowners as a group, and
thus, excluding the Company and many of its borrowers from the litigation. The
State of New York, the County of Madison and the County of Oneida remain as
defendants in the litigation. This ruling may be appealed by The Nation, and
does not prevent The Nation from suing landowners individually, in which case
the litigation could involve assets of the Company. On August 3, 2001, the
Justice Department moved to amend its complaint to drop landowners as
defendants. In February 2002, the State of New York, the Nation and the Counties
of Madison and Oneida announced that they have reached a tentative agreement to
settle the land claim. Among other things, this settlement would pay the three
Oneida tribes $500 million for their lost land. However, the proposed settlement
would require the approval of governments from county legislatures to the United
States Congress. Even if such approvals are received, a final agreement is
expected to be years away as the parties work out numerous details. Moreover,
the other two Oneida tribes, from Wisconsin and Ontario, which did not
participate in the settlement negotiations, have indicated that they do not
intend to go along with the settlement. The Wisconsin tribe subsequently filed
new lawsuits against individual landowners, and have publicly stated its
intention to continue to file other new suits against landowners. Management
believes that, ultimately, the State of New York will be held responsible for
these claims and this matter will be settled without adversely impacting the
Company.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's market risk arises principally from interest rate risk in its
lending, investing, deposit and borrowing activities. Management actively
monitors and manages its interest rate risk exposure using a computer simulation
model that measures the impact of changes in interest rates on its net interest
income. As of June 30, 2002, an instantaneous 200 basis point increase in market
interest rates was estimated to have a negative impact of 6.3% on net interest
income over the next twelve month period, while a 100 basis point decline in
market interest rates was estimated to have a positive impact of 3.4% on the
Company's net interest income. By comparison, at December 31, 2001 the Company
estimated that an instantaneous 200 basis point rise in rates would have a
negative impact of 6.9% on net interest income during the following twelve month
period while a 200 basis point decline in rates would have a positive impact of
6% on net interest income during the following twelve month period. The
Company's interest rate risk profile reflected little change during the first
half of 2002 as the Company reduced slightly its risk to rising interest rates.
The potential change in net interest income resulting from this analysis falls
within the Company's interest rate risk policy guidelines.
Computation of the prospective effects of hypothetical interest rate changes is
based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit rate and mix changes. These estimates and
assumptions assume that management takes no action to mitigate any negative
effects from changing interest rates. Although the Company uses various means to
measure its interest rate risk, the Company is unable to predict future
fluctuations in interest rates or the specific impact thereof.
At June 30, 2002, less than 1% of the Company's investment portfolio was
invested in corporate debt or non-government agency equity securities.
Accordingly, the Company has minimal risk that would result from a change in the
market value of these securities.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Shareholders on May 7, 2002 (the
"Meeting").
At the Meeting, each of the following persons was elected as a Class I Director
whose term will expire at the 2005 Annual Meeting of Shareholders:
VOTES FOR WITHHELD NON-VOTES
- ----- --- -------- ---------
DONALD S. AMES 2,607,465 103,245 731,628
PETER M. DUNN 2,605,490 105,220 731,628
MARGARET G. OGDEN 2,605,490 105,220 731,628
PAUL M. SOLOMON 2,607,465 103,245 731,628
DAVID J. TAYLOR 2,607,465 103,245 731,628
The other directors, whose term of office continued after the annual meeting,
are: Mary Pat Adams, John H. Buck, Donald H. Dew, David P. Kershaw, Robert M.
Lovell, Samuel J. Lanzafame, Charles E. Shafer, Charles H. Spaulding, and Jack
H. Webb.
At the Meeting, an amendment to the Company's 1998 Long Term Incentive
Compensation Plan was approved.
VOTES FOR VOTES AGAINST VOTES ABSTAINED NON-VOTES
- --------- ------------- --------------- ---------
2,424,225 235,789 50,692 731,632
- --------- ------- ------ -------
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits required by Item 601 of Regulation S-K:
Ex. No. Description
------- -----------
3.1 Amended and Restated Certificate of Incorporation of the
Company(1)
3.2 Amended and Restated Bylaws of the Company(1)
99.1 Certification of Jack H. Webb, Chairman of the Board,
President and Chief Executive Officer of the Registrant,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002(2)
99.2 Certification of David P. Kershaw, Treasurer and Chief
Financial Officer of the Registrant, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002(2)
- ----------
(1) Incorporated herein by reference to the exhibit with the same number
to the Registration Statement on Form S-4 (Registration No.
333-62623) of the Company previously filed with the Securities and
Exchange Commission on August 31, 1998, as amended.
(2) Filed herewith.
b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLIANCE FINANCIAL CORPORATION
DATE August 14, 2002 /s/ Jack H. Webb
------------------------------- ----------------------------------------
Jack H. Webb, Chairman of the Board,
President and Chief Executive Officer
DATE August 14, 2002 /s/ David P. Kershaw
------------------------------- ----------------------------------------
David P. Kershaw, Treasurer & Chief
Financial Officer