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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
For the fiscal year ended December 31, 2002
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-26481
FINANCIAL INSTITUTIONS, INC.
(Exact Name of Registrant as specified in its charter)
NEW YORK 16-0816610
(State of Incorporation) (I.R.S. Employer Identification Number)
220 Liberty Street Warsaw, NY 14569
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number Including Area Code:
(585) 786-1100
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant to Section 12(g) of the Act: Title of Class:
COMMON STOCK, PAR VALUE $.01 PER SHARE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
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. |_|
Aggregate market value of common stock held by non-affiliates of the registrant,
computed by reference to the closing price as of close of business on June 30,
2002 was $319,871,757.
As of March 12, 2003 there were issued and outstanding, exclusive of treasury
shares, 11,109,664 shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's proxy statement filed with the Securities and
Exchange Commission in connection with the 2003 Annual Meeting of Shareholders
are incorporated by reference in Part III of this Annual Report on Form 10-K.
FINANCIAL INSTITUTIONS, INC.
2002 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
Item 1. Business 3
Item 2. Properties 19
Item 3. Legal Proceedings 20
Item 4. Submission of Matters to a Vote of Security Holders 20
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters 20
Item 6. Selected Financial Data 21
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 23
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 42
Item 8. Financial Statements and Supplementary Data 45
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 74
PART III
Item 10. Directors and Executive Officers of the Registrant 74
Item 11. Executive Compensation 74
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 74
Item 13. Certain Relationships and Related Transactions 74
PART IV
Item 14. Controls and Procedures 74
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 75
2
PART I
Item I. Business
General
Financial Institutions, Inc. (the "Company" or "FII") is a financial holding
company headquartered in Warsaw, New York, which is located 45 miles southwest
of Rochester and 45 miles southeast of Buffalo. The Company operates a
super-community bank holding company - a bank holding company that owns multiple
community banks that are separately managed. The Company owns four commercial
banks that provide consumer, commercial and agricultural banking services in
Western and Central New York State: Wyoming County Bank ("WCB"), The National
Bank of Geneva ("NBG"), First Tier Bank & Trust ("FTB") and Bath National Bank
("BNB"), collectively referred to as the "Banks". During 2002, the Company
completed a geographic realignment of the subsidiary banks, which involved the
merger of the subsidiary formerly known as The Pavilion State Bank ("PSB") into
NBG and transfer of other branch offices between subsidiary banks. In recent
years, the Company has grown through a combination of internal growth, the
opening of new branch offices and acquisitions. The Company became qualified in
May 2000 as a financial holding company (see Gramm-Leach-Bliley Act discussion
beginning on page 14), and has since incorporated two financial services
subsidiaries into its operations: Burke Group, Inc. ("BGI") and The FI Group,
Inc. ("FIGI"), collectively referred to as the "Financial Services Group"
("FSG"). BGI is an employee benefits and compensation consulting firm acquired
by the Company in October 2001. FIGI is a brokerage subsidiary that commenced
operations as a start-up company in March 2000. In February 2001, the Company
formed FISI Statutory Trust I ("FISI"), to accommodate the private placement of
$16.2 million in capital securities, the proceeds of which were utilized to
partially fund the acquisition of Bath National Corporation ("BNC"). The capital
securities are identified on the consolidated statements of financial condition
as guaranteed preferred beneficial interests in corporation's junior
subordinated debentures.
We make available free of charge through our website at www.fiiwarsaw.com all
reports we electronically file with, or furnish to, the Securities and Exchange
Commission, or "SEC," including our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q and Current Reports on Form 8-K, as well as any amendments
to those reports, as soon as reasonably practicable after those documents are
filed with, or furnished to, the SEC. These filings are also accessible on the
SEC's website at www.sec.gov.
As a super-community bank holding company, the Company's strategy has been to
manage its bank subsidiaries on a decentralized basis. This strategy provides
the Banks the flexibility to efficiently serve their markets and respond to
local customer needs. While generally operating on a decentralized basis, the
Company has consolidated selected lines of business, operations and support
functions in order to achieve economies of scale, greater efficiency and
operational consistency. In furtherance of this objective, the Company hired a
Senior Credit Executive in September 2002 to review Company-wide credit policies
and develop and implement recommendations for strengthened, centralized credit
administration. By increasing the use of existing technology and by further
centralizing back-office operations, management believes substantial additional
growth can be accomplished without incurring proportionately greater operational
costs.
The relative sizes and profitability of the Company's operating subsidiaries in
thousands of dollars as of and for the year ended December 31, 2002, are
depicted in the following table:
Percent Percent
Subsidiary Assets of Total Net Income of Total
- --------------------------------------------------------------------------------
Wyoming County Bank $ 674,755 32 $ 10,565 40
The National Bank of Geneva 721,090 34 9,765 37
Bath National Bank 495,055 24 5,001 19
First Tier Bank & Trust 203,382 10 2,775 10
Financial Services Group 5,052 -- 246 1
Parent and eliminations, net 5,700 -- (1,896) (7)
---------- --- -------- ----
Total $2,105,034 100 $ 26,456 100
========== === ======== ====
3
Mergers and Acquisitions
On December 13, 2002, BNB acquired the two Chemung County branch offices of BSB
Bank & Trust Company of Binghamton, New York. The two offices purchased, located
in Elmira and Elmira Heights, had deposit liabilities totaling $44.2 million at
the time of acquisition. The acquisition was accounted for as a business
combination using the purchase method of accounting, and accordingly, the excess
of the purchase price over the fair value of identifiable tangible and
intangible assets acquired, less liabilities assumed, of approximately $1.5
million has been recorded as goodwill. In accordance with Statement of Financial
Accounting Standard (SFAS) No. 142, "Goodwill and Other Intangible Assets," the
Company is not required to amortize goodwill recognized in this acquisition. The
Company also recorded a $2.0 million intangible asset attributable to core
deposits, which is being amortized using the straight-line method over seven
years. The 2002 results of operations include the results from the branches from
the date of acquisition (December 13, 2002).
On May 1, 2002, FII acquired all of the common stock of the Bank of Avoca
("BOA") in exchange for 47,036 shares of FII common stock. BOA was a community
bank with its main office located in Avoca, New York, as well as a branch office
in Cohocton, New York. Subsequent to the acquisition, BOA was merged with BNB.
The acquisition was accounted for as a business combination using the purchase
method of accounting, and accordingly, the excess of the purchase price ($1.5
million) over the fair value of identifiable tangible and intangible assets
acquired ($18.4 million), less liabilities assumed ($17.3 million), of
approximately $0.4 million has been recorded as goodwill. In accordance with
SFAS No. 142, the Company is not required to amortize goodwill recognized in
this acquisition. The Company recorded a $146,000 core deposit intangible asset,
which is being amortized using the straight-line method over seven years. The
2002 results of operations for BOA are included in the income statements from
the date of acquisition (May 1, 2002).
On October 22, 2001, the Company acquired the Burke Group, Inc. ("BGI"), an
employee benefits administration and compensation consulting firm, with offices
in Honeoye Falls and Syracuse, New York. BGI's expertise includes design and
consulting for retirement and employee welfare plans, administrative services
for defined contribution and benefit plans, actuarial services and post
employment benefits. Under the terms of the agreement, BGI shareholders received
primarily common stock as consideration for their ownership in BGI. The
acquisition was accounted for as a business combination using the purchase
method of accounting, and accordingly, the excess of the purchase price ($3.3
million including earned amounts and contingent amounts to date - see Note 2 of
the notes to consolidated financial statements for additional discussion
regarding the merger consideration) over the fair value of identifiable tangible
and intangible assets acquired ($1.7 million), less liabilities assumed ($1.7
million), of approximately $3.3 million has been recorded as goodwill. In
accordance with SFAS No. 142, the Company is not required to amortize goodwill
recognized in this acquisition. The Company also recorded a $500,000 intangible
asset for a customer list which is being amortized using the straight-line
method over five years. The results of operations for BGI are included in the
income statements from the date of acquisition (October 22, 2001).
On May 1, 2001, FII acquired all of the common stock of Bath National
Corporation ("BNC") , and its wholly-owned subsidiary bank, Bath National Bank.
BNB is a full service community bank headquartered in Bath, New York, which has
9 branch locations in Steuben, Yates, Ontario and Schuyler Counties. The Company
paid $48.00 per share in cash for each of the outstanding shares of BNC common
stock with an aggregate purchase price of approximately $62.6 million. The
acquisition was accounted for under the purchase method of accounting, and
accordingly, the excess of the purchase price ($62.6 million) over the fair
value of identifiable tangible and intangible assets acquired ($295.4 million),
less liabilities assumed ($269.9 million), of approximately $37.1 million has
been recorded as goodwill. Goodwill was amortized in 2001 using the
straight-line method over 15 years, since the transaction was consummated prior
to June 30, 2001, the effective date of SFAS No. 142. However, in accordance
with SFAS No. 142, the Company ceased goodwill amortization on January 1, 2002.
The results of operations for BNB are included in the income statements from the
date of acquisition (May 1, 2001).
4
Forward Looking Statements
This Report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), that involve substantial risks and uncertainties. When used in this
report, or in the documents incorporated by reference herein, the words
"anticipate", "believe", "estimate", "expect", "intend", "may", and similar
expressions identify such forward-looking statements. Actual results,
performance or achievements could differ materially from those contemplated,
expressed or implied by the forward-looking statements contained herein. These
forward-looking statements are based on the current expectations of the Company
or the Company's management and are subject to a number of risks and
uncertainties, including but not limited to, economic, competitive, regulatory,
and other factors affecting the Company's operations, markets, products and
services, as well as expansion strategies and other factors discussed elsewhere
in this report filed by the Company with the Securities and Exchange Commission.
Many of these factors are beyond the Company's control.
Market Area and Competition
The Company provides a wide range of consumer and commercial banking services to
individuals, municipalities and businesses through a network of 47 branches and
62 ATMs in thirteen contiguous counties of Western and Central New York State:
Allegany, Cattaraugus, Chemung, Erie, Genesee, Livingston, Monroe, Ontario,
Schuyler, Seneca, Steuben, Wyoming and Yates Counties.
The Company's market area is geographically and economically diversified in that
it serves both rural markets and, increasingly, the larger more affluent markets
of suburban Rochester and suburban Buffalo. Rochester and Buffalo are the two
largest cities in New York State outside of New York City, with combined
metropolitan area populations of over two million people. The Company
anticipates increasing its presence in the markets around these two cities.
The Company faces significant competition in both making loans and attracting
deposits, as Western and Central New York have a high density of financial
institutions. The Company's competition for loans comes principally from
commercial banks, savings banks, savings and loan associations, mortgage banking
companies, credit unions, insurance companies and other financial service
companies. Its most direct competition for deposits has historically come from
savings and loan associations, savings banks, commercial banks and credit
unions. The Company faces additional competition for deposits from
non-depository competitors such as the mutual fund industry, securities and
brokerage firms and insurance companies.
Lending Activities
General. The Company, through its banking subsidiaries, offers a broad range of
loans including commercial and agricultural working capital and revolving lines
of credit, commercial and agricultural mortgages, equipment loans, crop and
livestock loans, residential mortgage loans and home equity lines of credit,
home improvement loans, student loans, automobile loans, personal loans and
credit cards. The Company sells most of its newly originated fixed rate
residential mortgage loans in the secondary market. Under the Company's
decentralized management philosophy, each of the banks determines individually
which loans are sold and which are retained for the portfolio. The Company
retains the servicing rights on most mortgage loans it sells and realizes
monthly service fee income.
Underwriting Standards. The Company's loan policy establishes the general
parameters of the types of loans that are desirable, emphasizing cash flow and
collateral coverage. Under the decentralized management structure, credit
decisions are made at the subsidiary bank level by officers who generally have
had long personal experience with most of their commercial and many of their
individual borrowers. The Company hired a Senior Credit Executive in September
2002 to review Company-wide credit policies and develop and implement
recommendations for strengthened, centralized credit administration. Each
subsidiary bank's loan policy must comply with the Company's overall loan
policy. These policies establish the lending authority of individual loan
officers as well as the loan authority of the banks' loan committees. The policy
limits exposure to any one borrower or affiliated group of borrowers to a limit
of $8,000,000 unless the amount above that number has liquid collateral pledged
as security or has a U.S. Government agency guarantee. The subsidiary bank CEO
and Senior Loan Administrator each have
5
loan authority up to $250,000 while other lending authorities are generally
$100,000 or less. The CEO and Senior Loan Administrator can approve loans up to
$500,000 jointly. Each subsidiary bank has an External Loan Committee that
consists of up to three lending officers and at least two outside bank
directors. The External Loan Committee may approve loans up to $2,000,000. Loans
over $2,000,000 require the approval of the Company's Executive Loan Committee.
The Executive Loan Committee consists of the Company's CEO, Chief Credit Officer
(non-voting), each subsidiary bank CEO, and each subsidiary bank Senior Loan
Administrator. To assure the maximum salability of the residential loan products
for possible resale into the secondary mortgage markets, the Company has
formally adopted the underwriting, appraisal, and servicing guidelines of the
Federal Home Loan Mortgage Corporation ("Freddie Mac") as part of its standard
loan policy and procedures manual.
Commercial Loans. The Company, through its banking subsidiaries, originates
commercial loans in its primary market areas and underwrites them based on the
borrower's ability to service the loan from operating income. The Company,
through its banking subsidiaries, offers a broad range of commercial lending
products, including term loans and lines of credit. Short and medium-term
commercial loans, primarily collateralized, are made available to businesses for
working capital (including inventory and receivables), business expansion
(including acquisition of real estate, expansion and improvements) and the
purchase of equipment. As a general practice, a collateral lien is placed on any
available real estate, equipment or other assets owned by the borrower and a
personal guarantee of the borrower is obtained. At December 31, 2002, $43.5
million, or 16.6%, of the aggregate commercial loan portfolio was at fixed rates
while $219.1 million, or 83.4%, was at variable rates. The Company also utilizes
government loan guarantee programs offered by the Small Business Administration
(or "SBA") and Rural Economic and Community Development (or "RECD") when
appropriate. See "Government Guarantee Programs" below.
Commercial Real Estate Loans. In addition to commercial loans secured by real
estate, the Company, through its banking subsidiaries, makes commercial real
estate loans to finance the purchase of real property which generally consists
of real estate with completed structures. Commercial real estate loans are
secured by first liens on the real estate, typically have variable interest
rates and are amortized over a 10 to 20 year period. The underwriting analysis
includes credit verification, appraisals and a review of the borrower's
financial condition. At December 31, 2002, $49.1 million, or 14.8%, of the
aggregate commercial real estate loan portfolio was at fixed rates while $283.0
million, or 85.2%, was at variable rates.
Agricultural Loans. Agricultural loans are offered for short-term crop
production, farm equipment and livestock financing and agricultural real estate
financing, including term loans and lines of credit. Short and medium-term
agricultural loans, primarily collateralized, are made available for working
capital (crops and livestock), business expansion (including acquisition of real
estate, expansion and improvement) and the purchase of equipment. The Banks also
closely monitor commodity prices and inventory build-up in various commodity
categories to better anticipate price changes in key agricultural products that
could adversely affect the borrowers' ability to repay their loans. At December
31, 2002 the Company has $118.1 million in loans to the dairy industry which
represents 9% of the total loan portfolio. The dairy industry is under stress
from an extended period of low milk prices. The Company routinely evaluates the
effect of those price changes on the cash flow of borrowers and the values of
collateral supporting those loans. At December 31, 2002, $20.1 million, or 8.6%,
of the agricultural loan portfolio was at fixed rates while $213.7 million, or
91.4%, was at variable rates. The Banks utilize government loan guarantee
programs offered by the SBA and the Farm Service Agency (or "FSA") of the United
States Department of Agriculture where available and appropriate. See
"Government Guarantee Programs" below.
Residential Real Estate Loans. The Banks originate fixed and variable rate
one-to-four family residential real estate loans collateralized by
owner-occupied properties located in its market areas. A variety of real estate
loan products which generally are amortized over five to 30 years are offered.
Loans collateralized by one-to-four family residential real estate generally
have been originated in amounts of no more than 80% of appraised value or have
mortgage insurance. Mortgage title insurance and hazard insurance are normally
required. The Company sells most newly originated fixed rate one-to-four family
residential mortgages to Freddie Mac and retains the rights to service the
mortgages. At December 31, 2002, the servicing portfolio totaled $301.4 million
in residential mortgages, the majority of which have been sold to
6
Freddie Mac. At December 31, 2002, $188.1 million, or 74.7%, of residential real
estate loans retained in portfolio was at fixed rates while $63.8 million, or
25.3%, was at variable rates.
Consumer and Home Equity Loans. The Banks originate direct and indirect credit
automobile loans, recreational vehicle loans, boat loans, home improvement
loans, fixed and open-ended home equity loans, personal loans (collateralized
and uncollateralized), student loans and deposit account collateralized loans.
Visa cards that provide consumer credit lines are also issued. The terms of
these loans typically range from 12 to 120 months and vary based upon the nature
of the collateral and the size of loan. The majority of the consumer lending
program is underwritten on a secured basis using the customer's home or the
financed automobile, mobile home, boat or recreational vehicle as collateral. At
December 31, 2002, $158.8 million, or 65.8%, of aggregate consumer and home
equity loans was at fixed rates while $82.7 million, or 34.2%, was at variable
rates.
Government Guarantee Programs. The Banks participate in government loan
guarantee programs offered by the SBA, RECD and FSA. At December 31, 2002, the
Banks had loans with an aggregate principal balance of $44.8 million that were
covered by guarantees under these programs. The guarantees only cover a certain
percentage of these loans. By participating in these programs, the Banks are
able to broaden their base of borrowers while minimizing credit risk.
Delinquencies and Nonperforming Assets. The Banks have several procedures in
place to assist in maintaining the overall quality of the Company's loan
portfolio. Specific underwriting guidelines have been established to be followed
by the lending officers. The Company requires each bank subsidiary to report
delinquencies on a monthly basis, and the Senior Credit Executive, as part of
the Company's ongoing centralized loan administration function, monitors these
levels to identify adverse trends.
Classification of Assets. Through the loan review process, the Banks maintain
internally classified loan lists which, along with delinquency reporting, helps
management assess the overall quality of the loan portfolio and the allowance
for loan losses. Loans classified as "substandard" are those loans with clear
and defined weaknesses such as a higher leveraged position, unfavorable
financial ratios, uncertain repayment sources or poor financial condition, which
may jeopardize recoverability of the debt. Loans classified as "doubtful" are
those loans which have characteristics similar to substandard accounts but with
an increased risk that a loss may occur, or at least a portion of the loan may
require a charge-off if liquidated at present. Loans are charged-off when it
becomes evident that such balances are not collectible.
A loan is generally placed on nonaccrual status and ceases accruing interest
when the payment of principal or interest is delinquent for 90 days, or earlier
in some cases, unless the loan is in the process of collection and the
underlying collateral further supports the carrying value of the loan.
Allowance for Loan Losses. The allowance for loan losses is established through
charges to earnings in the form of a provision for loan losses. The allowance
reflects management's estimate of the amount of probable loan losses in the
portfolio, based on the following factors:
- the amount of historical charge-off experience;
- the evaluation of the loan portfolio by the loan review function;
- levels and trends in delinquencies and non-accruals;
- trends in volume and terms;
- effects of changes in lending policy;
- experience, ability and depth of management;
- national and local economic trends and conditions; and
- concentration of credit.
Management presents a quarterly review of the allowance for loan losses to each
subsidiary bank's Board of Directors as well as to the Company's Board of
Directors, indicating any change in the
7
allowance since the last review and any recommendations as to adjustments in the
allowance. In order to determine the allowance for loan losses, the risk
classification and delinquency status of loans and other factors are considered,
such as collateral value, government guarantees, portfolio composition, trends
in economic conditions and the financial strength of borrowers. Specific
allowances for loans which have been individually evaluated for impairment are
established when required. An allowance is also established for groups of loans
with similar risk characteristics, based upon average historical charge-off
experience taking into account levels and trends in delinquencies, loan volumes,
economic and industry trends and concentrations of credit.
Investment Activities
General. The Company's investment securities policy is contained within the
overall Asset-Liability Management and Investment Policy. This policy dictates
that investment decisions will be made based on the safety of the investment,
liquidity requirements, potential returns, cash flow targets, need for
collateral and desired risk parameters. In pursuing these objectives, the
Company considers the ability of an investment to provide earnings consistent
with factors of quality, maturity, marketability and risk diversification. The
Board of each subsidiary bank adopts an asset/liability policy containing an
investment securities policy within the parameters of the Company's overall
asset/liability policy. The FII Treasurer, guided by the separate ALCO
Committees of each subsidiary bank, is responsible for securities portfolio
decisions within the established policies.
The Company's investment securities strategy centers on providing liquidity to
meet loan demand and redeeming liabilities, meeting pledging requirements,
managing overall interest rate risk and maximizing portfolio yield. Subsidiary
bank policies generally limit security purchases to the following:
- U.S. treasury securities;
- U.S. government agency and government sponsored agency securities;
- mortgage-backed pass-through securities and collateralized mortgage
obligations ("CMOs") issued by the Federal National Mortgage
Association ("FNMA"), the Government National Mortgage Association
("GNMA") and Freddie Mac ("FHLMC");
- investment grade municipal securities, including tax, revenue and
bond anticipation notes and general obligation and revenue notes and
bonds;
- certain creditworthy un-rated securities issued by municipalities;
and investment grade corporate debt.
The Company currently does not participate in hedging programs, interest rate
swaps, or other activities involving the use of off-balance sheet derivative
financial instruments. SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," requires recognition of derivatives as either assets or
liabilities, with the instruments measured at fair value. The accounting for
gains and losses resulting from changes in fair value of the derivative
instrument depends on the intended use of the derivative and the type of risk
being hedged. The Company adopted SFAS No. 133 on January 1, 2001. The adoption
of this statement did not have a material effect on the Company's financial
position or results of operations.
Additionally, the Company's investment policy limits investments in corporate
bonds to no more than 10% of total investments and to bonds rated as Baa or
better by Moody's Investor Services, Inc. or BBB or better by Standard & Poor's
Ratings Services at the time of purchase.
Sources of Funds
General. Deposits and borrowed funds, primarily Federal Home Loan Bank ("FHLB")
advances and sweep repurchase agreements, are the primary sources of the
Company's funds for use in lending, investing and for other general purposes. In
addition, repayments on loans, proceeds from sales of loans and securities, and
cash flows from operations provide additional sources of funds.
Deposits. The Company, through its banking subsidiaries, offers a variety of
deposit account products with a range of interest rates and terms. The deposit
accounts consist of savings, interest-bearing
8
checking accounts, checking accounts, money market accounts, savings, club
accounts and certificates of deposit. The Company offers certificates of deposit
with balances in excess of $100,000 at preferential rates (jumbo certificates)
to local municipalities, businesses, and individuals as well as Individual
Retirement Accounts ("IRAs") and other qualified plan accounts. To enhance its
deposit product offerings, the Company provides commercial checking accounts for
small to moderately-sized commercial businesses, as well as a low-cost checking
account service for low-income customers.
The flow of deposits is influenced significantly by general economic conditions,
changes in money market rates, prevailing interest rates and competition. The
Banks' deposits are obtained predominantly from the areas in which the Banks'
branch offices are located. The Banks rely primarily on competitive pricing of
their deposit products, customer service and long-standing relationships with
customers to attract and retain these deposits.
Borrowed Funds. Borrowings consist primarily of advances entered into with the
FHLB and repurchase agreements. The Company anticipates the continued use of
borrowings as a source of funding loan growth.
Guaranteed Preferred Beneficial Interests in Corporation's Junior Subordinated
Debentures. The Company formed a trust in February 2001 to accommodate the
private placement of $16.2 million in capital securities, the proceeds of which
were utilized to partially fund the acquisition of BNC.
Supervision and Regulation
The supervision and regulation of financial holding companies and their
subsidiaries is intended primarily for the protection of depositors, the deposit
insurance funds regulated by the FDIC and the banking system as a whole, and not
for the protection of shareholders or creditors of bank holding companies. The
various bank regulatory agencies have broad enforcement power over bank holding
companies and banks, including the power to impose substantial fines,
operational restrictions and other penalties for violations of laws and
regulations.
The following description summarizes some of the laws to which the Company and
its subsidiaries are subject. References to applicable statutes and regulations
are brief summaries and do not claim to be complete. They are qualified in their
entirety by reference to such statutes and regulations. Management believes the
Company is in compliance in all material respects with these laws and
regulations. Changes in the laws, regulations or policies that impact the
Company cannot necessarily be predicted, but they may have a material effect on
the business and earnings of the Company.
The Company
The Company is a financial holding company registered under the Bank Holding
Company Act of 1956, as amended, and is subject to supervision, regulation and
examination by the Federal Reserve Board. The Bank Holding Company Act and other
federal laws subject bank holding companies to particular restrictions on the
types of activities in which they may engage, and to a range of supervisory
requirements and activities, including regulatory enforcement actions for
violations of laws and regulations.
Regulatory Restrictions on Dividends; Source of Strength. It is the policy of
the Federal Reserve Board that bank holding companies should pay cash dividends
on common stock only out of income available over the past year, and only if
prospective earnings retention is consistent with the holding company's expected
future needs and financial condition. The policy provides that bank holding
companies should not maintain a level of cash dividends that undermines the bank
holding company's ability to serve as a source of strength to its banking
subsidiaries.
Under Federal Reserve Board policy, a bank holding company is expected to act as
a source of financial strength to each of its banking subsidiaries and commit
resources to their support. Such support may be required at times when, absent
this Federal Reserve Board policy, a holding company may not be inclined to
provide it. As discussed below, a bank holding company in certain circumstances
could be required to guarantee the capital plan of an undercapitalized banking
subsidiary.
9
Safe and Sound Banking Practices. Bank holding companies are not permitted to
engage in unsafe and unsound banking practices. The Federal Reserve Board's
Regulation Y, for example, generally requires a holding company to give the
Federal Reserve Board prior notice of any redemption or repurchase of its own
equity securities, if the consideration to be paid, together with the
consideration paid for any repurchases or redemptions in the preceding year, is
equal to 10% or more of the company's consolidated net worth. The Federal
Reserve Board may oppose the transaction if it believes that the transaction
would constitute an unsafe or unsound practice or would violate any law or
regulation. Depending upon the circumstances, the Federal Reserve Board could
take the position that paying a dividend would constitute an unsafe or unsound
banking practice.
The Federal Reserve Board has broad authority to prohibit activities of bank
holding companies and their non-banking subsidiaries which represent unsafe and
unsound banking practices or which constitute violations of laws or regulations,
and can assess civil money penalties for certain activities conducted on a
knowing and reckless basis, if those activities caused a substantial loss to a
depository institution. The penalties can be as high as $1,000,000 for each day
the activity continues.
Anti-Tying Restrictions. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates.
Capital Adequacy Requirements. The Federal Reserve Board has adopted a system
using risk-based capital guidelines to evaluate the capital adequacy of bank
holding companies. Under the guidelines, specific categories of assets are
assigned different risk weights, based generally on the perceived credit risk of
the asset. These risk weights are multiplied by corresponding asset balances to
determine a "risk-weighted" asset base. The guidelines require a minimum total
risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist
of Tier 1 capital elements). Total capital is the sum of Tier 1 and Tier 2
capital. As of December 31, 2002, the Company's ratio of Tier 1 capital to total
risk-weighted assets was 9.82% and the ratio of total capital to total
risk-weighted assets was 11.08%. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Financial Condition-Capital
Resources."
In addition to the risk-based capital guidelines, the Federal Reserve Board uses
a leverage ratio as an additional tool to evaluate the capital adequacy of bank
holding companies. The leverage ratio is a company's Tier 1 capital divided by
three-month average consolidated assets. Certain highly-rated bank holding
companies may maintain a minimum leverage ratio of 3.0%, but other bank holding
companies may be required to maintain a leverage ratio of up to 200 basis points
above the regulatory minimum. As of December 31, 2002, the Company's leverage
ratio was 6.96%.
The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
Federal Reserve Board guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets.
Imposition of Liability for Undercapitalized Subsidiaries. Bank regulators are
required to take "prompt corrective action" to resolve problems associated with
insured depository institutions whose capital declines below certain levels. In
the event an institution becomes "undercapitalized," it must submit a capital
restoration plan. The capital restoration plan will not be accepted by the
regulators unless each company having control of the undercapitalized
institution guarantees the subsidiary's compliance with the capital restoration
plan up to a certain specified amount. Any such guarantee from a depository
institution's holding company is entitled to a priority of payment in
bankruptcy.
10
The aggregate liability of the holding company of an undercapitalized bank is
limited to the lesser of 5% of the institution's assets at the time it became
undercapitalized or the amount necessary to cause the institution to be
"adequately capitalized." The bank regulators have greater power in situations
where an institution becomes "significantly" or "critically" undercapitalized or
fails to submit a capital restoration plan. For example, a bank holding company
controlling such an institution can be required to obtain prior Federal Reserve
Board approval of proposed dividends, or might be required to consent to a
consolidation or to divest the troubled institution or other affiliates.
Acquisitions by Bank Holding Companies. The Bank Holding Company Act requires
every bank holding company to obtain the prior approval of the Federal Reserve
Board before it may acquire all or substantially all of the assets of any bank,
or ownership or control of any voting shares of any bank, if after such
acquisition it would own or control, directly or indirectly, more than 5% of the
voting shares of such bank. In approving bank acquisitions by bank holding
companies, the Federal Reserve Board is required to consider the financial and
managerial resources and future prospects of the bank holding company and the
banks concerned, the convenience and needs of the communities to be served, and
various competitive factors.
Control Acquisitions. The Change in Bank Control Act prohibits a person or group
of persons from acquiring "control" of a bank holding company unless the Federal
Reserve Board has been notified and has not objected to the transaction. Under a
rebuttable presumption established by the Federal Reserve Board, the acquisition
of 10% of more of a class of voting stock of a bank holding company with a class
of securities registered under Section 12 of the Exchange Act, would, under the
circumstances set forth in the presumption, constitute acquisition of control of
the Company.
In addition, any entity is required to obtain the approval of the Federal
Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the
case of an acquirer that is a bank holding company) or more of the Company's
outstanding common stock, or otherwise obtaining control or a "controlling
influence" over the Company.
The Banks
Wyoming County Bank ("WCB") and First Tier Bank & Trust ("FTB") are New York
State-chartered banks. The National Bank of Geneva ("NBG") and Bath National
Bank ("BNB") are national banks chartered by the Office of the Comptroller of
Currency. All of the deposits of the four subsidiary banks are insured by the
FDIC through the Bank Insurance Fund. FTB is a member of the Federal Reserve
System. The Banks are subject to supervision and regulation that subject them to
special restrictions, requirements, potential enforcement actions and periodic
examination by the FDIC, the Federal Reserve Board and the New York State
Banking Department (in the case of the state-chartered banks) and the Office of
the Comptroller of Currency (in the case of the national banks). Because the
Federal Reserve Board regulates the bank holding company parent of the Banks,
the Federal Reserve Board also has supervisory authority which directly affects
the banks.
Restrictions on Transactions with Affiliates and Insiders. Transactions between
the holding company and its subsidiaries, including the Banks, are subject to
Section 23A of the Federal Reserve Act. In general, Section 23A imposes limits
on the amount of such transactions, and also requires certain levels of
collateral for loans to affiliated parties. It also limits the amount of
advances to third parties which are collateralized by the securities or
obligations of the Company or its subsidiaries.
Affiliate transactions are also subject to Section 23B of the Federal Reserve
Act which generally requires that certain transactions between the holding
company and its affiliates be on terms substantially the same, or at least as
favorable to the banks, as those prevailing at the time for comparable
transactions with or involving other nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O apply to all
insured institutions and their subsidiaries and holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such a loan can be made. There is also
11
an aggregate limitation on all loans to insiders and their related interests.
These loans cannot exceed the institution's total unimpaired capital and
surplus, and the FDIC may determine that a lesser amount is appropriate.
Insiders are subject to enforcement actions for knowingly accepting loans in
violation of applicable restrictions.
Restrictions on Distribution of Subsidiary Bank Dividends and Assets. Dividends
paid by the Banks have provided a substantial part of the Company's operating
funds and, for the foreseeable future, it is anticipated that dividends paid by
the Banks will continue to be its principal source of operating funds. Capital
adequacy requirements serve to limit the amount of dividends that may be paid by
the subsidiaries. Under federal law, the subsidiaries cannot pay a dividend if,
after paying the dividend, a particular subsidiary will be "undercapitalized."
The FDIC may declare a dividend payment to be unsafe and unsound even though the
bank would continue to meet its capital requirements after the dividend.
Because the Company is a legal entity separate and distinct from its
subsidiaries, the Company's right to participate in the distribution of assets
of any subsidiary upon the subsidiary's liquidation or reorganization will be
subject to the prior claims of the subsidiary's creditors. In the event of a
liquidation or other resolution of an insured depository institution, the claims
of depositors and other general or subordinated creditors are entitled to a
priority of payment over the claims of holders of any obligation of the
institution to its shareholders, including any depository bank holding company
(such as the Company) or any shareholder or creditor thereof.
Examinations. The New York State Banking Department (in the case of WCB and
FTB), the Office of the Comptroller of the Currency (in the case of NBG and
BNB), the Federal Reserve Board and the FDIC periodically examine and evaluate
the Banks. Based upon such examinations, the appropriate regulator may revalue
the assets of the institution and require that it establish specific reserves to
compensate for the difference between what the regulator determines the value to
be and the book value of such assets.
Audit Reports. Insured institutions with total assets of $500 million or more at
the beginning of a fiscal year must submit annual audit reports prepared by
independent auditors to federal and state regulators. In some instances, the
audit report of the institution's holding company can be used to satisfy this
requirement. Auditors must receive examination reports, supervisory agreements
and reports of enforcement actions. In addition, financial statements prepared
in accordance with generally accepted accounting principles, management's
certifications concerning responsibility for the financial statements, internal
controls and compliance with legal requirements designated by the FDIC, and an
attestation by the auditor regarding the statements of management relating to
the internal controls must be submitted. The FDIC Improvement Act of 1991
requires that independent audit committees be formed, consisting of outside
directors only. The committees of institutions with assets of more than $3
billion must include members with experience in banking or financial management,
must have access to outside counsel and must not include representatives of
large customers.
Capital Adequacy Requirements. The FDIC has adopted regulations establishing
minimum requirements for the capital adequacy of insured institutions. The FDIC
may establish higher minimum requirements if, for example, a bank has previously
received special attention or has a high susceptibility to interest rate risk.
The FDIC's risk-based capital guidelines generally require banks to have a
minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and a
ratio of total capital to total risk-weighted assets of 8.0%. The capital
categories have the same definitions for the Company. As of December 31, 2002,
the ratio of Tier 1 capital to total risk-weighted assets for the Banks was
8.94% for WCB, 8.90% for NBG, 9.70% for BNB, and 9.45% for FTB, and the ratio of
total capital to total risk-weighted assets was 10.20% for WCB, 10.16% for NBG,
10.95% for BNB, and 10.70% for FTB. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
The FDIC's leverage guidelines require banks to maintain Tier 1 capital of no
less than 4.0% of average total assets, except in the case of certain highly
rated banks for which the requirement is 3.0% of average total assets. As of
December 31, 2002, the ratio of Tier 1 capital to average total assets (leverage
ratio)
12
was 6.64% for WCB, 6.71% for NBG, 5.93% for BNB, and 5.67% for FTB. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
Corrective Measures for Capital Deficiencies. The federal banking regulators are
required to take "prompt corrective action" with respect to capital-deficient
institutions. Agency regulations define, for each capital category, the levels
at which institutions are "well-capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." A "well-capitalized" bank has a total risk-based capital
ratio of 10.0% or higher; a Tier 1 risk-based capital ratio of 6.0% or higher; a
leverage ratio of 5.0% or higher; and is not subject to any written agreement,
order or directive requiring it to maintain a specific capital level for any
capital measure. An "adequately capitalized" bank has a total risk-based capital
ratio of 8.0% or higher; a Tier 1 risk-based capital ratio of 4.0% or higher; a
leverage ratio of 4.0% or higher (3.0% or higher if the bank was rated a
composite 1 in its most recent examination report and is not experiencing
significant growth); and does not meet the criteria for a well-capitalized bank.
A bank is "undercapitalized" if it fails to meet any one of the ratios required
to be adequately capitalized.
In addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations contain broad restrictions on certain
activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from paying
management fees to control persons if the institution would be undercapitalized
after any such distribution or payment.
As an institution's capital decreases, the FDIC's enforcement powers become more
severe. A significantly undercapitalized institution is subject to mandated
capital raising activities, restrictions on interest rates paid and transactions
with affiliates, removal of management and other restrictions. The FDIC has only
very limited discretion in dealing with a critically undercapitalized
institution and is virtually required to appoint a receiver or conservator.
Banks with risk-based capital and leverage ratios below the required minimums
may also be subject to certain administrative actions, including the termination
of deposit insurance upon notice and hearing, or a temporary suspension of
insurance without a hearing in the event the institution has no tangible
capital.
Deposit Insurance Assessments. The bank subsidiaries must pay assessments to the
FDIC for federal deposit insurance protection. The FDIC has adopted a risk-based
assessment system as required by the FDIC Improvement Act. Under this system,
FDIC-insured depository institutions pay insurance premiums at rates based on
their risk classification. Institutions assigned to higher risk classifications
(that is, institutions that pose a greater risk of loss to their respective
deposit insurance funds) pay assessments at higher rates than institutions that
pose a lower risk. An institution's risk classification is assigned based on its
capital levels and the level of supervisory concern the institution poses to the
regulators. In addition, the FDIC can impose special assessments in certain
instances.
The FDIC maintains a process for raising or lowering all rates for insured
institutions semi-annually if conditions warrant a change. Under this system,
the FDIC has the flexibility to adjust the assessment rate schedule twice a year
without seeking prior public comment, but only within a range of five cents per
$100 above or below the premium schedule adopted. Changes in the rate schedule
outside the five cent range above or below the current schedule can be made by
the FDIC only after a full rulemaking with opportunity for public comment.
The Deposit Insurance Fund Act of 1996 contained a comprehensive approach to
recapitalizing the Savings Association Insurance Fund and to assuring the
payment of the Financing Corporation's bond obligations. Under this law, banks
insured under the Bank Insurance Fund are required to pay a portion of the
interest due on bonds that were issued by the Financing Corporation in 1987 to
help shore up the ailing Federal Savings and Loan Insurance Corporation.
13
Enforcement Powers. The FDIC and the other federal banking agencies have broad
enforcement powers, including the power to terminate deposit insurance, impose
substantial fines and other civil and criminal penalties and appoint a
conservator or receiver. Failure to comply with applicable laws, regulations and
supervisory agreements could subject the Company or its banking subsidiaries, as
well as the officers, directors and other institution-affiliated parties of
these organizations, to administrative sanctions and potentially substantial
civil money penalties.
Brokered Deposit Restrictions. Adequately capitalized institutions cannot
accept, renew or roll over brokered deposits except with a waiver from the FDIC,
and are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew or roll over
brokered deposits.
Cross-Guarantee Provisions. The Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") contains a "cross-guarantee" provision which
generally makes commonly controlled insured depository institutions liable to
the FDIC for any losses incurred in connection with the failure of a commonly
controlled depository institution.
Community Reinvestment Act. The Community Reinvestment Act of 1977 ("CRA") and
the regulations issued thereunder are intended to encourage banks to help meet
the credit needs of their service area, including low and moderate income
neighborhoods, consistent with the safe and sound operations of the banks. These
regulations also provide for regulatory assessment of a bank's record in meeting
the needs of its service area when considering applications regarding
establishing branches, mergers or other bank or branch acquisitions. FIRREA
requires federal banking agencies to make public a rating of a bank's
performance under the CRA. In the case of a bank holding company, the CRA
performance record of the banks involved in the transaction are reviewed in
connection with the filing of an application to acquire ownership or control of
shares or assets of a bank or to merge with any other bank holding company. An
unsatisfactory record can substantially delay or block the transaction.
Consumer Laws and Regulations. In addition to the laws and regulations discussed
herein, the subsidiary banks are also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include, among others, the Truth in Lending Act, the Truth in Savings Act, the
Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal
Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act
and the Real Estate Settlement Procedures Act. These laws and regulations
mandate certain disclosure requirements and regulate the manner in which
financial institutions must deal with customers when taking deposits or making
loans to such customers. The Banks must comply with the applicable provisions of
these consumer protection laws and regulations as part of their ongoing customer
relations.
Changing Regulatory Structure
Gramm Leach-Bliley Act
The Gramm-Leach-Bliley Act ("Gramm-Leach") was signed into law on November 12,
1999. Gramm-Leach permits, subject to certain conditions, combinations among
banks, securities firms and insurance companies beginning March 11, 2000. Under
Gramm-Leach, bank holding companies are permitted to offer their customers
virtually any type of financial service including banking, securities
underwriting, insurance (both underwriting and agency), and merchant banking. In
order to engage in these additional financial activities, a bank holding company
must qualify and register with the Board of Governors of the Federal Reserve
System as a "financial holding company" by demonstrating that each of its bank
subsidiaries is "well capitalized," "well managed," and has at least a
"satisfactory" rating under the CRA. On May 12, 2000 the Company received
approval from the Federal Reserve Bank of New York to become a financial holding
company. Gramm-Leach establishes that the federal banking agencies will regulate
the banking activities of financial holding companies and banks' financial
subsidiaries, the U.S. Securities and Exchange Commission will regulate their
securities activities and state insurance regulators will regulate their
insurance activities. Gramm-Leach also provides new protections against the
transfer and use by financial institutions of consumers' nonpublic, personal
information.
14
The major provisions of Gramm-Leach are:
Financial Holding Companies and Financial Activities. Title I establishes a
comprehensive framework to permit affiliations among commercial banks, insurance
companies, securities firms, and other financial service providers by revising
and expanding the Bank Holding Company Act framework to permit a holding company
system to engage in a full range of financial activities through qualification
as a new entity known as a financial holding company. A bank holding company
that qualifies as a financial holding company can expand into a wide variety of
services that are financial in nature, provided that its subsidiary depository
institutions are well-managed, well-capitalized and have received at least a
"satisfactory" rating on their last CRA examination. Services that have been
deemed to be financial in nature include securities underwriting, dealing and
market making, sponsoring mutual funds and investment companies, insurance
underwriting and agency activities and merchant banking.
Title I also required the FDIC to adopt regulations implementing Section 121 of
Title I, regarding permissible activities and investments of insured state
banks. Final regulations adopted by the FDIC in January 2001, in the form of
amendments to Part 362 of the FDIC rules and regulations, provide the framework
for subsidiaries of state nonmember banks to engage in financial activities that
Gramm-Leach permits national banks to conduct through a financial subsidiary.
The regulations require that prior to commencing such financial activities, a
state nonmember bank must notify the FDIC of its intent to do so, and must
certify that it is well-managed and that it and all of its subsidiary insured
depository institutions are well-capitalized after deducting its investment in
the new subsidiary. Furthermore, the regulations require that the notifying bank
must, and must continue to, (i) disclose the capital deduction in published
financial statements, and (ii) comply with sections 23A and 23B of the Federal
Reserve Act and (iii) comply with all required financial and operational
safeguards.
Activities permissible for financial subsidiaries of national banks, and,
pursuant to Section 362 of the FDIC rules and regulations, also permissible for
financial subsidiaries of state nonmember banks, include, but are not limited
to, the following: (a) Lending, exchanging, transferring, investing for others,
or safeguarding money or securities; (b) Insuring, guaranteeing, or indemnifying
against loss, harm, damage, illness, disability, or death, or providing and
issuing annuities, and acting as principal, agent, or broker for purposes of the
foregoing, in any State; (c) Providing financial, investment, or economic
advisory services, including advising an investment company; (d) Issuing or
selling instruments representing interests in pools of assets permissible for a
bank to hold directly; and (e) Underwriting, dealing in, or making a market in
securities.
Securities Activities. Title II narrows the exemptions from the securities laws
previously enjoyed by banks, requires the Federal Reserve Board and the SEC to
work together to draft rules governing certain securities activities of banks
and creates a new, voluntary investment bank holding company.
Insurance Activities. Title III restates the proposition that the states are the
functional regulators for all insurance activities, including the insurance
activities of federally-chartered banks, and bars the states from prohibiting
insurance activities by depository institutions. The law encourages the states
to develop uniform or reciprocal rules for the licensing of insurance agents.
Privacy. Under Title V, federal banking regulators were required to adopt rules
that have limited the ability of banks and other financial institutions to
disclose non-public information about consumers to nonaffiliated third parties.
These limitations require disclosure of privacy policies to consumers and, in
some circumstances, allow consumers to prevent disclosure of certain personal
information to a nonaffiliated third party. Federal banking regulators issued
final rules on May 10, 2000 to implement the privacy provisions of Title V.
Under the rules, financial institutions must provide:
- initial notices to customers about their privacy policies,
describing the conditions under which they may disclose nonpublic
personal information to nonaffiliated third parties and affiliates;
- annual notices of their privacy policies to current customers; and
- a reasonable method for customers to "opt out" of disclosures to
nonaffiliated third parties.
15
Compliance with the rules is mandatory after July 1, 2001. The Company and the
banks were in full compliance with the rules as of or prior to their respective
effective dates.
Safeguarding Confidential Customer Information. Under Title V, federal banking
regulators are required to adopt rules requiring financial institutions to
implement a program to protect confidential customer information. In January
2000, the federal banking agencies adopted guidelines requiring financial
institutions to establish an information security program to:
- identify and assess the risks that may threaten customer
information;
- develop a written plan containing policies and procedures to manage
and control these risks;
- implement and test the plan; and
- adjust the plan on a continuing basis to account for changes in
technology, the sensitivity of customer information and internal or
external threats to information security.
The Banks' approved security programs appropriate to their size and complexity
and the nature and scope of their operations prior to the July 1, 2001 effective
date of the regulatory guidelines. The implementation of the programs is an
ongoing process.
Community Reinvestment Act Sunshine Requirements. In February 2001, the federal
banking agencies adopted final regulations implementing Section 711 of Title
VII, the CRA Sunshine Requirements. The regulations require nongovernmental
entities or persons and insured depository institutions and affiliates that are
parties to written agreements made in connection with the fulfillment of the
institution's CRA obligations to make available to the public and the federal
banking agencies a copy of each agreement. The regulations impose annual
reporting requirements concerning the disbursement, receipt and use of funds or
other resources under these agreements. The effective date of the regulations
was April 1, 2001. Neither the Company nor the banks is a party to any agreement
that would be the subject of reporting pursuant to the CRA Sunshine
Requirements.
The Company continues to evaluate the strategic opportunities presented by the
broad powers granted to bank holding companies that elect to be treated as
financial holding companies. In the event that the Company determines that
access to the broader powers of a financial holding company is in the best
interests of the Company, its shareholders and the banks, the Company will file
the appropriate election with the Federal Reserve Board.
USA Patriot Act
As part of the Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001 ("USA Patriot Act"),
signed into law on October 26, 2001, Congress adopted the International Money
Laundering Abatement and Financial Anti-Terrorism Act of 2001 ("IMLAFATA").
IMLAFATA authorizes the Secretary of the Treasury, in consultation with the
heads of other government agencies, to adopt special measures applicable to
banks, bank holding companies, or other financial institutions. During 2002, the
Department of Treasury issued a number of regulations relating to enhanced
recordkeeping and reporting requirements for certain financial transactions that
are of primary money laundering concern, due diligence requirements concerning
the beneficial ownership of certain types of accounts, and restrictions or
prohibitions on certain types of accounts with foreign financial institutions.
Covered financial institutions also are barred from dealing with foreign "shell"
banks. In addition, IMLAFATA expands the circumstances under which funds in a
bank account may be forfeited and requires covered financial institutions to
respond under certain circumstances to requests for information from federal
banking agencies within 120 hours.
Regulations were also adopted during 2002 to implement minimum standards to
verify customer identity, to encourage cooperation among financial institutions,
federal banking agencies, and law enforcement authorities regarding possible
money laundering or terrorist activities, to prohibit the anonymous use of
"concentration accounts," and to require all covered financial institutions to
have in place a Bank Secrecy Act compliance program. IMLAFATA also amends the
Bank Holding Company Act and the Bank Merger
16
Act to require the federal banking agencies to consider the effectiveness of a
financial institution's anti-money laundering activities when reviewing an
application under these acts.
The Banks have in place a Bank Secrecy Act compliance program, and they engage
in very few transactions of any kind with foreign financial institutions or
foreign persons.
Sarbanes-Oxley Act
On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002
(the "Act") implementing legislative reforms intended to address corporate and
accounting fraud. In addition to the establishment of a new accounting oversight
board which will enforce auditing, quality control and independence standards
and will be funded by fees from all publicly traded companies, the law restricts
provision of both auditing and consulting services by accounting firms. To
ensure auditor independence, any non-audit services being provided to an audit
client will require pre-approval by the issuer's audit committee members. In
addition, the audit partners must be rotated. The Act requires chief executive
officers and chief financial officers, or their equivalent, to certify to the
accuracy of periodic reports filed with the SEC, subject to civil and criminal
penalties if they knowingly or willfully violate this certification requirement.
In addition, under the Act, legal counsel will be required to report evidence of
a material violation of the securities laws or a breach of fiduciary duty by a
company to its chief executive officer or its chief legal officer, and, if such
officer does not appropriately respond, to report such evidence to the audit
committee or other similar committee of the board of directors or the board
itself.
Longer prison terms and increased penalties will also be applied to corporate
executives who violate federal securities laws, the period during which certain
types of suits can be brought against a company or its officers has been
extended, and bonuses issued to top executives prior to restatement of a
company's financial statements are now subject to disgorgement if such
restatement was due to corporate misconduct. Executives are also prohibited from
insider trading during retirement plan "blackout" periods, and loans to company
executives are restricted. The Act accelerates the time frame for disclosures by
public companies, as they must immediately disclose any material changes in
their financial condition or operations. Directors and executive officers must
also provide information for most changes in ownership in a company's securities
within two business days of the change.
The Act also prohibits any officer or director of a company or any other person
acting under their direction from taking any action to fraudulently influence,
coerce, manipulate or mislead any independent public or certified accountant
engaged in the audit of the company's financial statements for the purpose of
rendering the financial statement's materially misleading. The Act also requires
the SEC to prescribe rules requiring inclusion of an internal control report and
assessment by management in the annual report to stockholders. In addition, the
Act requires that each financial report required to be prepared in accordance
with (or reconciled to) accounting principles generally accepted in the United
States of America and filed with the SEC reflect all material correcting
adjustments that are identified by a "registered public accounting firm" in
accordance with accounting principles generally accepted in the United States of
America and the rules and regulations of the SEC.
Effective August 29, 2002, as directed by Section 302(a) of the Act, the
Company's chief executive officer and chief financial officer are each required
to certify that the Company's quarterly and annual reports do not contain any
untrue statement of a material fact. The Act imposes several requirements,
including having these officers certify that: they are responsible for
establishing, maintaining and regularly evaluating the effectiveness of the
Company's internal controls; they have made certain disclosures to the Company's
auditors and the audit committee of the Board of Directors about the Company's
internal controls; and they have included information in the Company's quarterly
and annual reports about their evaluation and whether there have been
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls subsequent to the evaluation.
Fair Credit Reporting Act
In 1970, the U. S. Congress the Fair Credit Reporting Act (the "FCRA") in order
to ensure the confidentiality, accuracy, relevancy and proper utilization of
consumer credit report information. Under the framework of the FCRA, the United
States has developed a highly advanced and efficient credit
17
reporting system. The information contained in that broad system is used by
financial institutions, retailers and other creditors of every size in making a
wide variety of decisions regarding financial transactions. Employers, and law
enforcement agencies have also made wide use of the information collected and
maintained in databases made possible by the FCRA. The FCRA affirmatively
preempts state law in a number of areas, including the ability of entities
affiliated by common ownership to share and exchange information freely, the
requirements on credit bureaus to reinvestigate the contents of reports in
response to consumer complaints, among others. By its terms, the preemption
provision of the FCRA will terminate as of December 31, 2003. Termination of the
preemption provisions could significantly impact the ability of the existing
credit bureau system to continue operating.
The Company may incur additional costs, and be required to implement additional
costly procedures and systems in the event that the preemption provisions of the
FCRA terminate at the end of 2003, and New York, or other states, adopts
legislation that would have the effect of prohibiting the continued sharing of
information such as that currently collected by credit bureaus throughout the
United States. The likelihood of the FCRA preemption provisions terminating by
their terms, and of the adoption of such restrictive provisions by state
legislatures, cannot be estimated at this time.
Expanding Enforcement Authority
The Federal Reserve Board, the Office of the Comptroller of Currency, the New
York State Superintendent of Banks and the FDIC possess extensive authority to
police unsafe or unsound practices and violations of applicable laws and
regulations by depository institutions and their holding companies. For example,
the FDIC may terminate the deposit insurance of any institution which it
determines has engaged in an unsafe or unsound practice. The agencies can also
assess civil money penalties, issue cease and desist or removal orders, seek
injunctions, and publicly disclose such actions.
Effect On Economic Environment
The policies of regulatory authorities, including the monetary policy of the
Federal Reserve Board, have a significant effect on the operating results of
bank holding companies and their subsidiaries. Among the means available to the
Federal Reserve Board to affect the money supply are open market operations in
U.S. Government securities, changes in the discount rate on member bank
borrowings and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth and
distribution of bank loans, investments and deposits, and their use may affect
interest rates charged on loans or paid for deposits. Federal Reserve Board
monetary policies have materially affected the operating results of commercial
banks in the past and are expected to continue to do so in the future.
18
Item 2. Properties
The Company's headquarters and operations center is located in Warsaw, New York.
This facility is leased for a nominal rent from the Wyoming County Industrial
Development Agency for local tax reasons and the Company has the right to
purchase it for nominal consideration beginning in November, 2006. The following
table lists the properties of each of the Company's subsidiaries:
TYPE OF LEASED OR EXPIRATION
ENTITY \ LOCATION FACILITY OWNED OF LEASE
----------------- -------- ----- --------
Wyoming County Bank
Warsaw................................... Main Office Own --
Attica................................... Branch Own --
Batavia.................................. Branch Lease October 2011
Batavia (In-Store)....................... Branch Lease August 2008
Dansville................................ Branch Lease March 2003
East Aurora.............................. Branch Lease December 2012
Geneseo.................................. Branch Own --
Lakeville................................ Branch Own --
Mount Morris............................. Branch Own --
North Java............................... Branch Own --
North Warsaw............................. Branch Own --
Pavilion................................. Branch Own --
Strykersville............................ Branch Own --
Williamsville............................ Branch Lease May 2003
Wyoming.................................. Branch Own --
Yorkshire................................ Branch Lease November 2007
The National Bank of Geneva
Geneva................................... Main Office Own --
Geneva................................... Drive-up Branch Own --
Geneva (Plaza)........................... Branch Ground Lease January 2016
Caledonia................................ Branch Lease April 2006
Canandaigua.............................. Branch Own --
Honeoye Falls............................ Branch Lease April 2007
Leroy.................................... Branch Own --
North Chili.............................. Branch Lease July 2015
Ovid..................................... Branch Own --
Penn Yan................................. Branch Own --
Victor................................... Branch Own --
Waterloo................................. Branch Own --
Bath National Bank
Bath..................................... Main Office Own --
Bath..................................... Drive-up Branch Own --
Avoca.................................... Branch Own --
Avoca.................................... Drive-up Branch Lease September 2004
Cohocton................................. Branch Lease August 2005
Dundee................................... Branch Own --
Elmira................................... Branch Own --
Elmira Heights........................... Branch Lease November 2008
Erwin.................................... Branch Lease August 2004
Hammondsport............................. Branch Own --
Hornell.................................. Branch Own --
Horseheads............................... Branch Lease September 2012
Naples................................... Branch Own --
Wayland.................................. Branch Own --
First Tier Bank & Trust
Olean.................................... Main Office Own --
Olean.................................... Drive-up Branch Own --
Allegany................................. Branch Own --
Cuba..................................... Branch Lease November 2007
Ellicottville............................ Branch Own --
Salamanca................................ Branch Own --
Burke Group
Honeoye Falls............................ Main Office Lease December 2018
Syracuse................................. Branch Lease April 2005
19
Item 3. Legal Proceedings
From time to time the Company and its subsidiaries are parties to or otherwise
involved in legal proceedings arising in the normal course of business.
Management does not believe that there is any pending or threatened proceeding
against the Company or its subsidiaries which, if determined adversely, would
have a material effect on the Company's business, results of operations or
financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted during the fourth quarter of the year ended December
31, 2002 to a vote of security holders.
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
The common stock of the Company is traded under the symbol of FISI on the Nasdaq
National Market. At March 12, 2003, the Company had 11,109,664 shares of common
stock outstanding (exclusive of treasury shares) and had approximately 2,175
shareholders of record.
The high and low prices listed below represent actual sales transactions as
reported by Nasdaq.
Sales Price Cash Dividends
High Low Close Declared
----------------------------------------------------------------
2002
First Quarter $ 30.000 $ 23.330 $ 29.110 $ 0.13
Second Quarter 38.850 28.740 37.860 0.14
Third Quarter 38.250 24.350 27.150 0.15
Fourth Quarter 32.040 25.050 29.360 0.16
2001
First Quarter 20.000 13.000 19.625 0.11
Second Quarter 24.250 18.000 22.400 0.12
Third Quarter 26.650 21.000 23.440 0.12
Fourth Quarter 24.850 17.100 23.400 0.13
Since becoming publicly traded the Company has paid regular quarterly cash
dividends on its common stock, and the Board of Directors presently intends to
continue the payment of regular quarterly cash dividends, subject to the need
for those funds for debt service and other purposes. However, because
substantially all of the funds available for the payment of dividends are
derived from the Banks, future dividends will depend upon the earnings of the
Banks', their financial condition and need for funds. Furthermore, there are a
number of federal banking policies and regulations that restrict the Company's
ability to pay dividends. For further discussion on dividend restrictions,
please refer to page 9, as these restrictions may have the effect of reducing
the amount of dividends that the Company can declare to its shareholders.
20
Item 6. Selected Financial Data
(Dollars in thousands) December 31
--------------------------------------------------------------------
2002 2001 2000 1999 1998
--------------------------------------------------------------------
Selected Financial Condition Data
Total assets $2,105,034 $1,794,296 $1,289,327 $1,136,460 $976,185
Loans, net 1,300,232 1,146,976 873,262 752,324 645,857
Securities available for sale 596,862 428,423 257,823 197,134 154,171
Securities held to maturity 47,125 61,281 76,947 81,356 91,016
Deposits 1,708,523 1,433,658 1,078,111 949,531 850,455
Borrowed funds 195,479 190,389 62,384 56,336 13,862
Shareholders' equity 178,294 149,187 131,618 117,539 96,578
(Dollars in thousands) For the years ended December 31
--------------------------------------------------------------------
2002 2001 2000 1999 1998
--------------------------------------------------------------------
Selected Results of Operations Data
Interest income $ 118,439 $ 114,468 $ 96,467 $ 78,692 $ 72,660
Interest expense 42,585 49,694 43,605 31,883 30,958
--------------------------------------------------------------------
Net interest income 75,854 64,774 52,862 46,809 41,702
Provision for loan losses 6,119 4,958 4,211 3,062 2,732
--------------------------------------------------------------------
Net interest income after
Provision for loan loss 69,735 59,816 48,651 43,747 38,970
Noninterest income 22,189 15,782 9,409 8,055 6,591
Noninterest expense (3) 53,049 43,352 30,156 27,032 24,602
--------------------------------------------------------------------
Income before income taxes 38,875 32,246 27,904 24,770 20,959
Income taxes 12,419 11,033 9,804 8,813 7,354
--------------------------------------------------------------------
Net income $ 26,456 $ 21,213 $ 18,100 $ 15,957 $ 13,605
====================================================================
At or for the years ended December 31
------------------------------------------------------------
2002 2001 2000 1999 1998
------------------------------------------------------------
Per Common Share Data
Net income - basic $ 2.26 $ 1.79 $ 1.51 $ 1.38 $ 1.22
Net income - diluted 2.23 1.77 1.51 1.38 1.22
Cash dividends declared 0.58 0.48 0.42 0.31 0.26
Book value 14.46 11.93 10.36 9.05 7.94
Market value 29.36 23.40 13.61 12.12 --
Selected Financial Ratios and Other Data
Performance Ratios:
Return on common equity 17.01% 15.84% 15.78% 16.16% 16.28%
Return on assets 1.35 1.34 1.51 1.54 1.48
Common dividend payout 25.66 26.82 27.81 22.46 21.31
Net interest rate spread 3.96 3.96 3.98 4.19 4.24
Net interest margin (1) 4.37 4.62 4.87 5.00 5.06
Efficiency ratio 50.62 48.49 45.19 45.55 46.64
Noninterest income to average total assets (2) 1.11 0.96 0.76 0.75 0.69
Noninterest expenses to average total assets 2.70 2.73 2.52 2.61 2.68
Average interest-earning assets to average interest bearing
liabilities 117.82 119.67 123.25 124.86 123.05
Asset Quality Ratios:
Non-performing loans to total loans 2.81% 0.86% 0.80% 0.75% 0.93%
Non-performing assets to total loans and other real estate 2.90 0.94 0.91 0.88 1.24
Allowance for loan losses to non-performing loans 58 190 195 199 157
Allowance for loan losses to total loans 1.64 1.64 1.56 1.50 1.46
Net charge-offs during the period to average loans
outstanding during the year 0.30 0.23 0.21 0.17 0.21
Capital ratios:
Equity to total assets 8.47% 8.31% 10.21% 10.34% 9.89%
Average common equity to average assets 7.47 7.84 8.78 8.63 8.09
Other Data:
Number of full-service offices 47 41 32 29 28
Loans serviced for others (in millions) $ 356.4 $ 302.3 $ 205.2 $ 200.2 $ 177.8
Full time equivalent employees 685 608 441 411 384
(1) Net interest income divided by average interest earning assets. A
tax-equivalent adjustment to interest earned from tax-exempt securities
has been computed using a federal tax rate of 35%.
(2) Noninterest income excludes net gain (loss) on sale of securities
available for sale.
(3) Noninterest expense includes goodwill amortization, which amounted to
$1,653,000 for 2001 compared to zero in all other years presented.
21
----------------------------------------
(Dollars in thousands) First Second Third Fourth
Quarter Quarter Quarter Quarter
----------------------------------------
Selected Quarterly Financial Information
2002
Results of operations data:
Interest income $28,560 $29,927 $30,343 $29,609
Interest expense 10,483 10,941 10,810 10,351
Net interest income 18,077 18,986 19,533 19,258
Provision for loan losses 1,007 1,181 1,452 2,479
Net interest income after provision for loan losses 17,070 17,805 18,081 16,779
Noninterest income 4,937 5,157 5,687 6,408
Noninterest expense 12,100 13,093 13,418 14,438
Income before income taxes 9,907 9,869 10,350 8,749
Income taxes 3,250 3,225 3,466 2,478
Net income 6,657 6,644 6,884 6,271
Per common share data:
Net income - basic $ 0.57 $ 0.57 $ 0.59 $ 0.53
Net income - diluted 0.56 0.56 0.58 0.53
Cash dividends declared 0.13 0.14 0.15 0.16
Book value 12.26 13.23 14.03 14.46
Market value 29.11 37.86 27.15 29.36
2001
Results of operations data:
Interest income $25,754 $29,152 $30,231 $29,331
Interest expense 12,165 13,167 13,093 11,269
Net interest income 13,589 15,985 17,138 18,062
Provision for loan losses 811 1,026 1,563 1,558
Net interest income after provision for loan losses 12,778 14,959 15,575 16,504
Noninterest income 2,785 3,452 4,002 5,543
Noninterest expense 8,244 10,409 11,309 13,390
Income before income taxes 7,319 8,002 8,268 8,657
Income taxes 2,514 2,817 2,908 2,794
Net income 4,805 5,185 5,360 5,863
Per common share data:
Net income - basic $ 0.40 $ 0.44 $ 0.45 $ 0.50
Net income - diluted 0.40 0.43 0.45 0.49
Cash dividends declared 0.11 0.12 0.12 0.13
Book value 10.88 11.20 11.85 11.93
Market value 9.63 22.40 23.44 23.40
22
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
INTRODUCTION
The principal objective of this discussion is to provide an overview of the
financial condition and results of operations of Financial Institutions, Inc.
and its subsidiaries for the three years ended December 31, 2002. This
discussion and tabular presentations should be read in conjunction with the
accompanying consolidated financial statements and accompanying notes.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States and are consistent
with predominant practices in the financial services industry. Application of
critical accounting policies, those policies that Management believes are the
most important to the Company's financial position and results, requires
Management to make estimates, assumptions, and judgments that affect the amounts
reported in the consolidated financial statements and accompanying notes and are
based on information available as of the date of the financial statements.
Future changes in information may affect these estimates, assumptions, and
judgments, which, in turn, may affect amounts reported in the financial
statements.
The Company has numerous accounting policies, of which the most significant are
presented in Note 1 of the notes to consolidated financial statements. These
policies, along with the disclosures presented in the other financial statement
notes and in this discussion, provide information on how significant assets and
liabilities are reported in the financial statements and how those reported
amounts are determined. Based on the sensitivity of financial statement amounts
to the methods, assumptions, and estimates underlying those amounts, Management
has determined that the accounting policies with respect to the allowance for
loan losses and goodwill require subjective or complex judgments important to
the Company's financial position and results of operations, and, as such, are
considered to be critical accounting policies as discussed below.
Allowance for Loan Losses
Arriving at an appropriate level of allowance for loan losses involves a high
degree of judgment. The Company's allowance for loan losses provides for
probable losses based upon evaluations of known and inherent risks in the loan
portfolio. Management uses historical information to assess the adequacy of the
allowance for loan losses and considers the prevailing business environment; as
it is affected by changing economic conditions and various external factors,
which may impact the portfolio in ways currently unforeseen. The allowance is
increased by provisions for loan losses and by recoveries of loans previously
charged-off and reduced by loans charged-off. For additional discussion related
to the Company's accounting policies for the allowance for loan losses, see Note
1 of the notes to consolidated financial statements.
Goodwill
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that the purchase method of accounting be used
for all business combinations and further clarifies the criteria for the initial
recognition and measurement of intangible assets separate from goodwill. SFAS
No. 142 prescribes the accounting for goodwill and intangible assets subsequent
to initial recognition. The provisions of SFAS No. 142 discontinue the
amortization of goodwill and intangible assets with indefinite lives. Instead,
these assets are subject to at least an annual impairment review, and more
frequently if certain impairment indicators are in evidence. SFAS No. 142 also
requires that reporting units be identified for the purpose of assessing
impairment of goodwill. For additional discussion related to the Company's
accounting policy for goodwill and other intangible assets, see Note 1 of the
notes to the consolidated financial statements.
23
OVERVIEW
Net income in 2002 was $26.5 million, or 25% more than the $21.2 million earned
in 2001. In 2000, net income was $18.1 million. Diluted earnings per share for
the year ended December 31, 2002 was $2.23, compared to $1.77 in 2001 and $1.51
in 2000. The return on average common equity in 2002 was 17.01%, compared to
15.84% in 2001 and 15.78% in 2000. The return on average assets in 2002 was
1.35%, compared to 1.34% in 2001 and 1.51% in 2000. In accordance with a new
accounting standard, goodwill was no longer required to be amortized effective
January 1, 2002. In 2001, goodwill amortization, none of which was tax
deductible, totaled $1.7 million. There was no goodwill amortization in 2000.
Accordingly, excluding the effect of goodwill amortization, net income for 2001
would have been $22.9 million, or $1.92 per diluted common share. Based on these
pro forma results, there would have been a $3.6 million or 16% increase in net
income for 2002 compared to 2001.
Nonperforming assets at December 31, 2002 were $38.4 million compared to $11.0
million at December 31, 2001, an increase of $27.4 million. Nonaccrual loans
account for $22.9 million and restructured loans $4.1 million of the increase in
nonperforming assets. The increase in nonperforming assets for 2002 reflects
recent deterioration in the commercial and agricultural portfolios at NBG and to
a lesser extent BNB, which resulted in downgrades to a number of commercial and
agricultural loans at these banks. These downgrades occurred in the course of
loan portfolio reviews performed by the Company's senior credit executive, its
outside auditors and, with respect to loans at NBG and BNB, the Office of the
Comptroller of the Currency ("OCC"), as well as being reflective of current
economic conditions in the Company's market area. Beginning with the hiring of
the Senior Credit Executive in September 2002, the Company has begun
implementation of that aspect of its strategic plan which calls for improved
credit administration on a Company-wide basis, by increasing consistency among
subsidiary banks in reporting and grading loans, and strengthening the review
and oversight process of subsidiary bank lending and credit administration at
the Company level. To facilitate the implementation plan, the Company plans to
add additional credit administration staff and loan workout specialists in the
early part of 2003. See "Nonaccrual Loans and Nonperforming Assets" for
additional discussion.
Aside from the increase in nonperforming assets, the Company concluded another
solid year of strong earnings growth and continued execution of its corporate
strategic plan in 2002. The Company completed a geographic realignment of the
subsidiary banks, which involved the merger of PSB into NBG and transfer of
other branch offices between subsidiary banks. These changes were the forerunner
to the Company's organization wide re-branding initiative commenced in January
2003. In addition, FII expanded markets with BNB's purchase of Bank of Avoca and
two Chemung County offices of BSB Bank & Trust Company. These transactions are
discussed in further detail below.
On May 1, 2002, FII acquired all of the common stock of the Bank of Avoca
("BOA") in exchange for 47,036 shares of FII common stock. BOA was a community
bank with total assets of $18.4 million with its main office located in Avoca,
New York, as well as a branch office in Cohocton, New York. Subsequent to the
acquisition, BOA was merged with BNB. The acquisition was accounted for under
the purchase method of accounting. The results of operations for BOA are
included in the income statement from the date of acquisition.
On December 13, 2002, BNB acquired the two Chemung County branch offices of BSB
Bank & Trust Company of Binghamton, New York. The two offices purchased, located
in Elmira and Elmira Heights, had deposit liabilities totaling $44.2 million at
the time of acquisition. The acquisition was accounted for as a business
combination using the purchase method of accounting, and accordingly, the excess
of the purchase price over the fair value of identifiable tangible and
intangible assets acquired, less liabilities assumed, of approximately $1.5
million has been recorded as goodwill. In accordance with SFAS No. 142, the
Company is not required to amortize goodwill recognized in this acquisition. The
Company also recorded a $2.0 million intangible asset attributable to core
deposits, which is being amortized using the straight-line method over seven
years.
24
LENDING ACTIVITIES
Set forth below is selected information concerning the composition of the
Company's loan portfolio.
At December 31
---------------------------------------------------------------------
(Dollars in thousands) 2002 2001 2000 1999 1998
---------------------------------------------------------------------
Commercial $ 262,630 $ 232,379 $ 169,832 $ 140,376 $ 117,750
Commercial real estate 332,134 274,702 166,041 137,648 106,897
Agricultural 233,769 186,623 165,367 151,534 123,754
Residential real estate 251,898 240,141 201,160 189,149 181,828
Consumer and home equity 241,461 232,205 184,745 145,038 125,198
----------- ----------- --------- --------- ---------
Total loans, gross 1,321,892 1,166,050 887,145 763,745 655,427
Allowance for loan losses (21,660) (19,074) (13,883) (11,421) (9,570)
----------- ----------- --------- --------- ---------
Total loans, net $ 1,300,232 $ 1,146,976 $ 873,262 $ 752,324 $ 645,857
=========== =========== ========= ========= =========
Gross loans increased to $1.322 billion at December 31, 2002 from $1.166 billion
at December 31, 2001, an increase of $155.8 million or 13.4%, principally from
continued expansion of the commercial, commercial real estate and agricultural
loan portfolios. Commercial loans increased $30.2 million or 13.0%, while
commercial real estate loans increased by $57.4 million or 20.9%. At December
31, 2002, commercial loans totaled $262.6 million, representing 19.9% of total
loans, and commercial real estate loans totaled $332.1 million, representing
25.1% of total loans. At December 31, 2002, agricultural loans, which include
agricultural real estate loans, represented 17.7% of the total loan portfolio.
During 2002, agricultural loans increased by $47.1 million or 25.3%, to $233.8
million. The increases in commercial, commercial real estate and agricultural
loans reflects the Company's expanded business development efforts.
As of December 31, 2002, residential real estate loans grew by $11.8 million or
4.9% from December 31, 2001, and totaled $251.9 million or 19.1% of total loans.
The relatively small percentage increase in residential real estate loans in
comparison to commercial loan types corresponds with the Company's trend towards
selling newly originated residential real estate mortgages, which is evidenced
by the increase in the sold and serviced loan portfolio to $301.4 million at
December 31, 2002 from $246.0 million at December 31, 2001. During 2002 and
2001, the Company sold residential real estate loans totaling $139.4 million and
$117.4 million, respectively.
The Company also offers a broad range of consumer loan products. Consumer and
home equity loans grew by $9.3 million or 4.0%, in 2002 and ended the year at
$241.5 million, representing 18.2% of the total loan portfolio. The relatively
small percentage increase in consumer products is a reflection of slower growth
in the Company's indirect lending program.
Gross loans increased to $1.166 billion at December 31, 2001 from $887.1 million
at December 31, 2000, an increase of $279.0 million or 31.4%. The acquisition of
BNB accounted for $189.5 million of the loan growth with the balance of $89.5
million generated principally from continued expansion of the commercial loan
portfolio. Commercial loans increased $62.6 million ($40.5 million from the BNB
acquisition) or 36.8%, while commercial real estate loans increased by $108.7
million ($56.9 million from the BNB acquisition) or 65.4%. At December 31, 2001,
commercial loans totaled $232.4 million, representing 19.9% of total loans, and
commercial real estate loans totaled $274.7 million, representing 23.6% of total
loans. At December 31, 2001, agricultural loans, which include agricultural real
estate loans, represented 16.0% of the total loan portfolio. During 2001,
agricultural loans increased by $21.2 million ($7.2 million from the BNB
acquisition), or 12.9%, to $186.6 million.
As of December 31, 2001, residential real estate loans grew by $39.0 million
($50.5 million from the BNB acquisition) or 19.4% from December 31, 2000, and
totaled $240.1 million or 20.6% of total loans. Considering BNB residential real
estate loans acquired amounted to $50.5 million, the residential real estate
portfolio decreased $11.5 million in 2001, a result of the Company selling newly
originated
25
residential real estate mortgages while retaining the servicing rights. Consumer
and home equity loans grew by $47.5 million ($34.4 million from the BNB
acquisition) or 25.7%, in 2001 and ended the year at $232.2 million,
representing 19.9% of the total loan portfolio.
Nonaccrual Loans and Nonperforming Assets
The significant increase in nonperforming assets is primarily the result of
recent deterioration in the commercial and agricultural loan portfolios at NBG
and BNB. The decline in asset quality was first identified by the Company's
annual loan review procedures. Subsequently, the Company's outside auditors and
the Senior Credit Executive and his staff identified additional credit and
credit administration issues, primarily at NBG and to a lesser extent BNB.
Concurrently NBG's and BNB's regulator, the OCC, was completing its regularly
scheduled safety and soundness examinations. During their examinations the OCC
identified additional credits for nonperforming status. The results of each of
these reviews is reflected in the nonperforming assets reported as of December
31, 2002. Among the loans at NBG that were re-classified from performing to
nonperforming were a group of loans made to a company controlled by a director
of NBG (who was not re-appointed in January 2003) which aggregated $4.2 million,
and a single loan to a company controlled by another director of NBG (who became
a non-voting director emeritus in January 2003) with a balance of $0.7 million.
The Company's internal loan review process has indicated that there may be
potential Regulation O issues with respect to these and certain other loans made
by NBG to its directors arising out of the approval process for additional
extensions of credit.
Total nonperforming loans increased by $27.1 million for the full year 2002,
including $22.7 million in the fourth quarter of 2002, to $37.1 million at year
end. In the fourth quarter of 2002 nonperforming loans increased by $15.4
million at NBG and $4.8 million at BNB. The OCC has indicated that it expects to
deliver final Reports of Examination for NBG and BNB, late in the first or early
in the second quarter of 2003. The total fourth quarter 2002 increase was
comprised of $18.6 million in nonaccrual loans and loans 90 days or more
delinquent and still accruing and $4.1 million in loans that are considered
troubled debt restructurings. Commercial loans account for $13.5 million and
agricultural loans $9.2 million of the total increase. The Company has performed
a comprehensive analysis of each impaired loan over $250,000, including the
borrower's paying capacity, assessed the collateral supporting the loans
outstanding and made appropriate allocations of loss allowances.
Included in the $18.6 million fourth quarter increase in nonaccrual and 90 day
delinquent loans were $14.2 million of loans on which payment is current as of
December 31, 2002. Despite the fact that these loans are current, either the
loan structure, the borrower's financial outlook, the borrower's debt service
capabilities or other items made it prudent to classify these loans
nonperforming at December 31, 2002. Also included in the fourth quarter increase
were $4.1 million in restructured loans, all of which were current with respect
to the modified terms.
The majority of the nonperforming loans are secured by various forms of
collateral including receivables, inventory, livestock, equipment, real
property, and other assets. For each of the nonperforming loans added in the
fourth quarter, the Company has performed a comprehensive assessment of
collateral values and borrower paying capacity. The results of this assessment
showed that provision for loan losses of $2.5 million was required and recorded
in the fourth quarter.
26
The following table sets forth information regarding nonaccrual loans and other
nonperforming assets.
At December 31
----------------------------------------------------
(Dollars in thousands) 2002 2001 2000 1999 1998
----------------------------------------------------
Nonaccrual loans (1)
Commercial $12,760 $ 2,623 $1,044 $1,159 $1,250
Commercial real estate 8,407 3,344 1,619 1,373 995
Agricultural 8,739 1,529 2,881 1,455 2,340
Residential real estate 1,065 921 835 413 733
Consumer and home equity 915 541 217 375 423
------- ------- ------ ------ ------
Total nonaccrual loans 31,886 8,958 6,596 4,775 5,741
Restructured loans 4,129 -- -- -- --
Accruing loans 90 days or more delinquent 1,091 1,064 521 969 360
------- ------- ------ ------ ------
Total nonperforming loans 37,106 10,022 7,117 5,744 6,101
Other real estate owned 1,251 947 932 969 2,084
------- ------- ------ ------ ------
Total nonperforming assets $38,357 $10,969 $8,049 $6,713 $8,185
======= ======= ====== ====== ======
Total nonperforming loans to total loans 2.81% 0.86% 0.80% 0.75% 0.93%
Total nonperforming assets to total loans
and other real estate 2.90% 0.94% 0.91% 0.88% 1.24%
(1) Although, loans are generally placed on nonaccrual status when they become
90 days or more past due they may be placed on nonaccrual status earlier
if they have been identified by the Company as presenting uncertainty with
respect to the collectibility of interest or principal.
Analysis of the Allowance for Loan Losses
The allowance for loan losses represents the estimated amount of probable credit
losses inherent in the Banks' loan portfolios. The Company performs periodic,
systematic reviews of its Banks' portfolios to identify these probable losses,
and to assess the overall collectibility of these portfolios. While in the past
the Company has relied on an outside loan review firm to perform loan reviews at
each of the subsidiary banks, the hiring of a Senior Credit Executive in
September 2002 and the anticipated hiring of additional staff in 2003 will
enable the Company to perform these reviews using its own personnel. In
addition, the Senior Credit Executive will review and oversee loan
administration on a Company-wide basis to improve quality control and
consistency in the application of Company credit policies among the four
subsidiary banks. These reviews result in the identification and quantification
of loss factors, which are used in determining the amount of the allowance for
loan losses. In addition, the Company periodically evaluates prevailing economic
and business conditions, industry concentrations, changes in the size and
characteristics of the portfolio and other pertinent factors. The allowance for
loan losses is allocated to cover the estimated losses in each loan category
based on the results of this detailed review. The process used by the Company to
determine the overall allowance for loan losses is based on this analysis,
taking into consideration management's judgment. Allowance methodology is
reviewed on a periodic basis and modified as appropriate. Based on this
analysis, the Company believes that the allowance for loan losses is fairly
stated at December 31, 2002.
At December 31, 2002, the Company's allowance for loan losses totaled $21.7
million, an increase of $2.6 million over the previous year end. The allowance
as a percentage of total loans was 1.64% at December 31, 2002 and 2001. The
ratio of allowance for loan losses to nonperforming loans was 58% at December
31, 2002 versus 190% at December 31, 2001. The decline in this coverage ratio is
a result of the previously discussed increase in nonperforming loans. The
Company is actively monitoring these problem credits. Despite the decline in the
ratio of allowance for loan losses to nonperforming loans, the allowance for
loan losses at December 31, 2002 represents the estimated probable losses in the
loan portfolio based on the Company's comprehensive assessment of collateral
values and borrower paying
27
capacity on impaired loans in excess of $250,000 together with the Company's
assessment of current economic conditions in the Company's market area.
The following table sets forth an analysis of the activity in the allowance for
loan losses for the periods indicated.
Years Ended December 31
------------------------------------------------------
(Dollars in thousands) 2002 2001 2000 1999 1998
------------------------------------------------------
Balance at beginning of year $19,074 $13,883 $11,421 $ 9,570 $8,145
Addition resulting from acquisitions 174 2,686 -- -- --
Charge-offs:
Commercial 1,771 1,003 466 312 263
Commercial real estate 944 394 629 139 687
Agricultural 106 58 85 12 19
Residential real estate 98 178 113 461 215
Consumer and home equity 1,499 1,319 905 663 488
------- ------- ------- ------- ------
Total charge-offs 4,418 2,952 2,198 1,587 1,672
Recoveries:
Commercial 210 58 206 88 106
Commercial real estate 69 23 22 23 84
Agricultural 36 -- 1 -- --
Residential real estate 67 19 5 163 42
Consumer and home equity 329 399 215 102 133
------- ------- ------- ------- ------
Total recoveries 711 499 449 376 365
Net charge-offs 3,707 2,453 1,749 1,211 1,307
Provision for loan losses 6,119 4,958 4,211 3,062 2,732
------- ------- ------- ------- ------
Balance at end of year $21,660 $19,074 $13,883 $11,421 $9,570
======= ======= ======= ======= ======
Ratio of net charge-offs during the year to
average loans outstanding during the year 0.30% 0.23% 0.21% 0.17% 0.21%
Ratio of allowance for loan losses to total loans 1.64% 1.64% 1.56% 1.50% 1.46%
Ratio of allowance for loan losses to
nonperforming loans 58% 190% 195% 199% 157%
The following table summarizes the loan delinquencies (excluding past due
nonaccrual loans) in the loan portfolio as of December 31, 2002:
60-89 90 Days
(Dollars in thousands) Days or More
------ -------
Commercial $ 585 $ 363
Commercial real estate 204 155
Agricultural -- 37
Residential real estate 263 80
Consumer and home equity 547 456
------ ------
Total $1,599 $1,091
====== ======
28
Allocation of Allowance for Loan Losses
The following table sets forth the allocation of the allowance for loan losses
by loan category at the dates indicated. The allocation is made for analytical
purposes and is not necessarily indicative of the categories in which actual
losses may occur. The total allowance is available to absorb losses from any
segment of the loan portfolio.
At December 31
------------------------------------------------------------------
2002 2001 2000
------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent
of of Loans of of Loans of of Loans
Allowance in Each Allowance in Each Allowance in Each
for Category for Category for Category
Loan to Total Loan to Total Loan to Total
(Dollars in thousands) Losses Loans Losses Loans Losses Loans
------------------------------------------------------------------
Commercial $ 5,321 19.9% $ 4,376 19.9% $ 2,924 19.1%
Commercial real estate 4,725 25.1 3,611 23.6 1,902 18.7
Agricultural 3,711 17.7 2,341 16.0 2,270 18.7
Residential real estate 1,414 19.1 1,700 20.6 1,186 22.7
Consumer and home equity 2,007 18.2 2,578 19.9 1,818 20.8
Unallocated 4,482 -- 4,468 -- 3,783 --
------- ----- ------- ----- ------- -----
Total $21,660 100% $19,074 100% $13,883 100%
======= ===== ======= ===== ======= =====
At December 31
-------------------------------------------
1999 1998
-------------------------------------------
Amount Percent Amount Percent
of of Loans of of Loans
Allowance in Each Allowance in Each
for Category for Category
Loan to Total Loan to Total
(Dollars in thousands) Losses Loans Losses Loans
-------------------------------------------
Commercial $ 1,909 18.4% $2,461 17.9%
Commercial real estate 2,071 18.0 1,629 16.3
Agricultural 1,443 19.8 1,106 18.9
Residential real estate 914 24.8 1,370 27.8
Consumer and home equity 1,270 19.0 1,303 19.1
Unallocated 3,814 -- 1,701 --
------- ----- ------ -----
Total $11,421 100% $9,570 100%
======= ===== ====== =====
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 portfolio. Demand
loans having no stated schedule of repayment and no stated maturity and
overdrafts are reported as due in one year or less. Adjustable and floating-rate
loans are included in the period in which interest rates are next scheduled to
adjust rather than the period in which they contractually mature, and fixed-rate
loans are included in the period in which the final contractual repayment is
due.
At December 31, 2002
----------------------------------------------------------
One
Within Through After
One Five Five
(Dollars in thousands) Year Years Years Total
-------- -------- -------- ----------
Commercial $123,491 $ 97,690 $ 41,449 $ 262,630
Commercial real estate 12,207 42,581 277,346 332,134
Agricultural 56,908 63,212 113,649 233,769
Residential real estate 6,204 23,646 222,048 251,898
Consumer and home equity 13,031 126,914 101,516 241,461
-------- -------- -------- ----------
Total loans $211,841 $354,043 $756,008 $1,321,892
======== ======== ======== ==========
Loans maturing after one year:
With a predetermined interest rate $207,683 $227,582
With a floating or adjustable rate 146,360 528,426
29
INVESTING ACTIVITIES
U.S. Treasury and Agency Securities. At December 31, 2002, the U.S. Treasury and
Agency securities portfolio totaled $120.6 million, all of which was classified
as available for sale. The portfolio consisted of $1.0 million in U. S. Treasury
securities and $119.6 million in U. S. federal agency securities. The U.S.
federal agency security portfolio consists of predominately callable securities.
These callable securities provide higher yields than similar securities without
call features. At December 31, 2001, the U.S. Treasury and Agency securities
portfolio totaled $185.4 million, of which $183.5 million was classified as
available for sale. The portfolio consisted of $10.8 million in U. S. Treasury
securities and $174.6 million in U. S. federal agency securities. The $64.8
million decline in the Company's investment in U.S. Treasury and Agency
securities during 2002 resulted from funds being invested in other security
classes, such as state and municipal obligations and mortgage backed securities
which are discussed in further detail below.
State and Municipal Obligations. At December 31, 2002, the portfolio of state
and municipal obligations totaled $222.0 million, of which $174.9 million was
classified as available for sale. At that date, $47.1 million was classified as
held to maturity, with a fair value of $48.1 million. . At December 31, 2001,
the portfolio of state and municipal obligations totaled $202.6 million, of
which $143.2 million was classified as available for sale. At that date, $59.4
million was classified as held to maturity, with a fair value of $60.3 million.
Over the past few years, more favorable yields on new purchases of these
securities, when compared to taxable investment alternatives, has led to growth
in this portfolio. In addition, the Company has expanded its overall municipal
banking relationship business which includes both deposit activities and
investing in obligations issued by those municipalities.
Mortgage-Backed Securities. Mortgage-backed securities, all of which were
classified as available for sale, totaled $283.5 million and $90.0 million at
December 31, 2002 and 2001, respectively. The portfolio was comprised of $193.4
million of mortgage-backed pass-through securities and $90.1 million of
collateralized mortgage obligations (CMOs) at December 31, 2002. Over 99% of the
mortgage backed pass-through securities were agency issued debt (FNMA, FHLMC, or
GNMA). Over 75% of the agency mortgage-backed pass-through securities were in
fixed rate securities that were predominately formed with mortgages having a
balloon payment of five or seven years. The adjustable rate agency
mortgage-backed securities portfolio is principally indexed to the one-year
Treasury bill. The CMO portfolio consists of $52.2 million of government agency
issues, $26.4 million of privately issued AAA rated securities, and includes
$11.5 million of Student Loan Marketing Association (SLMA) floaters, which are
securities backed by student loans. At December 31, 2001 the portfolio consisted
of $80.0 million of mortgage-backed pass-through securities and $10.0 million of
CMOs. All of the mortgage-backed securities at December 31, 2001 were agency
issued (FNMA, FHLMC, GNMA) obligations. The significant increase in
mortgage-backed securities is a result of a strategy to further diversify the
Company's investment portfolio, enhance yields, and increase cash flows from the
portfolio.
Corporate Bonds. The corporate bond portfolio, all of which was classified as
available for sale, totaled $13.9 million and $7.9 million at December 31, 2002
and 2001, respectively. The portfolio was purchased to further diversify the
investment portfolio and increase investment yield. The Company's investment
policy limits investments in corporate bonds to no more than 10% of total
investments and to bonds rated as Baa or better by Moody's Investors Service,
Inc. or BBB or better by Standard & Poor's Ratings Services at the time of
purchase.
Equity Securities. At December 31, 2002 and 2001, available for sale equity
securities totaled $3.9 million and $3.8 million, respectively. Included in the
portfolio in each year is $3.0 million of FHLMC preferred stock.
30
Security Yields and Maturities Schedule
The following table sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of the Company's debt
securities portfolio as of December 31, 2002. No tax equivalent adjustments were
made to the weighted average yields.
December 31, 2002
----------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years
----------------------------------------------------------------------
Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average
(Dollars in thousands) Cost Yield Cost Yield Cost Yield
----------------------------------------------------------------------
Available for Sale:
US Treasury and Agency $ 1,983 6.62% $ 60,763 5.52% $ 45,760 3.78%
Mortgage-backed securities 1,455 5.96 45,823 4.86 93,235 4.87
State and municipal
obligations 10,973 4.66 108,374 4.05 43,568 4.27
Corporate bonds 2,741 6.46 6,972 5.46 -- --
----------------------------------------------------------------------
Total debt securities
available for sale $17,152 5.28% $221,932 4.67% $182,563 4.46%
======================================================================
Held to Maturity:
State and municipal
obligations $25,649 3.08% $ 18,236 4.48% $ 2,756 4.90%
----------------------------------------------------------------------
Total debt securities
held to maturity $25,649 3.08% $ 18,236 4.48% $ 2,756 4.90%
======================================================================
December 31, 2002
-----------------------------------------------
After Ten Years Total
-----------------------------------------------
Weighted Weighted
Amortized Average Amortized Average
(Dollars in thousands) Cost Yield Cost Yield
-----------------------------------------------
Available for Sale:
US Treasury and Agency $ 9,075 5.66% $117,581 4.88%
Mortgage-backed securities 137,234 3.66 277,747 4.28
State and municipal
obligations 4,066 4.90 166,981 4.17
Corporate bonds 4,062 8.33 13,775 6.51
-----------------------------------------------
Total debt securities
available for sale $154,437 3.93% $576,084 4.42%
===============================================
Held to Maturity:
State and municipal
obligations $ 484 5.78% $ 47,125 3.75%
-----------------------------------------------
Total debt securities
held to maturity $ 484 5.78% $ 47,125 3.75%
===============================================
FUNDING ACTIVITIES
Borrowings
Outstanding borrowings at December 31, 2002 and 2001 are summarized as follows:
(Dollars in thousands) 2002 2001
------- --------
Short-term borrowings:
Federal funds purchased and securities
sold under repurchase agreements $60,679 $ 60,957
FHLB advances 26,000 42,135
Other 510 678
------- --------
Total short-term borrowings $87,189 $103,770
======= ========
Long-term borrowings:
FHLB advances $86,822 $ 65,097
Other 5,268 5,322
------- --------
Total long-term borrowings $92,090 $ 70,419
======= ========
Information related to Federal funds purchased and securities sold under
repurchase agreements as of and for the years ended December 31, 2002, 2001 and
2000 is summarized as follows:
(Dollars in thousands) 2002 2001 2000
------- ------- -------
Weighted average interest rate at year-end 1.50% 1.88% 4.26%
Maximum outstanding at any month-end $61,951 $65,474 $26,135
Average amount outstanding during the year $47,924 $33,157 $ 7,939
The average amounts outstanding are computed using daily average balances.
Related interest expense for 2002, 2001 and 2000 was $951,000, $1,108,000 and
$400,000, respectively.
At December 31, 2002, the Company had outstanding various short and long-term
FHLB advances with maturity dates extending through 2009. The FHLB advances bear
interest at fixed rates ranging from
31
1.40% to 6.71% and the weighted average interest rate amounted to 4.29% as of
December 31, 2002. The Company's FHLB advances include $20.0 million in
fixed-rate callable borrowings, which can be called by the FHLB on a quarterly
basis. FHLB advances are collateralized by $6.3 million of FHLB stock and
mortgage loans with a carrying value of $138.1 million at December 31, 2002. At
December 31, 2002, the Company had remaining credit available of $13.0 million
under lines of credit with the FHLB. The Company also had $56.2 million of
remaining credit available under unsecured lines of credit with various banks at
December 31, 2002. During 2001, the Company also obtained lines of credit with
Farmer Mac permitting borrowings to a maximum of $50.0 million. However, no
advances were outstanding against the Farmer Mac lines at December 31, 2002.
Other long-term borrowings consist primarily of a $5.0 million advance on a
credit agreement with another commercial bank, which was executed to aid in
funding the acquisition of BNB during 2001. The credit agreement requires
monthly payments of interest only, at a variable interest rate of LIBOR plus
1.50%, with 3.30% being the rate in effect at December 31, 2002. The credit
agreement expires in April 2004.
Guaranteed Preferred Beneficial Interests in Corporations Junior Subordinated
Debentures
On February 22, 2001, the Company established FISI Statutory Trust I (the
"Trust"), which is a statutory business trust formed under Connecticut law. The
Trust exists for the exclusive purposes of (i) issuing and selling 30 year
guaranteed preferred beneficial interests in the Corporation's junior
subordinated debentures ("capital securities") in the aggregate amount of $16.2
million at a fixed rate of 10.20%, (ii) using the proceeds from the sale of the
capital securities to acquire the junior subordinated debentures issued by the
Company and (iii) engaging in only those other activities necessary, advisable
or incidental thereto. The junior subordinated debentures are the sole assets of
the Trust and, accordingly, payments under the corporation obligated junior
debentures are the sole revenue of the Trust. All of the common securities of
the Trust are owned by the Company. The Company used the net proceeds from the
sale of the capital securities to partially fund the BNB acquisition. As of
December 31, 2002 and 2001, respectively, $16.2 million and $12.4 million of the
capital securities qualified as Tier I capital under regulatory definitions. The
Company's primary source of funds to pay interest on the debentures owed to the
Trust are current dividends from its subsidiary banks. Accordingly, the
Company's ability to service the debentures is dependent upon the continued
ability of the subsidiary banks to pay dividends to the Company. Since the
capital securities are classified as debt for financial statement purposes, the
tax-deductible expense associated with the capital securities is recorded as
interest expense in the consolidated statements of income. The Company incurred
$487,000 in costs to issue the securities and the costs are being amortized over
20 years using the straight-line method.
Deposits
The Banks offer a broad array of core deposit products including checking
accounts, interest-bearing transaction accounts, savings and money market
accounts and certificates of deposit under $100,000. These core deposits totaled
$1.507 billion or 88.2% of total deposits of $1.709 billion at December 31,
2002. The core deposit base consists almost exclusively of in-market accounts.
Core deposits are supplemented with certificates of deposit over $100,000, which
amounted to $201.8 million as of December 31, 2002, largely from in-market
municipal, business and individual customers. As of December 31, 2002, brokered
certificates of deposit included in certificates of deposit over $100,000
totaled $71.6 million.
Total deposits at December 31, 2001 amounted to $1.434 billion, an increase of
$355.6 million or 33.0% from $1.078 billion at December 31, 2000. Core deposit
products were $1.199 billion or 83.6% of total deposits at December 31, 2001.
Certificates of deposit over $100,000 totaled $234.5 million at December 31,
2001, which included $44.9 million in brokered certificates of deposit.
32
The daily average balances, percentage composition and weighted average rates
paid on deposits for each of the years ended December 31, 2002, 2001 and 2000
are presented below:
For the year ended December 31
----------------------------------------------------------------------------------------------
2002 2001 2000
----------------------------------------------------------------------------------------------
Percent Percent Percent
Of Total Weighted Of Total Weighted Of Total Weighted
Average Average Average Average Average Average Average Average Average
(Dollars in thousands) Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
----------------------------------------------------------------------------------------------
Interest-bearing checking $ 354,687 22.2% 1.43% $ 172,022 13.2% 1.23% $113,344 11.4% 1.36%
Savings and money market 366,708 23.0 1.57 253,128 19.4 2.07 193,027 19.3 2.66
Certificates of deposit
under $100,000 438,587 27.5 3.80 376,256 28.9 5.36 294,926 29.5 5.63
Certificates of deposit
over $100,000 217,150 13.6 3.53 319,974 24.6 4.97 260,757 26.1 6.32
Non-interest bearing accounts 219,028 13.7 -- 181,831 13.9 -- 136,614 13.7 --
----------------------------------------------------------------------------------------------
Total average deposits $1,596,160 100.0% 2.20% $1,303,211 100.0% 3.33% $998,668 100.0% 3.98%
==============================================================================================
The following table indicates the amount of the Company's certificates of
deposit by time remaining until maturity as of December 31, 2002:
At December 31, 2002
----------------------------------------------------------------
3 Months Over 3 To Over 6 To Over 12
(Dollars in thousands) Or Less 6 Months 12 Months Months Total
----------------------------------------------------------------
Certificates of deposit
less than $100,000 $141,266 $ 85,340 $165,620 $ 94,019 $486,245
Certificates of deposit
of $100,000 or more 39,820 23,405 53,452 85,074 201,751
-------- -------- -------- -------- --------
Total certificates of deposit $181,086 $108,745 $219,072 $179,093 $687,996
======== ======== ======== ======== ========
33
NET INCOME ANALYSIS
Average Balance Sheet
The following table sets forth certain information relating to the Company's
consolidated statements of financial condition and reflects the average yields
earned on interest-earning assets, as well as the average rates paid on
interest-bearing liabilities for the years indicated. Such yields and rates were
derived by dividing interest income or expense by the average balances of
interest-earning assets or interest-bearing liabilities, respectively, for the
years shown. Tax equivalent adjustments have been made. All average balances are
average daily balances. Nonaccrual loans are included in the yield calculations
in this table.
Year ended December 31
-----------------------------------------------------------------------------------
2002 2001
-------------------------------------- ---------------------------------------
Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
(Dollars in thousands) Balance Paid Rate Balance Paid Rate
-------------------------------------- ---------------------------------------
Interest-earning assets:
Federal funds sold and
interest bearing deposits $ 28,889 $ 494 1.71% $ 8,634 $ 358 4.15%
Investment securities (1):
Taxable 364,356 19,109 5.24 251,794 15,288 6.07
Non-taxable 211,358 13,109 6.20 170,151 11,279 6.63
----------- ------- ------- ----------- -------- -------
Total investment securities 575,714 32,218 5.59 421,945 26,567 6.30
Loans (2):
Commercial and agricultural 766,818 52,177 6.80 611,866 51,244 8.38
Residential real estate 234,813 19,362 8.25 227,784 20,193 8.86
Consumer and home equity 233,173 18,776 8.05 217,070 20,045 9.23
----------- ------- ------- ----------- -------- -------
Total loans 1,234,804 90,315 7.31 1,056,720 91,482 8.66
Total interest-earning assets 1,839,407 123,027 6.69 1,487,299 118,407 7.96
Allowance for loan losses (20,030) (16,825)
Other non-interest earning assets 145,639 117,698
----------- -----------
Total assets $ 1,965,016 $ 1,588,172
=========== ===========
Interest-bearing liabilities:
Savings and money market $ 366,708 $ 5,768 1.57% $ 253,128 $ 5,244 2.07%
Interest-bearing checking 354,687 5,059 1.43 172,022 2,110 1.23
Certificates of deposit 655,737 24,340 3.71 696,230 36,060 5.18
Borrowed funds 167,883 5,741 3.42 107,530 4,840 4.50
Guaranteed preferred beneficial
interests in corporations junior
subordinated debentures 16,200 1,677 10.35 13,892 1,440 10.37
----------- ------- ------- ----------- -------- -------
Total interest-bearing liabilities 1,561,215 42,585 2.73 1,242,802 49,694 4.00
----------- ------- ------- ----------- -------- -------
Non-interest bearing demand deposits 219,028 181,831
Other non-interest-bearing liabilities 20,306 21,318
----------- -----------
Total liabilities 1,800,549 1,445,951
Stockholders' equity (3) 164,467 142,221
----------- -----------
Total liabilities and
stockholders' equity $ 1,965,016 $ 1,588,172
=========== ===========
Net interest income $80,442 $ 68,713
======= ========
Net interest rate spread 3.96% 3.96%
====== ======
Net earning assets $ 278,192 $ 244,497
=========== ===========
Net interest income as a percentage
of average interest-earning assets 4.37% 4.62%
====== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities 117.82% 119.67%
====== ======
Year ended December 31
--------------------------------------
2000
--------------------------------------
Average Interest
Outstanding Earned/ Yield/
(Dollars in thousands) Balance Paid Rate
--------------------------------------
Interest-earning assets:
Federal funds sold and
interest bearing deposits $ 3,039 $ 184 6.05%
Investment securities (1):
Taxable 202,160 12,955 6.41
Non-taxable 106,483 7,369 6.92
----------- ------- -------
Total investment securities 308,643 20,324 6.58
Loans (2):
Commercial and agricultural 464,995 45,142 9.71
Residential real estate 194,014 17,276 8.90
Consumer and home equity 166,944 16,120 9.66
----------- ------- -------
Total loans 825,953 78,538 9.51
Total interest-earning assets 1,137,635 99,046 8.70
Allowance for loan losses (12,509)
Other non-interest earning assets 72,390
-----------
Total assets $ 1,197,516
===========
Interest-bearing liabilities:
Savings and money market $ 193,027 $ 5,135 2.66%
Interest-bearing checking 113,344 1,537 1.36
Certificates of deposit 555,683 33,086 5.95
Borrowed funds 60,978 3,847 6.31
Guaranteed preferred beneficial
interests in corporations junior
subordinated debentures -- -- --
----------- ------- -------
Total interest-bearing liabilities 923,032 43,605 4.72
----------- ------- -------
Non-interest bearing demand deposits 136,614
Other non-interest-bearing liabilities 14,906
-----------
Total liabilities 1,074,552
Stockholders' equity (3) 122,964
-----------
Total liabilities and
stockholders' equity $ 1,197,516
===========
Net interest income $55,441
=======
Net interest rate spread 3.98%
======
Net earning assets $ 214,603
===========
Net interest income as a percentage
of average interest-earning assets 4.87%
======
Ratio of average interest-earning assets
to average interest-bearing liabilities 123.25%
======
(1) Amounts shown are amortized cost for held to maturity securities and fair
value for available for sale securities. In order to make pre-tax income
and resultant yields on tax-exempt securities comparable to those on
taxable securities and loans, a tax-equivalent adjustment to interest
earned from tax-exempt securities has been computed using a federal tax
rate of 35%.
(2) Net of deferred loan fees and costs, and loan discounts and premiums.
(3) Includes unrealized gains/(losses) on securities available for sale.
34
Net Interest Income
Net interest income, the principal source of the Company's earnings, was $75.9
million in 2002, an $11.1 million or 17% increase over 2001. Average earning
assets increased $352 million or 24% to $1.839 billion for the year ended
December 31, 2002. Average loans increased $178 million or 17% to $1.235 billion
for 2002 and accounted for 51% of the growth in average earning assets.
Investment securities represented 44% of the growth in average earning assets
and increased $154 million or 36% to $576 million for 2002. The Company's yield
on average earning assets was 6.69% for 2002 down 127 basis points from 2001.
The Company's loan portfolio yield was 7.31% and tax-equivalent investment yield
was 5.59% for 2002 down 135 basis points and 71 basis points, respectively, from
2001. The principal reason for the decline in loan and investment yields was the
reinvestment of investment portfolio cash flows and the acquisition of new loan
assets at lower yields, reflective of the fall in overall market interest rates.
Lower loan yields were influenced by tighter margins on loan products reflecting
competitive pricing pressures as well as the impact of declining rates on
variable rate loan products.
Total average interest-bearing liabilities were $1.561 billion for the year
ended December 31, 2002 representing a $318 million increase over 2001 and
represented 90% of the average increased funding required to support the growth
in average earning assets. In 2002 there were significant changes to the mix of
interest bearing liabilities with increases over 2001 in average savings and
money market balances of $114 million, average interest bearing checking
balances of $183 million, while certificates of deposit declined $40 million.
The shift from certificates of deposit to savings, money market, and interest
bearing checking deposits is related to the overall lower level of market
interest rates, the Company's deposit pricing strategies, and customer
preference in deposit product selection. As market interest rates have fallen
the Company has lowered the offering rates on certificates of deposits to a
greater degree then on savings, money market, and interest bearing checking
accounts. The compression in the spread between the offering rates on these
products as well as customer preference for deposit products with greater
liquidity has contributed to the shift in deposit mix. The Company's cost of
interest bearing liabilities at 2.73% for 2002 dropped 127 basis points from
2001 with the drop limited by the Company's pricing strategy on savings, money
market, and interest-bearing checking products. Interest bearing liabilities
represented 84.9% of the funding sources for earning assets in 2002 compared to
83.6% in 2001 with the balance of earning assets being funded by net noninterest
bearing funding sources. Net noninterest bearing funding sources represent the
amount of zero interest cost funds such as demand deposits and equity that are
available to fund earning assets after funding non-interest earning assets.
Coupling these zero interest cost net non interest bearing fund sources, which
had no change in cost year over year, with interest bearing liabilities results
in a total cost of funds for the Company in 2002 of 2.32% down 102 basis points
from the 2001 total cost of funds of 3.34%.
The result of a 127 basis point decline in earning asset yield while the cost of
funds fell 102 basis points was a drop of 25 basis points in the net interest
margin to 4.37% in 2002 from 4.62% in 2001. The growth in earning assets for
2002 mitigated the drop in net interest margin resulting in the increase of
$11.1 million in 2002 in net interest income.
Net interest income was $64.8 million in 2001 compared with $52.9 million in
2000, an increase of $11.9 million or 22%. Average earning assets grew by $349.7
million to $1.487 billion in 2001, or 31% over 2000, which offset the effects of
a 25 basis point decline in the net interest margin from 4.87% in 2000 to 4.62%
in 2001. The increase in average earning assets in 2002 compared to 2001 and
also 2001 compared to 2000, as well as the increases in net interest income in
those periods were impacted by the acquisition of BNC on May, 1, 2001 which was
accounted for under the purchase method of accounting.
35
Rate/Volume Analysis
The following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to: (i) changes attributable to changes in volume (changes in volume
multiplied by current year rate); (ii) changes attributable to changes in rate
(changes in rate multiplied by prior volume); and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
Year ended December 31
---------------------------------------------------------------------------------
2002 vs. 2001 2001 vs. 2000
---------------------------------------------------------------------------------
Increase/(Decrease) Total Increase/(Decrease) Total
Due To Increase/ Due To Increase/
(Dollars in thousands) Volume Rate (Decrease) Volume Rate (Decrease)
---------------------------------------------------------------------------------
Interest-earning assets:
Federal funds sold and
interest-bearing deposits $ 349 $ (213) $ 136 $ 232 $ (58) $ 174
Investment securities:
Taxable 5,957 (2,136) 3,821 3,012 (679) 2,333
Non-taxable 2,565 (735) 1,830 4,098 (188) 3,910
-------- -------- -------- ------- ------- -------
Total investment securities 8,522 (2,871) 5,651 7,110 (867) 6,243
Loans:
Commercial and agricultural 11,249 (10,316) 933 12,375 (6,273) 6,102
Residential real estate 595 (1,426) (831) 2,994 (77) 2,917
Consumer and home equity 1,300 (2,569) (1,269) 4,638 (713) 3,925
-------- -------- -------- ------- ------- -------
Total loans 13,144 (14,311) (1,167) 20,007 (7,063) 12,944
-------- -------- -------- ------- ------- -------
Total interest-earning assets 22,015 (17,395) 4,620 27,349 (7,988) 19,361
======== ======== ======== ======= ======= =======
Interest-bearing liabilities:
Savings and money market 1,807 (1,283) 524 1,431 (1,322) 109
Interest-bearing checking 2,606 343 2,949 721 (148) 573
Certificates of deposit (1,500) (10,220) (11,720) 7,329 (4,355) 2,974
Borrowed funds 2,059 (1,158) 901 2,108 (1,115) 993
Guaranteed preferred beneficial
interests in corporation's junior
subordinated debentures 240 (3) 237 1,440 -- 1,440
-------- -------- -------- ------- ------- -------
Total interest-bearing liabilities 5,212 (12,321) (7,109) 13,029 (6,940) 6,089
======== ======== ======== ======= ======= =======
Net interest income $ 16,803 $ (5,074) $ 11,729 $14,320 $(1,048) $13,272
======== ======== ======== ======= ======= =======
Provision for Loan Losses
The provision for loan losses represents management's estimate of the expense
necessary to maintain the allowance for loan losses at a level representing
losses probable in the portfolio. The provision for loan losses was $6.1 million
in 2002, compared to $5.0 million in 2001 and $4.2 million in 2000. The increase
in the provision for loan losses of $1.1 million in 2002 over 2001 was
principally due to the increased level of impaired loans and the related
specific allowance allocations required on those loans based on analysis of the
collateral value and borrower paying capacity performed by the Company. The
provision for loan losses exceeded net loan charge-offs by $2.4 million in 2002,
by $2.5 million in 2001, and $2.5 million in 2000. Nonperforming loans were
$37.1 million at December 31, 2002, representing 2.81% of total loans
outstanding at year-end. Nonperforming loans at year-end 2001 were $10.0
million, representing 0.86% of total loans outstanding. In 2002 net loan
charge-offs were $3.7 million or 0.30% of average loans, compared to net loan
charge-offs of $2.5 million or 0.23% of average loans for 2001. The ratio of the
allowance for loan losses to nonperforming loans was 58% at December 31, 2002
versus 190% at December 31, 2001. The ratio of allowance for loan losses to
total loans was 1.64% at December 31, 2002 and 2001.
36
Noninterest Income
The following table presents the major categories of noninterest income during
the years indicated:
Year Ended December 31
----------------------------
(Dollars in thousands) 2002 2001 2000
------- ------- ------
Service charges on deposits ..................... $10,603 $ 7,653 $5,003
Financial services group fees and commissions ... 5,629 2,690 1,151
Mortgage banking activities ..................... 2,279 2,190 1,536
Gain on sale or call of securities .............. 285 531 27
Other ........................................... 3,393 2,718 1,692
------- ------- ------
Total noninterest income ...................... $22,189 $15,782 $9,409
======= ======= ======
Noninterest income increased 41% to $22.2 million in 2002 compared to $15.8
million in 2001. The increase in noninterest income is partially attributed to
the growth in deposits and related service fees. In addition, the increase in
FSG fees and commissions reflects the ongoing expansion of the financial
services line of business. The year ended December 31, 2002 reflects a full year
of fees and commissions generated by the Company's employee benefits
administration and compensation consulting firm, BGI, which was acquired during
the fourth quarter of 2001. The Company has focused on growing fee income, and
the integration of BGI with the Company's existing broker/dealer and trust
businesses is expected to further enhance the Company's ability to generate
additional fee income. Mortagage banking activities include gains and losses
from the sale of loans, mortgage servicing income and the amortization and
impairment of mortgage servicing rights.
Noninterest income increased 67.7% to $15.8 million in 2001 compared to $9.4
million in 2000. Service charges on deposit accounts increased significantly in
2001, which reflects the benefit of the continued growth in core deposits and
the related fee-based products and services. The increase in FSG fees and
commissions results from FIGI, the Company's brokerage subsidiary, commencing
operations in March 2000, enabling FII to retain a higher portion of commissions
on mutual fund sales. Also, BGI was acquired during October 2001 and contributed
to the increase. The increase in mortgage banking activities results from the
increase in the gain on sale of residential mortgage loans and an increase in
the serviced loan portfolio.
Noninterest Expense
The following table presents the major categories of noninterest expense during
the years indicated:
Year Ended December 31
-----------------------------
(Dollars in thousands) 2002 2001 2000
------- ------- -------
Salaries and employee benefits ............. $30,093 $22,958 $16,803
Occupancy and equipment .................... 7,285 6,050 4,614
Supplies and postage ....................... 2,371 1,953 1,500
Amortization of goodwill ................... -- 1,653 --
Amortization of other intangible assets .... 898 728 737
Computer and data processing ............... 1,759 1,501 877
Professional fees .......................... 1,612 1,326 826
Other ...................................... 9,031 7,183 4,799
------- ------- -------
Total noninterest expense ................ $53,049 $43,352 $30,156
======= ======= =======
Noninterest expense increased 22% to $53.0 million in 2002 compared to $43.4
million in 2001. The Company's largest component of noninterest expense,
salaries and employee benefits, increased 31% in 2002, a reflection of staffing
additions from recent years acquisitions and other additions necessary to
support the Company's growth. The increase also results from overhead coupled
with integrating the newly acquired companies, expenditures associated with
maintaining the Company's investment in technology and costs connected with
opening new branch offices. In contrast, goodwill amortization
37
expense recognized on the BNB acquisition, which amounted to $1.7 million in
2001, ceased on January 1, 2002 with the adoption of SFAS No. 142. The Company's
efficiency ratio, which measures the amount of overhead required to produce a
dollar of revenue, has remained at relatively low levels. For the years ended
December 31, 2002, 2001 and 2000, the efficiency ratio was 50.6%, 48.5% and
45.2%, respectively.
Noninterest expense increased 44% to $43.4 million in 2001 compared to $30.2
million in 2000. The increase was partially attributed to $6.2 million in
noninterest expense from the acquired companies, BNB and BGI. The Company's
largest component of noninterest expense, salaries and employee benefits,
increased 36.6% in 2001, a reflection of staffing additions from acquisitions
and additions necessary to support the Company's growth.
Income Tax Expense
The provision for income taxes provides for Federal and New York State income
taxes, which amounted to $12.4 million, $11.0 million and $9.8 million for the
years ended December 31, 2002, 2001 and 2000, respectively. The increasing trend
corresponds generally to increased levels of taxable income. The effective tax
rate for 2002 was 31.9%, compared to 34.2% in 2001 and 35.1% in 2000. The lower
effective tax rate in 2002 is primarily attributable to the elimination of
non-deductible goodwill amortization expense recognized in 2001.
Segment Information
In accordance with the provisions of SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information," the Company's reportable segments are
comprised of WCB, NBG, BNB and FTB as the Company evaluates performance on an
individual bank basis. During 2002 the Company completed a geographic
realignment of the subsidiary banks, which involved the merger of the subsidiary
formerly known as PSB into NBG and subsequent transfer of branches between NBG
and WCB. Accordingly, the Company restated segment results to reflect the merger
and transfers for each of the years presented Financial information related to
the Company's segments is presented in Note 17 of the notes to consolidated
financial statements.
Recent Accounting Developments
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The statement
supersedes SFAS No. 121 and is effective for fiscal years beginning after June
15, 2002 although early adoption is encouraged. SFAS No. 144 retains many of the
fundamental principles of SFAS No. 121, but differs from it in that it excludes
goodwill and intangible assets from its provisions and provides greater
direction relating to the implementation of its principles. The provisions of
SFAS No. 144 are not expected to have a material impact on the Company's
consolidated financial statements.
In June 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements No. 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS
No. 145 addresses a number of different issues and is effective at various dates
in 2002 and 2003, with earlier application encouraged. None of the provisions of
SFAS No. 145 had or are expected to have a material impact on the Company's
consolidated financial statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
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)." SFAS No. 146 requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of a commitment to an exit or disposal
plan. The provisions of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002, with early application
encouraged. SFAS No. 142 does not apply to costs associated with an exit
activity that involves an entity newly acquired in a business combination. The
provisions of SFAS No. 146 are not expected to have a material impact on the
Company's consolidated financial statements.
38
In October 2002, FASB issued SFAS No. 147, "Acquisitions of Certain Financial
Institutions", an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9 (SFAS No. 147). This statement removes acquisitions of
financial institutions from the scope of both Statement No. 72 and
Interpretation No. 9 and requires that those transactions, which constitute a
business combination, be accounted for in accordance with SFAS No. 141 and SFAS
No. 142. Thus, the requirement in paragraph 5 of Statement 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 no longer applies to acquisitions within the
scope of SFAS No. 147. SFAS No. 147 also clarifies that an acquisition that does
not meet the definition of a business combination because the transferred net
assets and activities do not constitute a business is an acquisition of net
assets. Those acquisitions should be accounted for in the same manner as any
other net asset acquisition and do not give rise to goodwill. SFAS No. 147 is
effective for acquisitions on or after October 1, 2002 with mandatory
implementation effective January 1, 2002 for existing intangibles. The adoption
of SFAS No. 147 did not have a material impact on the Company's consolidated
financial statements.
FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others," was
issued in November 2002. FASB Interpretation No. 45 elaborates on 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 clarifies that a guarantor is required 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 initial measurement
provisions of FASB 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 or annual periods
ending after December 15, 2002. The Company has provided the required
disclosures. The Company adopted the recognition and measurement provisions of
FASB Interpretation No. 45 effective January 1, 2003. Such adoption did not 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." SFAS No. 148 provides alternative methods of transition for voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
amendments to SFAS No. 123 as provided in SFAS No. 148 are effective for
financial statements for fiscal years ending after December 15, 2002, while the
interim reporting requirements are effective for financial reports containing
condensed financial statements for interim periods beginning after December 15,
2002.
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities," was
issued in January 2003. FASB Interpretation No. 46 clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FASB Interpretation No. 46 requires an enterprise to
consolidate a variable interest entity if that enterprise has a variable
interest (or combination of variable interests) that will absorb a majority of
the entity's expected losses if they occur, receive a majority of the entity's
expected returns if they occur, or both. 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. FASB 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 adoption of the provisions of FASB Interpretation No. 46 is not expected to
have a material impact on the Company's consolidated financial statements.
39
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
The objective of maintaining adequate liquidity is to assure the ability of the
Company and its subsidiaries to meet their financial obligations. These
obligations include the withdrawal of deposits on demand or at their contractual
maturity, the repayment of borrowings as they mature, the ability to fund new
and existing loan commitments and the ability to take advantage of new business
opportunities. The Company and its subsidiaries achieve liquidity by maintaining
a strong base of core customer funds, maturing short-term assets, the ability to
sell securities, lines of credit, and access to capital markets.
Liquidity at the subsidiary bank level is managed through the monitoring of
anticipated changes in loans, core deposits, and wholesale funds. The strength
of the subsidiary bank's liquidity position is a result of its base of core
customer deposits. These core deposits are supplemented by wholesale funding
sources which include credit lines with the other banking institutions, the
FHLB, Farmer Mac, and the Federal Reserve Bank.
The primary source of liquidity for the parent company is dividends from
subsidiaries, lines of credit, and access to capital markets. Dividends from
subsidiaries are limited by various regulatory requirements related to capital
adequacy and earnings trends. The Company's subsidiaries rely on cash flows from
operations, core deposits, borrowings, short-term liquid assets, and, in the
case of non-banking subsidiaries, funds from the parent company.
In the normal course of business, the Company has outstanding commitments to
extend credit which are not reflected in the Company's consolidated financial
statements. The commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. At December 31, 2002
letters of credit totaling $13.4 million and unused loan commitments of $316.6
million were contractually available. Comparable amounts for these commitments
at December 31, 2001 were $8.6 million and $265.9 million, respectively. The
total commitment amounts do not necessarily represent future cash requirements
as many of the commitments are expected to expire without funding.
The Company's cash and cash equivalents were $48.4 million at December 31, 2002,
a decrease of $4.8 million from the balance of $53.2 million at December 31,
2001. The primary factor leading to the decrease in cash relates to the
Company's more effective management of the Federal Reserve Bank reserve
requirements for the subsidiary banks.
40
Capital Resources
The Federal Reserve Board has adopted a system using risk-based capital
guidelines to evaluate the capital adequacy of bank holding companies. The
guidelines require a minimum total risk-based capital ratio of 8.0%. Leverage
ratio is also utilized in assessing capital adequacy with a minimum requirement
that can range from 3.0% to 5.0%. The following table reflects the changes in
the components of those ratios:
(Dollars in thousands) 2002 2001 2000
---------- ---------- -----------
Total shareholders' equity $ 178,294 $ 149,187 $ 131,618
Less: Unrealized gains/(losses) on securities
available or sale 10,368 2,176 (144)
Goodwill and other intangible assets 44,547 39,166 2,381
Disallowed mortgage servicing asset 120 90 --
Plus: Minority interests in consolidated subsidiaries 161 475 458
Qualifying trust preferred securities 16,200 12,408 --
---------- ---------- -----------
Total Tier 1 capital $ 139,620 $ 120,638 $ 129,839
========== ========== ===========
Adjusted average assets $2,005,837 $1,718,034 $ 1,273,657
Tier 1 leverage ratio 6.96% 7.02% 10.19%
Total Tier 1 capital $ 139,620 $ 120,638 $ 129,839
Plus: Qualifying allowance for loan losses 17,813 15,417 11,607
Nonqualifying trust preferred securities -- 3,792 --
---------- ---------- -----------
Total risk-based capital $ 157,433 $ 139,847 $ 141,446
========== ========== ===========
Net risk-weighted assets $1,421,160 $1,229,811 $ 926,291
Total risk-based capital ratio 11.08% 11.37% 15.27%
The Company's Tier 1 leverage ratio was 6.96% at December 31, 2002 and is
well-above minimum regulatory capital requirements. The ratio declined slightly
from 7.02% at December 31, 2001. Total Tier 1 capital of $139.6 million at
December 31, 2002 increased $19.0 million from $120.6 million at December 31,
2001. The increase in Tier 1 capital relates primarily to the increase in
retained earnings resulting from 2002 net income of $26.5 million and reduced by
$7.9 million in preferred and common dividends declared during 2002.
The Company's total risk-weighted capital ratio was 11.08% at December 31, 2002
and is well-above minimum regulatory capital requirements. The ratio declined
slightly from 11.37% at December 31, 2001. Total risk-based capital was $157.4
million at December 31, 2002 an increase of $17.6 million from $139.8 million at
December 31, 2001. The increase is attributed to the $19.0 million increase in
Tier 1 capital previously discussed plus a $2.4 million increase in qualifying
allowance for loan losses, offset by a $3.8 million decrease in nonqualifying
trust preferred securities.
The Company and all subsidiary banks are well capitalized. For further
information related to regulatory capital see Note 15 of the notes to
consolidated financial statements.
41
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
MARKET RISK
The principal objective of the Company's interest rate risk management is to
evaluate the interest rate risk inherent in certain assets and liabilities,
determine the appropriate level of risk to the Company given its business
strategy, operating environment, capital and liquidity requirements and
performance objectives, and manage the risk consistent with the guidelines
approved by the Company's Board of Directors. The Company's senior management is
responsible for reviewing with the Board its activities and strategies, the
effect of those strategies on the net interest margin, the fair value of the
portfolio and the effect that changes in interest rates will have on the
portfolio and exposure limits. Senior Management develops an Asset-Liability
Policy that meets strategic objectives and regularly reviews the activities of
the subsidiary banks. Each subsidiary bank board adopts an Asset-Liability
Policy within the parameters of the overall FII Asset-Liability Policy and
utilizes an asset/liability committee comprised of senior management of the bank
under the direction of the bank's board.
The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are "interest rate sensitive" and by
monitoring the Company's interest rate sensitivity "gap." An asset or liability
is said to be interest rate sensitive within a specific time period if it will
mature or re-price within that time period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets maturing
or re-pricing within a specific time period and the amount of interest-bearing
liabilities maturing or re-pricing within that same time period. A gap is
considered positive when the amount of interest rate sensitive assets exceeds
the amount of interest rate sensitive liabilities. A gap is considered negative
when the amount of interest rate sensitive liabilities exceeds the amount of
interest rate sensitive assets. At December 31, 2002, the one-year gap position,
the difference between the amount of interest-earning assets maturing or
re-pricing within one year and interest-bearing liabilities maturing or
re-pricing within one year, was $405.9 million, or 19.3% of total assets.
Accordingly, over the one-year period following December 31, 2002, the Company
will have an estimated $405.9 million more in assets re-pricing than
liabilities. Generally if rate-sensitive assets re-price sooner than
rate-sensitive liabilities, earnings will be positively impacted in a rising
rate environment. Conversely, in a declining rate environment, earnings will
generally be negatively impacted. If rate-sensitive liabilities re-price sooner
than rate-sensitive assets then generally earnings will be negatively impacted
in a rising rate environment. Conversely, in a declining rate environment
earnings will generally be positively impacted. Management believes that the
positive gap position at December 31, 2002 will not have a material adverse
effect on the Company's operating results.
Gap Analysis
The following table (the "Gap Table") sets forth the amounts of interest-earning
assets and interest-bearing liabilities outstanding at December 31, 2002 which
management anticipates, based upon certain assumptions, to re-price or mature in
each of the future time periods shown. Except as stated below, the amount of
assets and liabilities shown which re-price or mature during a particular period
were determined in accordance with the earlier of the re-pricing date or the
contractual maturity of the asset or liability. The table sets forth an
approximation of the projected re-pricing of assets and liabilities at December
31, 2002, on the basis of contractual maturities, anticipated prepayments and
scheduled rate adjustments within the selected time intervals. All non-maturity
deposits (demand deposits and savings deposits) were assumed to become rate
sensitive over time, with 1%, 3%, 4%, 15%, 14% and 63% of such deposits assumed
to re-price in the periods of less than 30 days, 31 to 180 days, 181 to 365
days, 1 to 3 years, 3 to 5 years and more than 5 years, respectively. Prepayment
and re-pricing rates can have a significant impact on the estimated gap. While
management believes the assumptions used in modeling the Gap Table are
reasonable, there can be no assurances.
42
Gap Table
----------------------------------------------------------------------------------------------
December 31, 2002
----------------------------------------------------------------------------------------------
Volumes Subject to Repricing Within
----------------------------------------------------------------------------------------------
0-30 31-180 181-365 1-3 3-5 >5 Non-
(Dollars in thousands) days days days years years years Sensitive Total
----------------------------------------------------------------------------------------------
Interest-earning assets:
Federal funds sold and
and interest-bearing
deposits $ -- $ -- $ 75 $ -- $ -- $ -- $ -- $ 75
Investment
securities (1) 87,973 63,849 63,462 123,416 68,889 236,398 -- 643,987
Loans (2) 430,279 231,013 152,030 298,558 144,963 61,327 3,722 1,321,892
-------- -------- --------- -------- -------- --------- -------- ----------
Total interest-earning
assets 518,252 294,862 215,567 421,974 213,852 297,725 3,722 1,965,954
-------- -------- --------- -------- -------- --------- -------- ----------
Interest-bearing liabilities:
Interest-bearing checking,
savings and money
market deposits 4,679 23,140 27,070 105,833 89,762 529,288 -- 779,772
Certificates of deposit 76,425 209,473 219,300 155,857 25,437 1,504 -- 687,996
Borrowed funds (3) 34,305 13,155 15,194 43,534 33,858 55,433 -- 195,479
-------- -------- --------- -------- -------- --------- -------- ----------
Total interest-bearing
liabilities 115,409 245,768 261,564 305,224 149,057 586,225 -- 1,663,247
-------- -------- --------- -------- -------- --------- -------- ----------
Period gap $402,843 $ 49,094 $ (45,997) $116,750 $ 64,795 $(288,500) $ 3,722 $ 302,707
======== ======== ========= ======== ======== ========= ======== ==========
Cumulative gap $402,843 $451,937 $ 405,940 $522,690 $587,485 $ 298,985 $302,707
======== ======== ========= ======== ======== ========= ========
Period gap to total assets 19.14% 2.33% (2.19%) 5.55% 3.08% (13.71%) 0.18% 14.38%
======== ======== ========= ======== ======== ========= ======== ==========
Cumulative gap to
total assets 19.14% 21.47% 19.28% 24.83% 27.91% 14.20% 14.38%
======== ======== ========= ======== ======== ========= ========
Cumulative interest-earning assets
to cumulative interest-
bearing liabilities 449.06% 225.13% 165.19% 156.33% 154.55% 117.98% 118.20%
======== ======== ========= ======== ======== ========= ========
(1) Amounts shown include the amortized cost of held to maturity securities
and the fair value of available for sale securities.
(2) Amounts shown include principal balance net of deferred loan fees and
costs, unamortized premiums and discounts.
(4) Amounts shown include guaranteed preferred beneficial interests in
Corporation's junior subordinated debentures.
Certain shortcomings are inherent in the method of analysis presented in the Gap
Table. For example, although certain assets and liabilities may have similar
maturities or periods to repricing, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate loans, have
features which restrict changes in interest rates, both on a short-term basis
and over the life of the asset. Further, in the event of changes in interest
rates, prepayment and early withdrawal levels would likely deviate significantly
from those assumed in calculating the table.
As a result of these shortcomings, the Company directs more attention on
simulation modeling, such as "net interest income at risk" discussed below,
rather than gap analysis. Even though the gap analysis reflects a ratio of
cumulative gap to total assets within acceptable limits, the net interest income
at risk simulation modeling is considered by management to be more informative
in forecasting future income at risk.
43
Net Interest Income at Risk Analysis
In addition to the Gap Analysis, management uses a "rate shock" simulation to
measure the rate sensitivity of the balance sheet. Rate shock simulation is a
modeling technique used to estimate the impact of changes in rates on net
interest income and economic value of equity. The following table sets forth the
results of the modeling analysis at December 31, 2002:
Change in Interest Net Interest Income Economic Value of Equity
Rates in Basis Points --------------------------------- ----------------------------------
(Rate Shock) Amount $ Change % Change Amount $ Change % Change
------------ ------ -------- -------- ------ -------- --------
(Dollars in thousands)
200 $77,807 $ 4,294 5.84% $364,403 $ (9,922) (2.65%)
100 77,015 3,502 4.76% 367,038 (7,287) (1.95%)
Static 73,513 -- -- 374,325 -- --
(100) 68,860 (4,653) (6.33%) 363,378 (10,947) (2.92%)
(200) 62,686 (10,827) (14.73%) 361,073 (13,252) (3.54%)
The Company measures net interest income at risk by estimating the changes in
net interest income resulting from instantaneous and sustained parallel shifts
in interest rates of plus or minus 200 basis points over a period of 12 months.
As of December 31, 2002, a 200 basis point increase in rates would increase net
interest income by $4.3 million, or 5.84%, over the next twelve month period.
Conversely, a 200 basis point decrease in rates would decrease net interest
income by $10.8 million, or 14.73%, over a 12 month period. This simulation is
based on management's assumption as to the effect of interest rate changes on
assets and liabilities and assumes a parallel shift of the yield curve. It also
includes certain assumptions about the future pricing of loans and deposits in
response to changes in interest rates. Further, it assumes that delinquency
rates would not change as a result of changes in interest rates, although there
can be no assurance that this will be the case. While this simulation is a
useful measure as to net interest income at risk due to a change in interest
rates, it is not a forecast of the future results and is based on many
assumptions that, if changed, could cause a different outcome.
44
Item 8. Financial Statements and Supplementary Data
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2002 AND 2001
(Dollars in thousands, except per share amounts) 2002 2001
----------- -----------
Assets
Cash, due from banks and interest-bearing deposits $ 48,429 $ 52,171
Federal funds sold -- 1,000
Securities available for sale, at fair value 596,862 428,423
Securities held to maturity (fair value of $48,089 and
$62,317 at December 31, 2002 and 2001, respectively) 47,125 61,281
Loans, net 1,300,232 1,146,976
Premises and equipment, net 27,254 24,467
Goodwill 40,593 36,829
Other assets 44,539 43,149
----------- -----------
Total assets $ 2,105,034 $ 1,794,296
=========== ===========
Liabilities And Shareholders' Equity
Liabilities:
Deposits:
Demand $ 240,755 $ 224,628
Savings, money market and interest-bearing checking 779,772 572,563
Certificates of deposit 687,996 636,467
----------- -----------
Total deposits 1,708,523 1,433,658
Short-term borrowings 87,189 103,770
Long-term borrowings 92,090 70,419
Guaranteed preferred beneficial interests in corporation's
junior subordinated debentures 16,200 16,200
Accrued expenses and other liabilities 22,738 21,062
----------- -----------
Total liabilities 1,926,740 1,645,109
Shareholders' equity:
3% cumulative preferred stock, $100 par value,
authorized 10,000 shares, issued and outstanding
1,666 shares in 2002 and 2001 167 167
8.48% cumulative preferred stock, $100 par value,
authorized 200,000 shares, issued and outstanding
175,755 shares in 2002 and 175,855 shares in 2001 17,575 17,585
Common stock, $0.01 par value, authorized 50,000,000
shares, issued 11,303,533 shares in 2002 and 2001 113 113
Additional paid-in capital 19,728 17,195
Retained earnings 131,320 112,786
Accumulated other comprehensive income 10,368 2,176
Treasury stock, at cost - 199,719 shares in 2002 and
282,219 shares in 2001 (977) (835)
----------- -----------
Total shareholders' equity 178,294 149,187
----------- -----------
Total liabilities and shareholders' equity $ 2,105,034 $ 1,794,296
=========== ===========
See accompanying notes to consolidated financial statements.
45
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(Dollars in thousands, except per share amounts) 2002 2001 2000
-------- -------- -------
Interest income:
Loans $ 90,315 $ 91,482 $78,538
Securities 27,630 22,628 17,745
Other 494 358 184
-------- -------- -------
Total interest income 118,439 114,468 96,467
-------- -------- -------
Interest expense:
Deposits 35,167 43,414 39,758
Borrowings 5,741 4,840 3,847
Guaranteed preferred beneficial interests in corporation's
junior subordinated debentures 1,677 1,440 --
-------- -------- -------
Total interest expense 42,585 49,694 43,605
-------- -------- -------
Net interest income 75,854 64,774 52,862
Provision for loan losses 6,119 4,958 4,211
-------- -------- -------
Net interest income after provision for loan losses 69,735 59,816 48,651
-------- -------- -------
Noninterest income:
Service charges on deposits 10,603 7,653 5,003
Financial services group fees and commissions 5,629 2,690 1,151
Mortgage banking activities 2,279 2,190 1,536
Gain on sale and call of securities 285 531 27
Other 3,393 2,718 1,692
-------- -------- -------
Total noninterest income 22,189 15,782 9,409
-------- -------- -------
Noninterest expense:
Salaries and employee benefits 30,093 22,958 16,803
Occupancy and equipment 7,285 6,050 4,614
Supplies and postage 2,371 1,953 1,500
Amortization of goodwill -- 1,653 --
Amortization of other intangible assets 898 728 737
Computer and data processing 1,759 1,501 877
Professional fees 1,612 1,326 826
Other 9,031 7,183 4,799
-------- -------- -------
Total noninterest expense 53,049 43,352 30,156
-------- -------- -------
Income before income taxes 38,875 32,246 27,904
Income taxes 12,419 11,033 9,804
-------- -------- -------
Net income $ 26,456 $ 21,213 $18,100
======== ======== =======
Earnings per common share:
Basic $ 2.26 $ 1.79 $ 1.51
Diluted $ 2.23 $ 1.77 $ 1.51
See accompanying notes to consolidated financial statements.
46
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND
COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
3% 8.48% Additional
(Dollars in thousands, Preferred Preferred Common Paid in Retained
except per share amounts) Stock Stock Stock Capital Earnings
----- ----- ----- ------- --------
Balance - December 31, 1999 $ 176 $ 17,636 $113 $ 16,448 $ 86,361
Purchase of 48 shares of 3% preferred stock (5) -- -- 3 --
Purchase of 490 shares of 8.48% preferred stock -- (49) -- (2) --
Purchase of 33,300 shares of common stock -- -- -- -- --
Issue 2,288 shares of common stock - directors plan -- -- -- 23 --
Comprehensive income:
Net income -- -- -- -- 18,100
Unrealized gain on securities available
for sale (net of tax of $1,757) -- -- -- -- --
Less: Reclassification adjustment for gains
included in net income (net of tax of $11) -- -- -- -- --
Net unrealized gain on securities available
for sale (net of tax of $1,746) -- -- -- -- --
Total comprehensive income -- -- -- -- --
Cash dividends declared:
3% Preferred - $3.00 per share -- -- -- -- (5)
8.48% Preferred - $8.48 per share -- -- -- -- (1,491)
Common - $0.42 per share -- -- -- -- (4,617)
----- -------- ---- -------- ---------
Balance - December 31, 2000 $ 171 $ 17,587 $113 $ 16,472 $ 98,348
Purchase of 45 shares of 3% preferred stock (4) -- -- 2 --
Purchase of 11 shares of 8.48% preferred stock -- (2) -- -- --
Purchase of 1,000 shares of common stock -- -- -- -- --
Issue 1,141 shares of common stock - directors plan -- -- -- 23 --
Issue 34,452 shares of common stock -
Burke Group, Inc. acquisition -- -- -- 698 --
Comprehensive income:
Net income -- -- -- -- 21,213
Unrealized gain on securities available
for sale (net of tax of $1,803) -- -- -- -- --
Less: Reclassification adjustment for gains
included in net income (net of tax of $215) -- -- -- -- --
Net unrealized gain on securities available
for sale (net of tax of $1,588) -- -- -- -- --
Total comprehensive income -- -- -- -- --
Cash dividends declared:
3% Preferred - $3.00 per share -- -- -- -- (5)
8.48% Preferred - $8.48 per share -- -- -- -- (1,491)
Common - $0.482 per share -- -- -- -- (5,279)
----- -------- ---- -------- ---------
Balance - December 31, 2001 $ 167 $ 17,585 $113 $ 17,195 $ 112,786
Purchase of 100 shares of 8.48% preferred stock -- (10) -- -- --
Purchase of 22,240 shares of common stock -- -- -- -- --
Issue 1,049 shares of common stock - directors plan -- -- -- 33 --
Issue 19,955 shares of common stock -
exercised stock options -- -- -- 342 --
Issue 36,700 shares of common stock -
Burke Group, Inc. earnout -- -- -- 840 --
Issue 47,036 shares of common stock -
Bank of Avoca acquisition -- -- -- 1,318 --
Comprehensive income:
Net income -- -- -- -- 26,456
Unrealized gain on securities available
for sale (net of tax of $5,603) -- -- -- -- --
Less: Reclassification adjustment for gains
included in net income (net of tax of $115) -- -- -- -- --
Net unrealized gain on securities available
for sale (net of tax of $5,488) -- -- -- -- --
Total comprehensive income -- -- -- -- --
Cash dividends declared:
3% Preferred - $3.00 per share -- -- -- -- (5)
8.48% Preferred - $8.48 per share -- -- -- -- (1,491)
Common - $0.58 per share -- -- -- -- (6,426)
----- -------- ---- -------- ---------
Balance - December 31, 2002 $ 167 $ 17,575 $113 $ 19,728 $ 131,320
===== ======== ==== ======== =========
Accumulated
Other
Comprehensive Total
(Dollars in thousands, Income Treasury Shareholders'
except per share amounts) (Loss) Stock Equity
------ ----- ------
Balance - December 31, 1999 $ (2,661) $(534) $ 117,539
Purchase of 48 shares of 3% preferred stock -- -- (2)
Purchase of 490 shares of 8.48% preferred stock -- -- (51)
Purchase of 33,300 shares of common stock -- (401) (401)
Issue 2,288 shares of common stock - directors plan -- 6 29
Comprehensive income:
Net income -- -- 18,100
Unrealized gain on securities available
for sale (net of tax of $1,757) 2,533 -- 2,533
Less: Reclassification adjustment for gains
included in net income (net of tax of $11) (16) -- (16)
---------
Net unrealized gain on securities available
for sale (net of tax of $1,746) -- -- 2,517
---------
Total comprehensive income -- -- 20,617
---------
Cash dividends declared:
3% Preferred - $3.00 per share -- -- (5)
8.48% Preferred - $8.48 per share -- -- (1,491)
Common - $0.42 per share -- -- (4,617)
-------- ----- ---------
Balance - December 31, 2000 $ (144) $(929) $ 131,618
Purchase of 45 shares of 3% preferred stock -- -- (2)
Purchase of 11 shares of 8.48% preferred stock -- -- (2)
Purchase of 1,000 shares of common stock -- (12) (12)
Issue 1,141 shares of common stock - directors plan -- 4 27
Issue 34,452 shares of common stock -
Burke Group, Inc. acquisition -- 102 800
Comprehensive income:
Net income -- -- 21,213
Unrealized gain on securities available
for sale (net of tax of $1,803) 2,636 -- 2,636
Less: Reclassification adjustment for gains
included in net income (net of tax of $215) (316) -- (316)
---------
Net unrealized gain on securities available
for sale (net of tax of $1,588) -- -- 2,320
---------
Total comprehensive income -- -- 23,533
---------
Cash dividends declared:
3% Preferred - $3.00 per share -- -- (5)
8.48% Preferred - $8.48 per share -- -- (1,491)
Common - $0.482 per share -- -- (5,279)
-------- ----- ---------
Balance - December 31, 2001 $ 2,176 $(835) $ 149,187
Purchase of 100 shares of 8.48% preferred stock -- -- (10)
Purchase of 22,240 shares of common stock -- (571) (571)
Issue 1,049 shares of common stock - directors plan -- 4 37
Issue 19,955 shares of common stock -
exercised stock options -- 84 426
Issue 36,700 shares of common stock -
Burke Group, Inc. earnout -- 160 1,000
Issue 47,036 shares of common stock -
Bank of Avoca acquisition -- 181 1,499
Comprehensive income:
Net income -- -- 26,456
Unrealized gain on securities available
for sale (net of tax of $5,603) 8,362 -- 8,362
Less: Reclassification adjustment for gains
included in net income (net of tax of $115) (170) -- (170)
---------
Net unrealized gain on securities available
for sale (net of tax of $5,488) -- -- 8,192
---------
Total comprehensive income -- -- 34,648
---------
Cash dividends declared:
3% Preferred - $3.00 per share -- -- (5)
8.48% Preferred - $8.48 per share -- -- (1,491)
Common - $0.58 per share -- -- (6,426)
-------- ----- ---------
Balance - December 31, 2002 $ 10,368 $(977) $ 178,294
======== ===== =========
See accompanying notes to consolidated financial statements.
47
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(Dollars in thousands) 2002 2001 2000
--------- --------- ---------
Cash flows from operating activities:
Net income $ 26,456 $ 21,213 $ 18,100
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 5,697 5,984 3,032
Provision for loan losses 6,119 4,958 4,211
Deferred income tax benefit (1,060) (112) (965)
Proceeds from sale of loans held for sale 139,426 117,446 25,880
Origination of loans held for sale (140,569) (119,994) (27,029)
Gain on sale and call of securities (285) (531) (27)
Gain on sale of loans held for sale (1,542) (1,513) (382)
Loss (gain) on sale of other assets 54 131 (88)
Minority interest in net income of subsidiaries 175 104 90
Increase in other assets (2,609) (1,518) (5,919)
Increase (decrease) in accrued expenses
and other liabilities 698 (625) 3,735
--------- --------- ---------
Net cash provided by operating activities 32,560 25,543 20,638
Cash flows from investing activities:
Purchase of securities:
Available for sale (425,269) (377,111) (100,150)
Held to maturity (35,152) (21,933) (21,124)
Proceeds from maturity and call of securities:
Available for sale 232,379 200,315 28,688
Held to maturity 43,419 37,381 25,248
Proceeds from sale and call of securities 45,059 91,412 14,022
Loan originations less principal payments (143,622) (87,814) (123,618)
Proceeds from sales of premises and equipment 73 174 41
Purchase of premises and equipment (5,251) (4,359) (3,234)
Net cash paid in equity method investment (2,400) -- --
Net cash acquired (paid) in purchase acquisitions 42,156 (49,072) --
--------- --------- ---------
Net cash used in investing activities (248,608) (211,007) (180,127)
Cash flows from financing activities:
Net increase in deposits 213,913 124,080 128,580
Net (decrease) increase in short-term borrowings (16,581) 46,497 807
Proceeds from long-term borrowings 23,056 28,912 7,089
Repayment of long-term borrowings (1,386) (179) (1,848)
Proceeds from guaranteed preferred beneficial interests in
corporation's junior subordinated debentures, net of costs -- 15,713 --
Purchase of preferred and common shares (581) (16) (454)
Issuance of preferred and common shares 463 27 29
Dividends paid (7,578) (6,551) (5,788)
--------- --------- ---------
Net cash provided by financing activities 211,306 208,483 128,415
--------- --------- ---------
Net (decrease) increase in cash and cash equivalents (4,742) 23,019 (31,074)
Cash and cash equivalents at the beginning of the year 53,171 30,152 61,226
--------- --------- ---------
Cash and cash equivalents at the end of the year $ 48,429 $ 53,171 $ 30,152
========= ========= =========
Supplemental disclosure of cash flow information:
Cash paid during year for:
Interest $ 44,309 $ 46,912 $ 40,436
Income taxes 14,295 10,793 10,821
Noncash investing and financing activities:
Fair value of noncash assets acquired in purchase acquisitions $ 19,020 $ 282,534 $ --
Fair value of liabilities assumed in purchase acquisitions 61,603 271,644 --
Issuance of common stock in purchase acquisitions/earnouts 2,499 800 --
See accompanying notes to consolidated financial statements.
48
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Basis of Presentation
Financial Institutions, Inc. ("FII"), a financial holding company organized
under the laws of New York State, and subsidiaries (the "Company") provide
deposit, lending and other financial services to individuals and businesses in
Central and Western New York State. FII and subsidiaries are each subject to
regulation by certain federal and state agencies.
The consolidated financial statements include the accounts of FII, its four
banking subsidiaries, Wyoming County Bank (99.65% owned) ("WCB"), The National
Bank of Geneva (100% owned) ("NBG"), First Tier Bank & Trust (100% owned)
("FTB") and Bath National Bank (100% owned) ("BNB"), collectively referred to as
the "Banks". During 2002, the Company completed a geographic realignment of the
subsidiary banks, which involved the merger of the subsidiary formerly known as
The Pavilion State Bank ("PSB") into NBG and transfer of other branch offices
between subsidiary banks. The merger and transfers were accounted for at
historical cost as a combination of entities under common control. Also included
are the accounts of the Burke Group, Inc. (100% owned) ("BGI") and The FI Group,
Inc. (100% owned) ("FIGI"), collectively referred to as the "Financial Services
Group". BGI is an employee benefits and compensation consulting firm acquired by
the Company in October 2001. FIGI is a brokerage subsidiary that commenced
operations in March 2000.
In February 2001, the Company formed FISI Statutory Trust I ("FISI") (100%
owned), to accommodate the private placement of $16.2 million in capital
securities, the proceeds of which were utilized to partially fund the
acquisition of BNB. The capital securities are identified on the consolidated
statements of financial condition as guaranteed preferred beneficial interests
in corporation's junior subordinated debentures.
The consolidated financial information included herein combines the results of
operations, the assets, liabilities and shareholders' equity of the Company and
its subsidiaries. All significant inter-company transactions and balances have
been eliminated in consolidation.
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
prevailing practices in the banking industry. In preparing the financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities, and the reported revenues and expenses for the period.
Actual results could differ from those estimates. Amounts in the prior years'
consolidated financial statements are reclassified when necessary to conform
with the current year's presentation.
Cash Equivalents
For purposes of the consolidated statements of cash flows, interest-bearing
deposits and federal funds sold are considered cash equivalents.
Securities
The Company classifies its debt securities as either available for sale or held
to maturity. Debt securities which the Company has the ability and positive
intent to hold to maturity are carried at amortized cost and classified as held
to maturity. Investments in other debt and equity securities are classified as
available for sale and are carried at estimated fair value. Unrealized gains or
losses related to securities available for sale are included in accumulated
other comprehensive income, a component of shareholders' equity, net of the
related deferred income tax effect.
A decline in the fair value of any security below cost that is deemed other than
temporary is charged to income resulting in the establishment of a new cost
basis for the security. Interest income includes interest earned on the
securities adjusted for amortization of premiums and accretion of discounts on
the
49
related securities using the interest method. Realized gains or losses from the
sale of available for sale securities are recognized on the trade date using the
specific identification method.
Loans
Loans are stated at the principal amount outstanding, net of discounts and
deferred loan origination fees and costs which are recorded in interest income
based on the interest method. Mortgage loans held for sale are stated at the
lower of aggregate cost or market value as determined by the current fair value.
Interest income on loans is recognized based on loan principal amounts
outstanding at applicable interest rates. Accrual of interest on loans is
suspended and all unpaid accrued interest is reversed when management believes,
after considering collection efforts and the period of time past due, that
reasonable doubt exists with respect to the collectibility of interest. Income
is subsequently recognized to the extent collected, assuming the principal
balance is expected to be recovered.
The Company services residential mortgage loans for other institutions.
Servicing fees are recognized when payments are received. The Company
capitalizes servicing assets when servicing rights are retained after selling
loans to other institutions. Capitalized servicing assets are reported in other
assets and are amortized to noninterest income in proportion to, and over the
period of, the estimated future net servicing income. Servicing assets are
evaluated for impairment based upon the fair value of the rights as compared to
amortized cost. Impairment is determined by stratifying rights by predominant
risk characteristics, such as interest rates and terms, using discounted cash
flows and market-based assumptions. Impairment is recognized through a valuation
allowance, to the extent that fair value is less than the capitalized asset.
Mortgage banking activities consist of fees earned for servicing mortgage loans
sold to third parties, gains (or losses) recognized on sales of mortgages,
amortization of capitalized mortgage servicing assets and impairment losses
recognized on capitalized mortgage servicing assets.
Allowance for Loan Losses
The allowance for loan losses is established through charges to income and is
maintained at a level to provide for probable losses in the portfolio. The
allowance is determined by management's periodic evaluation of the loan
portfolio based on such factors as: current economic conditions; the current
financial condition of the borrowers; the economic environment in which they
operate; delinquency in loan payments; and the value of any collateral held.
While management uses available information to recognize losses on loans, future
additions to the allowance may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Company's allowance for loan
losses and may require additions to the allowance based on their judgments about
information available to them at the time of their examinations.
A loan is considered impaired when, based on current information and events, it
is probable that a creditor will be unable to collect all amounts of principal
and interest under the original terms of the agreement. Accordingly, the Company
measures certain impaired commercial and agricultural loans based on the present
value of future cash flows discounted at the loan's effective interest rate, or
at the loan's observable market price or the fair value of the collateral if the
loan is collateral dependent. The Company has excluded large groups of small
balance, homogeneous loans which include commercial and agricultural loans less
than $250,000, all residential mortgages, home equity and consumer loans that
are collectively evaluated for impairment.
Federal Home Loan Bank (FHLB) Stock
As a member of the FHLB system, the Company is required to maintain a specified
investment in FHLB stock. This non-marketable investment, which is carried at
cost, must be at an amount at least equal to the greater of 5% of the
outstanding advance balance or 1% of the aggregate outstanding residential
mortgage loans held by the Company. Included in other assets is FHLB stock
totaling $6.3 million and $5.8 million, at December 31, 2002 and 2001,
respectively.
50
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation is computed using straight-line and accelerated
methods over estimated useful lives of the assets. Leasehold improvements are
amortized over the shorter of lease terms or the useful lives of the assets.
Goodwill and Other Intangible Assets
Statement of Financial Accounting Standards (SFAS) No. 142 requires that
goodwill (including goodwill reported in prior acquisitions) no longer be
amortized to earnings, but instead be reviewed for impairment annually, with
impairment losses charged to earnings when they occur. The Company adopted SFAS
No. 142 effective January 1, 2002. In accordance with SFAS No. 142, the Company
ceased goodwill amortization on January 1, 2002 and evaluates goodwill for
impairment annually. Prior to January 1, 2002, goodwill was amortized over a
period of 15 years.
Other intangible assets are being amortized on the straight-line method, over
the expected periods to be benefited. Intangible assets are periodically
reviewed for impairment or when events or changed circumstances may affect the
underlying basis of the assets.
Equity Method Investment
During 2002, the Company made a $2.4 million cash investment to acquire a 50%
interest in Mercantile Adjustment Bureau, LLC, a full-service accounts
receivable management firm located in Rochester, New York. The Company has
accounted for this investment using the equity method and the investment is
included in other assets on the consolidated statements of financial condition.
Stock Compensation
The Company uses a fixed award stock option plan to compensate certain key
members of management of the Company and its subsidiaries. The Company accounts
for issuance of stock options under the intrinsic value-based method of
accounting prescribed by Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees." Under APB No. 25, compensation
expense is recorded on the date the options are granted only if the current
market price of the underlying stock exceeded the exercise price. SFAS No. 123,
"Accounting for Stock-Based Compensation," established accounting and disclosure
requirements using a fair value-based method of accounting for stock-based
employee compensation plans. As allowed under SFAS No. 123, the Company has
elected to continue to apply the intrinsic value-based method of accounting
described above and has adopted only the disclosure requirements of SFAS No.
123, as amended by SFAS No. 148, "Accounting for Stock Based Compensation -
Transition and Disclosure."
Had the Company determined compensation cost based on the fair value method
under SFAS No. 123, the Company's net income and earnings per share would have
been reduced to the following:
Years ended December 31
(Dollars in thousands, except per share amounts) 2002 2001 2000
---------- ---------- ----------
Reported net income $ 26,456 $ 21,213 $ 18,100
Deduct: Total stock-based compensation expense
determined under fair value based method for
all awards, net of related tax effects (274) (288) (202)
---------- ---------- ----------
Pro forma net income $ 26,182 $ 20,925 $ 17,898
========== ========== ==========
Basic earnings per share:
Reported $ 2.26 $ 1.79 $ 1.51
Pro forma $ 2.23 $ 1.77 $ 1.49
Diluted earnings per share:
Reported $ 2.23 $ 1.77 $ 1.51
Pro forma $ 2.20 $ 1.75 $ 1.49
51
The weighted-average fair value of options granted during the years ended
December 31, 2002, 2001, and 2000 amounted to $11.90, $5.53 and $3.72,
respectively. The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model and the following
weighted-average assumptions:
For the years ended December 31
-------------------------------
2002 2001 2000
----- ----- -----
Dividend yield 1.94% 2.43% 2.98%
Expected life (in years) 10.00 10.00 10.00
Expected volatility 38.14% 20.00% 20.00%
Risk-free interest rate 4.98% 4.99% 6.17%
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and the respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period which includes the
enactment date.
Financial Instruments With Off-Balance Sheet Risk
The Company's financial instruments with off-balance sheet risk are commercial
letters of credit and mortgage, commercial and credit card loan commitments.
These financial instruments are reflected in the statement of financial
condition upon funding.
Financial Services Group Fees and Commissions
Financial services group fees and commissions consist of commissions from sales
of investment products and services to customers, fees and commissions from
trust services provided to customers, and fees and commissions earned from
design, consulting, administrative and actuarial services provided to employee
benefits plans and their sponsors. Fees and commissions are recognized when
earned.
New Accounting Pronouncements
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The statement
supersedes SFAS No. 121 and is effective for fiscal years beginning after June
15, 2002 although early adoption is encouraged. SFAS No. 144 retains many of the
fundamental principles of SFAS No. 121, but differs from it in that it excludes
goodwill and intangible assets from its provisions and provides greater
direction relating to the implementation of its principles. The provisions of
SFAS No. 144 are not expected to have a material impact on the Company's
consolidated financial statements.
In October 2002, FASB issued SFAS No. 147, "Acquisitions of Certain Financial
Institutions", an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9 (SFAS No. 147). This statement removes acquisitions of
financial institutions from the scope of both Statement No. 72 and
Interpretation No. 9 and requires that those transactions, which constitute a
business combination, be accounted for in accordance with SFAS No. 141 and SFAS
No. 142. Thus, the requirement in paragraph 5 of Statement 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 no longer applies to acquisitions within the
scope of SFAS No. 147. SFAS No. 147 also clarifies that an acquisition that does
not meet the definition of a business combination because the transferred net
assets and activities do not constitute a business is an acquisition of net
assets. Those acquisitions should be accounted for in the same manner as any
other net asset acquisition and do not give rise to goodwill. SFAS No. 147 is
effective for acquisitions on or after October 1, 2002 with mandatory
implementation effective January 1, 2002 for existing intangibles. The adoption
of SFAS No. 147 did not have a material impact on the Company's consolidated
financial statements.
52
(2) Mergers and Acquisitions
On December 13, 2002, BNB acquired the two Chemung County branch offices of BSB
Bank & Trust Company of Binghamton, New York. The two offices purchased, located
in Elmira and Elmira Heights, had deposit liabilities totaling $44.2 million at
the time of acquisition. The acquisition was accounted for as a business
combination using the purchase method of accounting, and accordingly, the excess
of the purchase price over the fair value of identifiable tangible and
intangible assets acquired, less liabilities assumed, of approximately $1.5
million has been recorded as goodwill. In accordance with SFAS No. 142, the
Company is not required to amortize goodwill recognized in this acquisition. The
Company also recorded a $2.0 million intangible asset attributable to core
deposits, which is being amortized using the straight-line method over seven
years.
On May 1, 2002, FII acquired all of the common stock of the Bank of Avoca
("BOA") in exchange for 47,036 shares of FII common stock. BOA was a community
bank with its main office located in Avoca, New York, as well as a branch office
in Cohocton, New York. Subsequent to the acquisition, BOA was merged with BNB.
The acquisition was accounted for as a business combination using the purchase
method of accounting, and accordingly, the excess of the purchase price ($1.5
million) over the fair value of identifiable tangible and intangible assets
acquired ($18.4 million), less liabilities assumed ($17.3 million), of
approximately $0.4 million has been recorded as goodwill. In accordance with
SFAS No. 142, the Company is not required to amortize goodwill recognized in
this acquisition. The Company recorded a $146,000 core deposit intangible asset,
which is being amortized using the straight-line method over seven years. The
2002 results of operations for BOA are included in the income statements from
the date of acquisition (May 1, 2002).
On October 22, 2001, the Company acquired the Burke Group, Inc. ("BGI"), an
employee benefits administration and compensation consulting firm, with offices
in Honeoye Falls and Syracuse, New York. BGI's expertise includes design and
consulting for retirement and employee welfare plans, administrative services
for defined contribution and benefit plans, actuarial services and post
employment benefits. The agreement provided for merger consideration of
$1,500,000 to BGI shareholders. Merger consideration payments of $200,000 in
cash and 34,452 shares of FII common stock (valued at $800,000 in accordance
with merger agreement) were made on October 22, 2001. The balance of the merger
consideration of $500,000 was paid on October 22, 2002 in the form of 18,852
shares of FII common stock as provided for in the agreement. In addition the
agreement provided for the payment of earned amount consideration based on
achievement of financial performance targets. For the period ending December 31,
2001 those targets were achieved and $500,000 in earned amount consideration was
paid on April 1, 2002 in the form of 17,848 shares of FII common stock. For the
period ending December 31, 2002 financial performance targets were also achieved
and $750,000 in the form of FII common stock will be paid on April 1, 2003 based
on the Company's average closing stock price for the 30 day period preceding the
payment date. The agreement further provides for payment of contingent
consideration in the form of FII common stock based on other financial
performance targets for the periods ending December 31, 2002, 2003, and 2004
with the maximum amount of payments for 2003 and 2004 being $2,250,000, and
$2,500,000 respectively. For the year ended December 31, 2002 financial
performance for contingent consideration was achieved and $590,000 in contingent
consideration will be paid on April 1, 2003 based on the Company's average
closing price for the 30 day period preceding the payment date. The acquisition
was accounted for as a business combination using the purchase method of
accounting, and accordingly, the excess of the purchase price ($3.3 million
including earned amounts and contingent amounts to date) over the fair value of
identifiable tangible and intangible assets acquired ($1.7 million), less
liabilities assumed ($1.7 million), of approximately $3.3 million has been
recorded as goodwill. In accordance with SFAS No. 142, the Company is not
required to amortize goodwill recognized in this acquisition. The Company also
recorded a $500,000 intangible asset for a customer list which is being
amortized using the straight-line method over five years. The results of
operations for BGI are included in the income statements from the date of
acquisition (October 22, 2001).
On May 1, 2001, FII acquired all of the common stock of Bath National
Corporation ("BNC") , and its wholly-owned subsidiary bank, Bath National Bank.
BNB is a full service community bank headquartered in Bath, New York, which has
9 branch locations in Steuben, Yates, Ontario and Schuyler Counties. The
53
Company paid $48.00 per share in cash for each of the outstanding shares of BNC
common stock with an aggregate purchase price of approximately $62.6 million.
The acquisition was accounted for under the purchase method of accounting, and
accordingly, the excess of the purchase price ($62.6 million) over the fair
value of identifiable tangible and intangible assets acquired ($295.4 million),
less liabilities assumed ($269.9 million), of approximately $37.1 million has
been recorded as goodwill. Goodwill was amortized in 2001 using the
straight-line method over 15 years, since the transaction was consummated prior
to June 30, 2001, the effective date of SFAS No. 142. However, in accordance
with SFAS No. 142, the Company ceased goodwill amortization on January 1, 2002.
The results of operations for BNB are included in the income statements from the
date of acquisition (May 1, 2001).
(3) Securities
The aggregate amortized cost and fair value of securities available for sale and
securities held to maturity follow:
December 31, 2002
---------------------------------------------------
Gross Unrealized
Amortized -------------------- Fair
(Dollars in thousands) Cost Gains Losses Value
--------- ------- ------ --------
Securities Available for Sale:
U.S. Treasury and agency $117,581 $ 3,058 $ 13 $120,626
Mortgage-backed securities 277,747 5,809 79 283,477
State and municipal obligations 166,981 7,959 17 174,923
Corporate bonds 13,775 203 55 13,923
Equity securities 3,010 903 -- 3,913
-------- ------- ------ --------
Total securities available for sale $579,094 $17,932 $ 164 $596,862
======== ======= ====== ========
Securities Held to Maturity:
State and municipal obligations $ 47,125 $ 969 $ 5 $ 48,089
-------- ------- ------ --------
Total securities held to maturity $ 47,125 $ 969 $ 5 $ 48,089
======== ======= ====== ========
December 31, 2001
---------------------------------------------------
Gross Unrealized
Amortized -------------------- Fair
(Dollars in thousands) Cost Gains Losses Value
--------- ------- ------ --------
Securities Available for Sale:
U.S. Treasury and agency $182,812 $ 1,949 $1,268 $183,493
Mortgage-backed securities 89,396 1,014 416 89,994
State and municipal obligations 141,637 2,220 635 143,222
Corporate bonds 7,824 121 35 7,910
Equity securities 3,082 722 -- 3,804
-------- ------- ------ --------
Total securities available for sale $424,751 $ 6,026 $2,354 $428,423
======== ======= ====== ========
Securities Held to Maturity:
U.S. Treasury and agency $ 1,950 $ 68 $ -- $ 2,018
State and municipal obligations 59,331 981 13 60,299
-------- ------- ------ --------
Total securities held to maturity $ 61,281 $ 1,049 $ 13 $ 62,317
======== ======= ====== ========
54
The amortized cost and fair value of debt securities by contractual maturity are
as follows:
December 31, 2002
----------------------------------------------------
Available for Sale Held to Maturity
------------------------ ----------------------
Amortized Fair Amortized Fair
(Dollars in thousands) Cost Value Cost Value
--------- -------- --------- -------
Due in one year or less $ 17,152 $ 17,429 $25,649 $25,804
Due in one to five years 221,932 230,817 18,236 19,007
Due in five to ten years 182,563 187,662 2,756 2,787
Due after ten years 154,437 157,041 484 491
-------- -------- ------- -------
$576,084 $592,949 $47,125 $48,089
======== ======== ======= =======
Maturities of mortgage-backed securities are classified in accordance with the
contractual repayment schedules. Expected maturities will differ from
contractual maturities since issuers generally have the right to prepay
obligations.
Proceeds from the sale and call of securities available for sale during 2002
were $45,059,000; realized gross gains were $615,000 and gross losses were
$330,000. Proceeds from the sale and call of securities available for sale
during 2001 were $91,412,000; realized gross gains were $617,000 and gross
losses were $86,000. Proceeds from the sale and call of securities available for
sale during 2000 were $14,022,000; realized gross gains were $52,000 and gross
losses were $25,000. Gains and losses were computed using the specific
identification method. There were no transfers between held to maturity and
available for sale securities in 2002, 2001 or 2000.
Securities held to maturity and available for sale with carrying values of
$475,567,000 and $340,989,000 were pledged as collateral for municipal deposits
and repurchase agreements at December 31, 2002 and 2001, respectively.
(4) Loans
Loans outstanding at December 31, 2002 and 2001 are summarized as follows:
(Dollars in thousands) 2002 2001
----------- -----------
Commercial $ 262,630 $ 232,379
Commercial real estate 332,134 274,702
Agricultural 233,769 186,623
Residential real estate 251,898 240,141
Consumer and home equity 241,461 232,205
----------- -----------
Loans, gross 1,321,892 1,166,050
Allowance for loan losses (21,660) (19,074)
----------- -----------
Loans, net $ 1,300,232 $ 1,146,976
=========== ===========
55
The following table sets forth the changes in the allowance for loan losses for
the years indicated.
Years ended December 31
(Dollars in thousands) 2002 2001 2000
------- ------- -------
Balance at beginning of year $19,074 $13,883 $11,421
Addition resulting from acquisitions 174 2,686 --
Charge-offs:
Commercial 1,771 1,003 466
Commercial real estate 944 394 629
Agricultural 106 58 85
Residential real estate 98 178 113
Consumer and home equity 1,499 1,319 905
------- ------- -------
Total charge-offs 4,418 2,952 2,198
Recoveries:
Commercial 210 58 206
Commercial real estate 69 23 22
Agricultural 36 -- 1
Residential real estate 67 19 5
Consumer and home equity 329 399 215
------- ------- -------
Total recoveries 711 499 449
------- ------- -------
Net charge-offs 3,707 2,453 1,749
Provision for loan losses 6,119 4,958 4,211
------- ------- -------
Balance at end of year $21,660 $19,074 $13,883
======= ======= =======
The following table sets forth information regarding nonaccrual loans and other
nonperforming assets at December 31:
(Dollars in thousands) 2002 2001
------- -------
Nonaccrual loans:
Commercial $12,760 $ 2,623
Commercial real estate 8,407 3,344
Agricultural 8,739 1,529
Residential real estate 1,065 921
Consumer and home equity 915 541
------- -------
Total nonaccrual loans 31,886 8,958
Restructured loans 4,129 --
Accruing loans 90 days or more delinquent 1,091 1,064
------- -------
Total nonperforming loans 37,106 10,022
Other real estate owned 1,251 947
------- -------
Total nonperforming assets $38,357 $10,969
======= =======
The recorded investment in loans that are considered to be impaired totaled
$24,626,000 and $8,289,000 at December 31, 2002 and 2001, respectively. The
allowance for loan losses related to impaired loans amounted to $4,462,000 and
$1,778,000 at December 31, 2002 and 2001, respectively. The average recorded
investment in impaired loans during 2002, 2001 and 2000 was $25,332,000,
$10,842,000 and $8,202,000, respectively. Interest income recognized on impaired
loans, while such loans were impaired, during 2002, 2001 and 2000 was
approximately $455,000, $392,000 and $316,000, respectively.
56
In the normal course of business there are various outstanding commitments to
extend credit which are not reflected in the accompanying consolidated financial
statements. Loan commitments have off-balance-sheet credit risk until
commitments are fulfilled or expire. The credit risk amounts are equal to the
contractual amounts, assuming that the amounts are ultimately advanced in full
and that the collateral or other security is of no value. The Company's policy
generally requires customers to provide collateral, usually in the form of
customers' operating assets or property, prior to the disbursement of approved
loans. At December 31, 2002, letters of credit totaling $13,359,000 and unused
loan commitments and lines of credit of $316,595,000 were contractually
available. Comparable amounts for these letters of credit and commitments at
December 31, 2001 were $8,602,000 and $265,933,000, respectively. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without funding, the total commitment amounts do not necessarily represent
future cash requirements.
Loans outstanding by subsidiary banks to certain officers, directors, or
companies in which they have 10% or more beneficial ownership, including
officers and directors of the Company, as well as its subsidiaries ("Insiders"),
approximated $36,406,000 and $25,592,000 at December 31, 2002 and 2001,
respectively.
An analysis of activity with respect to insider loans during the year ended
December 31, 2002 is as follows:
(Dollars in thousands)
Balance as of December 31, 2001 $ 25,592
New loans to insiders 12,322
Repayments received from insiders (4,658)
Other changes * 3,150
--------
Balance as of December 31, 2002 $ 36,406
========
* Other changes relate primarily to existing loans with directors elected
during 2002.
These loans were made on substantially the same terms, including interest rate
and collateral, as comparable transactions with other customers. Included in the
nonperforming asset totals are loans to two NBG directors totaling $4,934,000.
The Company has performed an assessment of the collateral on these loans and has
allocated $524,000 of the allowance for loan losses to these loans.
As of December 31, 2002, the Company had no significant concentration of credit
risk in the loan portfolio outside of normal geographic concentration pertaining
to the communities that the Company serves. There is no significant exposure to
highly leveraged transactions and there are no foreign credits in the loan
portfolio.
Loans serviced for others amounting to $356,419,000 and $302,258,000 at December
31, 2002 and 2001, respectively, are not included in the consolidated statements
of financial condition. The Company had capitalized mortgage servicing rights of
$1,243,000 and $944,000 as of December 31, 2002 and 2001, respectively. Proceeds
from the sale of loans were $139,426,000, $117,446,000 and $25,880,000 in 2002,
2001 and 2000, respectively. Net gain on the sale of loans included in mortgage
banking activities on the income statement, was $1,542,000, $1,513,000 and
$382,000 in 2002, 2001 and 2000, respectively. Included in net loans are loans
held for sale with commitments to be sold totaling $6,971,000 and $5,828,000 at
December 31, 2002 and 2001, respectively. The Company enters into forward
contracts for future delivery of residential mortgage loans at a specified yield
to reduce the interest rate risk associated with fixed rate residential mortgage
loans held for sale and commitments to fund residential mortgages. Credit risk
arises from the possible inability of the other parties to comply with the
contract terms. Substantially all of the Company's contracts are with
government-sponsored enterprises or government agencies (FHLMC and FHA).
57
(5) Premises and Equipment
A summary of premises and equipment at December 31, 2002 and 2001 follows:
(Dollars in thousands) 2002 2001
-------- --------
Land and land improvements $ 3,320 $ 2,584
Buildings and leasehold improvements 24,275 21,599
Furniture, fixtures, equipment and vehicles 19,129 16,967
-------- --------
Premises and equipment, gross 46,724 41,150
Accumulated depreciation and amortization (19,470) (16,683)
-------- --------
Premises and equipment, net $ 27,254 $ 24,467
======== ========
Depreciation and amortization expense amounted to $2,879,000, $2,403,000 and
$1,866,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
(6) Goodwill and Other Intangible Assets
As discussed in Note 1, the Company adopted the provisions of SFAS No. 142,
"Goodwill and Other Intangible Assets," on January 1, 2002. Under SFAS No. 142,
goodwill is no longer amortized, but is reviewed for impairment at least
annually. Identifiable intangible assets acquired in a business combination are
amortized over their useful lives.
The following table presents the consolidated results of operations for the
years ended December 31, 2002 and 2001, adjusted as though the adoption of SFAS
No. 142 occurred as of January 1, 2000.
Years ended December 31
(Dollars in thousands, except per share amounts) 2002 2001 2000
---------- ---------- ----------
Reported net income $ 26,456 $ 21,213 $ 18,100
Goodwill amortization add-back -- 1,653 --
---------- ---------- ----------
Adjusted net income $ 26,456 $ 22,866 $ 18,100
========== ========== ==========
Basic earnings per share:
Reported $ 2.26 $ 1.79 $ 1.51
Goodwill amortization add-back -- 0.15 --
---------- ---------- ----------
Adjusted $ 2.26 $ 1.94 $ 1.51
========== ========== ==========
Diluted earnings per share:
Reported $ 2.23 $ 1.77 $ 1.51
Goodwill amortization add-back -- 0.15 --
---------- ---------- ----------
Adjusted $ 2.23 $ 1.92 $ 1.51
========== ========== ==========
Goodwill resulting from the previously disclosed mergers and acquisitions (see
Note 2) amounted to $40.6 million and $36.8 million at December 31, 2002 and
2001, respectively. Goodwill amortization expense included in the results of
operations for 2001 amounted to $1.7 million, which was non-deductible for
income tax purposes. In accordance with SFAS No. 142, there is no goodwill
amortization included in 2002.
58
The following table presents the change in the carrying amount of goodwill
allocated by business segment for the years ended December 31, 2002 and 2001:
Financial Services
BNB Group
(Dollars in thousands) Segment Segment Total
-------- ------------------ --------
Balance as of December 31, 2000 $ -- $ -- $ --
Goodwill acquired during the period 37,188 794 37,982
Contingent earnout -- 500 500
Amortization expense (1,653) -- (1,653)
-------- ------ --------
Balance as of December 31, 2001 $ 35,535 $1,294 $ 36,829
Goodwill acquired during the period 1,925 -- 1,925
Contingent earnout -- 1,840 1,840
Goodwill adjustments (119) 118 (1)
-------- ------ --------
Balance as of December 31, 2002 $ 37,341 $3,252 $ 40,593
======== ====== ========
During 2002, the Company performed a goodwill impairment analysis as required by
SFAS No. 142 and determined no impairment existed.
A summary of the major classes of amortizable intangible assets (included in
other assets on the consolidated statements of financial condition) at December
31, 2002 and 2001 follows:
(Dollars in thousands) 2002 2001
-------- -------
Core deposits $ 11,452 $ 8,937
Customer list 500 500
-------- -------
Other intangible assets, gross 11,952 9,437
Accumulated amortization (7,998) (7,100)
-------- -------
Other intangible assets, net $ 3,954 $ 2,337
======== =======
Intangible amortization expense for these other intangible assets amounted to
$898,000, $728,000 and $737,000 for the years ended December 31, 2002, 2001 and
2000, respectively. Amortization of other intangible assets was computed using
the straight-line method over the estimated lives of the respective assets,
which primarily range from 5 to 10 years. Based on the current level of
intangible assets, estimated amortization expense for other intangible assets is
as follows:
Year ending December 31,
(Dollars in thousands)
2003 $1,222
2004 804
2005 526
2006 494
2007 320
Thereafter 588
------
$3,954
======
59
(7) Deposits
Scheduled maturities for certificates of deposit at December 31, 2002 are as
follows:
Mature in year ending December 31,
(Dollars in thousands)
2003 $508,902
2004 115,925
2005 39,736
2006 10,365
2007 12,953
Thereafter 115
--------
$687,996
========
Certificates of deposit greater than $100,000 totaled $201,751,000 and
$234,450,000 at December 31, 2002 and 2001, respectively. Interest expense on
certificates of deposit greater than $100,000 amounted to $7,682,000,
$15,922,000 and $15,962,000 for the years ended December 31, 2002, 2001 and
2000, respectively.
As of December 31, 2002 and 2001, overdrawn deposits included in loans on the
consolidated statements of financial condition amounted to $3,459,000 and
$2,553,000, respectively.
(8) Borrowings
Outstanding borrowings at December 31, 2002 and 2001 are summarized as follows:
(Dollars in thousands) 2002 2001
------- --------
Short-term borrowings:
Federal funds purchased and securities
sold under repurchase agreements $60,679 $ 60,957
FHLB advances 26,000 42,135
Other 510 678
------- --------
Total short-term borrowings $87,189 $103,770
======= ========
Long-term borrowings:
FHLB advances $86,822 $ 65,097
Other 5,268 5,322
------- --------
Total long-term borrowings $92,090 $ 70,419
======= ========
Information related to Federal funds purchased and securities sold under
repurchase agreements as of and for the years ended December 31, 2002, 2001 and
2000 is summarized as follows:
(Dollars in thousands) 2002 2001 2000
------- ------- -------
Weighted average interest rate at year-end 1.50% 1.88% 4.26%
Maximum outstanding at any month-end $61,951 $65,474 $26,135
Average amount outstanding during the year $47,924 $33,157 $ 7,939
The average amounts outstanding are computed using daily average balances.
Related interest expense for 2002, 2001 and 2000 was $951,000, $1,108,000 and
$400,000, respectively.
At December 31, 2002, the Company had outstanding various short and long-term
FHLB advances with maturity dates extending through 2009. The FHLB advances bear
interest at fixed rates ranging from 1.40% to 6.71% and the weighted average
interest rate amounted to 4.29% as of December 31, 2002.
60
The Company's FHLB advances include $20.0 million in fixed-rate callable
borrowings, which can be called by the FHLB on a quarterly basis. FHLB advances
are collateralized by $6.3 million of FHLB stock and mortgage loans with a
carrying value of $138.1 million at December 31, 2002. At December 31, 2002, the
Company had remaining credit available of $13.0 million under lines of credit
with the FHLB. The Company also had $56.2 million of remaining credit available
under unsecured lines of credit with various banks at December 31, 2002. During
2001, the Company also obtained lines of credit with Farmer Mac permitting
borrowings to a maximum of $50.0 million. However, no advances were outstanding
against the Farmer Mac lines at December 31, 2002.
Other long-term borrowings consist primarily of a $5.0 million advance on a
credit agreement with another commercial bank, which was executed to aid in
funding the acquisition of BNB during 2001. The credit agreement requires
monthly payments of interest only, at a variable interest rate of LIBOR plus
1.50%. As of December 31, 2002 the interest rate was 3.30%. The credit agreement
expires in April 2004.
The aggregate maturities of long-term borrowings at December 31, 2002 are as
follows:
Mature in year ending December 31,
(Dollars in thousands)
2004 $31,868
2005 8,179
2006 11,183
2007 14,213
2008 5,278
Thereafter 21,369
-------
$92,090
=======
(9) Guaranteed Preferred Beneficial Interests in Corporations Junior
Subordinated Debentures
On February 22, 2001, the Company established FISI Statutory Trust I (the
"Trust"), which is a statutory business trust formed under Connecticut law. The
Trust exists for the exclusive purposes of (i) issuing and selling 30 year
guaranteed preferred beneficial interests in the Corporation's junior
subordinated debentures ("capital securities") in the aggregate amount of $16.2
million at a fixed rate of 10.20%, (ii) using the proceeds from the sale of the
capital securities to acquire the junior subordinated debentures issued by the
Company and (iii) engaging in only those other activities necessary, advisable
or incidental thereto. The junior subordinated debentures are the sole assets of
the Trust and, accordingly, payments under the corporation obligated junior
debentures are the sole revenue of the Trust. All of the common securities of
the Trust are owned by the Company. The Company used the net proceeds from the
sale of the capital securities to partially fund the BNB acquisition. As of
December 31, 2002 and 2001, respectively, $16.2 million and $12.4 million of the
capital securities qualified as Tier I capital under regulatory definitions. The
Company's primary source of funds to pay interest on the debentures owed to the
Trust are current dividends from its subsidiary banks. Accordingly, the
Company's ability to service the debentures is dependent upon the continued
ability of the subsidiary banks to pay dividends to the Company. Since the
capital securities are classified as debt for financial statement purposes, the
tax-deductible expense associated with the capital securities is recorded as
interest expense in the consolidated statements of income. The Company incurred
$487,000 in costs to issue the securities. The costs are being amortized over 20
years using the straight-line method and are included in other assets on the
consolidated statements of financial condition.
61
(10) Income Taxes
Total income taxes for the years ended December 31, 2002, 2001 and 2000 were
allocated as follows:
(Dollars in thousands) 2002 2001 2000
------- ------- -------
Income from operations $12,419 $11,033 $ 9,804
Shareholders' equity, for unrealized gain
on securities available for sale 5,488 1,588 1,746
------- ------- -------
$17,907 $12,621 $11,550
======= ======= =======
Income tax expense (benefit) attributable to operations for the years ended
December 31, 2002, 2001 and 2000 consists of:
(Dollars in thousands) 2002 2001 2000
-------- -------- --------
Current:
Federal $ 10,828 $ 8,676 $ 8,380
State 2,651 2,469 2,389
-------- -------- --------
Total current 13,479 11,145 10,769
Deferred:
Federal (908) (68) (785)
State (152) (44) (180)
-------- -------- --------
Total deferred (1,060) (112) (965)
-------- -------- --------
Total income taxes $ 12,419 $ 11,033 $ 9,804
======== ======== ========
The following is a reconciliation of the actual and statutory tax rates
applicable to income from operations for the years ended December 31, 2002, 2001
and 2000:
2002 2001 2000
------ ------ ------
Statutory rate 35.0% 35.0% 35.0%
Increase (decrease) resulting from:
Tax exempt interest income (7.8) (8.1) (6.0)
State taxes, net of federal income tax benefit 4.2 4.9 5.1
Goodwill amortization -- 1.8 --
Other 0.5 0.6 1.0
------ ------ ------
Total 31.9% 34.2% 35.1%
====== ====== ======
62
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities at December 31, 2002 and 2001 are presented
as follows:
(Dollars in thousands) 2002 2001
-------- -------
Deferred tax assets:
Allowance for loan losses $ 8,216 $ 7,165
Core deposit intangible 822 773
Interest on nonaccrual loans 869 750
Other 946 395
-------- -------
Total gross deferred tax assets 10,853 9,083
Deferred tax liabilities:
Prepaid pension costs 1,017 1,150
Unrealized gain on securities available for sale 6,976 1,488
Depreciation of premises and equipment 917 693
Loan servicing assets 479 354
Other 697 476
-------- -------
Total gross deferred tax liabilities 10,086 4,161
-------- -------
Net deferred tax asset, at year-end * $ 767 $ 4,922
Net deferred tax asset, at beginning of year 4,922 4,581
-------- -------
Decrease (increase) in net deferred tax asset 4,155 (341)
Net deferred tax asset acquired 368 1,470
Initial purchase accounting adjustments, net (95) 347
Change in unrealized gain/loss on securities available for sale (5,488) (1,588)
-------- -------
Deferred tax benefit $ (1,060) $ (112)
======== =======
* Included in other assets on the consolidated statements of financial
condition
Realization of deferred tax assets is dependent upon the generation of future
taxable income or the existence of sufficient taxable income within the
carry-back period. A valuation allowance is provided when it is more likely than
not that some portion of the deferred tax assets will not be realized. In
assessing the need for a valuation allowance, management considers the scheduled
reversal of the deferred tax liabilities, the level of historical taxable income
and projected future taxable income over the periods in which the temporary
differences comprising the deferred tax assets will be deductible. Based on its
assessment, management determined that no valuation allowance is necessary at
December 31, 2002 and 2001.
The Company has Federal and state net operating loss carryforwards of $510,000
which expire in 2021. The utilization of the tax net operating carryforwards is
subject to limitations imposed by the Internal Revenue Code. The Company
believes these limitations will not prevent the carryforward benefits from being
utilized.
63
(11) Lease Commitments
At December 31, 2002, the Company was obligated under a number of noncancellable
operating leases for land, buildings and equipment. Certain of these leases
provide for escalation clauses and contain renewal options calling for increased
rentals if the lease is renewed. Future minimum lease payments on operating
leases at December 31, 2002 were as follows:
Operating lease payments in year ending December 31,
(Dollars in thousands)
2003 $ 646
2004 579
2005 520
2006 462
2007 400
Thereafter 2,136
------
$4,743
======
(12) Retirement Plans and Postretirement benefits
Defined Benefit Plan
The Company has a defined benefit pension plan covering substantially all
employees. The benefits are based on years of service and the employee's highest
average compensation during five consecutive years of employment. The Company's
funding policy is to contribute annually an actuarially determined amount to
cover current service cost plus amortization of prior service costs.
The following table sets forth the defined benefit pension plan's change in
benefit obligation and change in plan assets using the most recent actuarial
data measured at September 30:
(Dollars in thousands) 2002 2001 2000
-------- -------- --------
Change in benefit obligation:
Benefit obligation at beginning of year $(13,608) $(12,114) $(11,740)
Service cost (1,071) (1,249) (766)
Interest cost (968) (890) (806)
Actuarial (loss) gain (1,303) 72 603
Benefits paid 559 470 476
Plan expenses 109 103 119
-------- -------- --------
Benefit obligation at end of year (16,282) (13,608) (12,114)
Change in plan assets:
Fair value of plan assets at beginning of year 15,240 17,180 15,706
Actual (loss) return on plan assets (831) (1,367) 1,588
Employer contribution 552 -- 481
Benefits paid (559) (470) (476)
Plan expenses (108) (103) (119)
-------- -------- --------
Fair value of plan assets at end of year 14,294 15,240 17,180
-------- -------- --------
Funded status (1,988) 1,632 5,066
Unamortized net asset at transition (141) (179) (217)
Unrecognized net loss (gain) subsequent to transition 4,722 1,292 (1,433)
Unamortized prior service cost 322 345 (57)
-------- -------- --------
Prepaid benefit cost, included in other assets $ 2,915 $ 3,090 $ 3,359
======== ======== ========
Weighted average discount rate 6.75% 7.25% 7.50%
Expected long-term rate of return 8.50% 8.50% 8.50%
Rate of compensation increase 4.00% 5.00% 5.00%
64
Pension expense consists of the following components for the years ended
December 31:
(Dollars in thousands) 2002 2001 2000
------- ------- -------
Service cost $ 1,071 $ 850 $ 766
Interest cost on projected benefit obligation 968 890 806
Expected return on plan assets (1,297) (1,429) (1,307)
Amortization of net transition asset (38) (38) (38)
Amortization of unrecognized prior service cost 22 (3) (3)
------- ------- -------
Net periodic pension expense $ 726 $ 270 $ 224
======= ======= =======
Defined Contribution Plan
The Company also sponsors a defined contribution profit sharing (401(k)) plan
covering substantially all employees. The Company matches certain percentages of
each eligible employee's contribution to the plan. Expense for the plan amounted
to $1,057,000, $708,000 and $524,000 in 2002, 2001 and 2000, respectively.
Postretirement Benefits
Prior to December 31, 2001, BNB provided health and dental care benefits to
retired employees who met specified age and service requirements through a
postretirement health and dental care plan in which both BNB and the retiree
shared the cost. The plan provided for substantially the same medical insurance
coverage as for active employees until their death and was integrated with
Medicare for those retirees aged 65 or older. In 2001, the plan's eligibility
requirements were amended to curtail eligible benefit payments to only retired
employees and active participants who were fully vested under the Plan. The
accrued liability related to this plan amounted to $844,000 and $741,000 as of
December 31, 2002 and 2001, respectively. Expense for the plan amounted to
$172,000 and $80,000 for the years ended December 31, 2002 and 2001,
respectively.
(13) Stock Compensation Plans
The Company has a Management Stock Incentive Plan and a Directors' Stock
Incentive Plan. Under the plans, the Company may grant stock options to its
directors, directors of its subsidiaries, and key employees to purchase shares
of common stock, shares of restricted stock and stock appreciation rights.
Grants under the plans may be made to up to 10% of the number of shares of
common stock issued, including treasury shares. The exercise price of each
option equals the market price of the Company's stock on the date of the grant.
The maximum term of each option is ten years and the options' generally vest
between three and five years.
65
The following is a summary of the status of the Company's stock option plans as
of December 31, 2002, 2001 and 2000, as well changes in the plans during the
years then ended:
Weighted
Stock Average
Options Exercise
Outstanding Price
----------- --------
Balance December 31, 1999 $ 319,042 $14.00
Granted 70,638 13.45
Cancelled (5,162) (13.56)
--------- ------
Balance December 31, 2000 384,518 13.90
Granted 115,637 18.94
Cancelled (3,474) (13.65)
--------- ------
Balance December 31, 2001 496,681 15.08
Granted 52,353 27.41
Exercised (19,955) 13.95
Cancelled (74,792) (13.99)
--------- ------
Balance December 31, 2002 $ 454,287 $16.73
========= ======
Exercisable at:
December 31, 2002 $ 224,284 $14.75
December 31, 2001 153,826 13.92
December 31, 2000 65,986 14.00
The following table summarizes information about stock options outstanding and
exercisable at December 31, 2002:
Outstanding Exercisable
----------------------------------- ---------------------
Weighted Weighted Weighted
Number Average Average Number Average
Range of of Stock Exercise Life of Stock Exercise
Exercise Price Options Price (in years) Options Price
---------------- -------- -------- ---------- -------- --------
$11.75 to $14.17 330,551 $13.91 6.71 200,490 $13.89
$19.03 to $21.44 37,000 21.35 8.33 12,333 21.35
$21.45 to $23.87 34,383 22.59 8.72 11,461 22.59
$23.88 to $26.29 37,486 25.33 9.08 -- --
$26.30 to $28.72 4,950 26.45 9.68 -- --
$31.15 to $33.57 917 33.15 9.43 -- --
$33.58 to $36.00 9,000 36.00 9.35 -- --
------- ------ ------ ------- ------
454,287 $16.73 7.28 224,284 $14.75
======= ====== ====== ======= ======
66
(14) Earnings Per Common Share
Basic earnings per share, after giving effect to preferred stock dividends, has
been computed using weighted average common shares outstanding. Diluted earnings
per share reflects the effects, if any, of incremental common shares issuable
upon exercise of dilutive stock options.
Earnings per common share have been computed based on the following:
Years Ended December 31
-----------------------------
(Dollars and shares in thousands) 2002 2001 2000
------- ------- -------
Net income $26,456 $21,213 $18,100
Less: Preferred stock dividends 1,496 1,496 1,496
------- ------- -------
Net income available to common shareholders $24,960 $19,717 $16,604
======= ======= =======
Weighted average number of common shares outstanding
used to calculate basic earnings per common share 11,068 10,994 10,995
Add: Effect of dilutive options 150 132 1
------- ------- -------
Weighted average number of common shares used to
calculate diluted earnings per common share 11,218 11,126 10,996
======= ======= =======
(15) Regulatory Capital
The Company is subject to various regulatory capital requirements administered
by the Federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory, and possibly additional discretionary, actions
by regulators that, if undertaken, could have a direct material impact on the
Company's financial statements.
For evaluating regulatory capital adequacy, companies are required to determine
capital and assets under regulatory accounting practices. Quantitative measures
established by regulation to ensure capital adequacy require the Company to
maintain minimum amounts and ratios. The leverage ratio requirement is based on
period-end capital to average total assets during the previous three months.
Compliance with risk-based capital requirements is determined by dividing
regulatory capital by the sum of a company's weighted asset values. Risk
weightings are established by the regulators for each asset category according
to the perceived degree of risk. As of December 31, 2002 and 2001, the Company
and each subsidiary bank met all capital adequacy requirements to which they are
subject.
As of December 31, 2002, the most recent notification from the Federal Deposit
Insurance Corporation categorized the Company and its subsidiary banks as well
capitalized under the regulatory framework for prompt corrective action. There
are no conditions or events since that notification that management believes
have changed the Company's category.
Payments of dividends by the subsidiary banks to FII are limited or restricted
in certain circumstances under banking regulations. At December 31, 2002, an
aggregate of $9,609,000 was available for payment of dividends by the subsidiary
banks to FII without the approval from the appropriate regulatory authorities.
67
The following is a summary of the actual capital amounts and ratios for the
Company and its subsidiary banks as of December 31:
2002
------------------------------------------------------------------
Actual Regulatory
Capital Minimum Requirements Well-Capitalized
----------------- -------------------- ------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Leverage capital (Tier 1) as percent
of three-month average assets:
Company $139,620 6.96% $ 80,233 4.00% $100,292 5.00%
BNB 24,505 5.93 16,527 4.00 20,658 5.00
FTB 11,356 5.67 8,017 4.00 10,022 5.00
NBG 48,420 6.71 28,870 4.00 36,087 5.00
WCB 44,175 6.64 26,592 4.00 33,240 5.00
As percent of risk-weighted, period-end
assets: Core capital (Tier 1):
Company 139,620 9.82 56,846 4.00 85,270 6.00
BNB 24,505 9.70 10,110 4.00 15,165 6.00
FTB 11,356 9.45 4,807 4.00 7,210 6.00
NBG 48,420 8.90 21,758 4.00 32,637 6.00
WCB 44,175 8.94 19,761 4.00 29,642 6.00
Total capital (Tiers 1 and 2):
Company 157,433 11.08 113,693 8.00 142,116 10.00
BNB 27,669 10.95 20,220 8.00 25,275 10.00
FTB 12,861 10.70 9,613 8.00 12,017 10.00
NBG 55,243 10.16 43,515 8.00 54,394 10.00
WCB 50,369 10.20 39,522 8.00 49,403 10.00
2001
------------------------------------------------------------------
Actual Regulatory
Capital Minimum Requirements Well-Capitalized
----------------- -------------------- ------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Leverage capital (Tier 1) as percent
of three-month average assets:
Company $120,638 7.02% $ 68,721 4.00% $ 85,902 5.00%
BNB 27,428 8.43 13,008 4.00 16,260 5.00
FTB 8,951 6.08 5,893 4.00 7,366 5.00
NBG 37,415 6.96 21,506 4.00 26,883 5.00
PSB 12,154 7.02 6,922 4.00 8,652 5.00
WCB 35,437 6.56 21,538 4.00 26,922 5.00
As percent of risk-weighted, period-end
assets: Core capital (Tier 1):
Company 120,638 9.81 49,192 4.00 73,789 6.00
BNB 27,428 14.18 7,741 4.00 11,611 6.00
FTB 8,951 8.94 4,003 4.00 6,005 6.00
NBG 37,415 9.24 16,191 4.00 24,287 6.00
PSB 12,154 9.14 5,318 4.00 7,978 6.00
WCB 35,347 8.95 15,792 4.00 23,688 6.00
Total capital (Tiers 1 and 2):
Company 139,847 11.37 98,385 8.00 122,981 10.00
BNB 29,851 15.43 15,481 8.00 19,352 10.00
FTB 10,206 10.20 8,006 8.00 10,008 10.00
NBG 42,487 10.50 32,382 8.00 40,478 10.00
PSB 13,822 10.40 10,637 8.00 13,296 10.00
WCB 40,301 10.21 31,585 8.00 39,481 10.00
68
(16) Fair Value of Financial Instruments
The "fair value" of a financial instrument is defined as the price a willing
buyer and a willing seller would exchange in other than a distressed sale
situation. The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments at December 31, 2002 and 2001:
2002 2001
------------------------- -------------------------
Carrying Fair Carrying Fair
(Dollars in thousands) Amount Value Amount Value
---------- ---------- ---------- ----------
Financial Assets
Cash and cash equivalents $ 48,429 $ 48,429 $ 53,171 $ 53,171
Securities 643,987 644,951 489,704 490,740
FHLB and FRB stock 8,558 8,558 7,732 7,732
Loans, net 1,300,232 1,345,314 1,146,976 1,174,381
Financial Liabilities
Deposits:
Interest Bearing:
Savings and interest
bearing demand 779,772 779,772 572,563 572,563
Time deposits 687,996 691,020 636,467 635,425
Non-interest bearing demand 240,755 240,755 224,628 224,628
---------- ---------- ---------- ----------
Total deposits 1,708,523 1,711,547 1,433,658 1,432,616
Borrowings:
Short-term 87,189 88,027 103,770 103,770
Long-term 92,090 101,772 70,419 74,042
Guaranteed preferred beneficial
interests in corporation's junior
subordinated debentures 16,200 19,082 16,200 17,596
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments.
Cash and cash equivalents: The carrying amounts reported in the consolidated
statements of financial condition for cash, due from banks, interest-bearing
deposits and Federal funds sold approximate the fair value of those assets.
Securities: Fair value is based on quoted market prices, where available. Where
quoted market prices are not available, fair value is based on quoted market
prices of comparable instruments.
FHLB and FRB stock: The carrying amounts reported in the consolidated statements
of financial condition for FHLB and FRB stock approximate the fair value of
those assets.
Loans: For variable rate loans that reprice frequently, fair value approximates
carrying amount. The fair value for fixed rate loans is estimated through
discounted cash flow analysis using interest rates currently being offered for
loans with similar terms and credit quality. The fair value of loans held for
sale is based on quoted market prices and investor commitments. For
nonperforming loans, fair value is estimated by discounting expected cash flows
at a rate commensurate with the risk associated with the estimated cash flows.
Deposits: The fair value for savings, interest bearing and non-interest bearing
demand accounts is equal to the carrying amount because of the customer's
ability to withdraw funds immediately. The fair value of time deposits is
estimated using a discounted cash flow approach that applies prevailing market
interest rates for similar maturity instruments.
69
Borrowings: Carrying value approximates fair value for short-term borrowings.
The fair value for long-term borrowings is estimated using a discounted cash
flow approach that applies prevailing market interest rates for similar maturity
instruments.
Guaranteed Preferred Beneficial Interests in Corporation's Junior Subordinated
Debentures: The fair value for guaranteed preferred beneficial interests in
corporation's junior subordinated debentures is estimated using a discounted
cash flow approach that applies prevailing market interest rates for similar
maturity instruments.
(17) Segment Information
Reportable segments are comprised of WCB, NBG, BNB and FTB as the Company
evaluates performance on an individual bank basis. As stated in Note 1, during
2002 the Company completed a geographic realignment of the subsidiary banks,
which involved the merger of the subsidiary formerly known as PSB into NBG and
subsequent transfer of branches between NBG and WCB. Accordingly, the Company
restated segment results to reflect the merger and transfers for each of the
years presented. All of the revenue, expenses, assets and liabilities of PSB
have been reallocated to the WCB and NBG segments. The reportable segment
information as of and for the years ended December 31, 2002, 2001 and 2000
follows:
(Dollars in thousands) 2002 2001 2000
----------- ----------- -----------
Net interest income
WCB $ 28,577 $ 27,039 $ 24,790
NBG 26,853 24,732 22,148
BNB 14,048 8,184 --
FTB 8,175 6,041 5,173
Financial Services Group -- -- --
----------- ----------- -----------
Total segment net interest income 77,653 65,996 52,111
Parent and eliminations, net (1,799) (1,222) 751
----------- ----------- -----------
Total net interest income $ 75,854 $ 64,774 $ 52,862
=========== =========== ===========
Net income
WCB $ 10,565 $ 9,643 $ 8,463
NBG 9,765 9,777 8,245
BNB 5,001 1,142 --
FTB 2,775 1,827 1,523
Financial Services Group 246 143 5
----------- ----------- -----------
Total segment net income 28,352 22,532 18,236
Parent and eliminations, net (1,896) (1,319) (136)
----------- ----------- -----------
Total net income $ 26,456 $ 21,213 $ 18,100
=========== =========== ===========
Assets
WCB $ 674,755 $ 632,058 $ 572,650
NBG 721,090 642,827 581,306
BNB 495,055 362,645 --
FTB 203,382 161,763 131,638
Financial Services Group 5,052 2,788 172
----------- ----------- -----------
Total segment assets 2,099,334 1,802,081 1,285,766
Parent and eliminations, net 5,700 (7,785) 3,561
----------- ----------- -----------
Total assets $ 2,105,034 $ 1,794,296 $ 1,289,327
=========== =========== ===========
70
(18) Condensed Parent Company Only Financial Statements
The following are the condensed statements of condition of FII as of December
31, 2002 and 2001, and the condensed statements of income and cash flows for the
years ended December 31, 2002, 2001 and 2000:
Condensed Statements of Condition
(Dollars in thousands) 2002 2001
-------- --------
Assets:
Cash and due from subsidiaries $ 14,267 $ 7,186
Securities available for sale, at fair value 1,268 1,333
Investment in subsidiaries 186,703 163,053
Other assets 5,099 5,236
-------- --------
Total assets $207,337 $176,808
======== ========
Liabilities and shareholders' equity
Due to subsidiaries $ 16,702 $ 16,702
Short-term borrowings 500 500
Long-term borrowings 5,000 5,000
Other liabilities 6,841 5,419
Shareholders' equity 178,294 149,187
-------- --------
Total liabilities and shareholders' equity $207,337 $176,808
======== ========
Condensed Statements of Income
(Dollars in thousands) 2002 2001 2000
------- ------- --------
Dividends from subsidiaries $22,015 $16,643 $ 30,115
Other income 8,542 7,577 6,178
------- ------- --------
Total income 30,557 24,220 36,293
Expenses 11,477 9,602 6,190
------- ------- --------
Income before income taxes and effect of
subsidiaries' earnings and dividends 19,080 14,618 30,103
Income tax benefit (expense) 1,160 788 (33)
------- ------- --------
Income before effect of subsidiaries'
earnings and dividends 20,240 15,406 30,070
Equity in undistributed earnings (dividends in
excess of earnings) of subsidiaries 6,216 5,807 (11,970)
------- ------- --------
Net income $26,456 $21,213 $ 18,100
======= ======= ========
71
Condensed Statements of Cash Flows
(Dollars in thousands) 2002 2001 2000
-------- -------- --------
Cash flows from operating activities:
Net income $ 26,456 $ 21,213 $ 18,100
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 878 711 620
Dividends in excess of earnings
(equity in undistributed earnings)
of subsidiaries (6,216) (5,807) 11,970
Deferred income tax benefit (176) (102) (56)
Gain on sale of securities (161) -- --
Decrease (increase) in accrued dividends
receivable from subsidiaries -- 22,962 (22,962)
Increase in other assets (4,953) (1,139) (181)
Increase in accrued expense and
other liabilities 1,393 1,562 230
-------- -------- --------
Net cash provided by
operating activities 17,221 39,400 7,721
-------- -------- --------
Cash flows from investing activities:
Purchase of available for sale securities (26) -- (140)
Proceeds from sale of available for sale securities 256 -- --
Investment in Mercantile Adjustment Bureau, LLC (2,400) -- --
Equity investment in subsidiaries, net -- (63,381) --
Purchase of premises and equipment, net (274) (1,109) (340)
-------- -------- --------
Net cash used in
investing activities (2,444) (64,490) (480)
-------- -------- --------
Cash flows from financing activities:
Proceeds from short-term borrowings -- 500 --
Proceeds from long-term borrowings -- 5,000 --
Repayment of long-term borrowings -- -- (1,698)
Proceeds from issuance of guaranteed
preferred beneficial interests in
corporation's junior subordinated
debentures -- 16,200 --
Purchase of preferred and common shares (581) (16) (454)
Issuance of preferred and common shares 463 27 29
Dividends paid (7,578) (6,551) (5,788)
-------- -------- --------
Net cash (used in) provided by
financing activities (7,696) 15,160 (7,911)
-------- -------- --------
Net increase (decrease) in cash and
cash equivalents 7,081 (9,930) (670)
Cash and cash equivalents at the
beginning of the year 7,186 17,116 17,786
-------- -------- --------
Cash and cash equivalents at the
end of the year $ 14,267 $ 7,186 $ 17,116
======== ======== ========
72
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Financial Institutions, Inc.:
We have audited the accompanying consolidated statements of financial condition
of Financial Institutions, Inc. and subsidiaries as of December 31, 2002 and
2001, and the related consolidated statements of income, changes in
shareholders' equity and comprehensive income, and cash flows for each of the
years in the three-year period ended December 31, 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
the significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Financial
Institutions, Inc. and subsidiaries as of December 31, 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 Notes 1 and 6 to the consolidated financial statements, the
Company changed its method of accounting for goodwill in 2002 upon adoption of
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets."
/s/ KPMG LLP
Buffalo, New York
February 26, 2003
73
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information regarding directors and all of the executive officers of the
Registrant on pages 3, 4, 10, 12, 13 and 14 of the Proxy Statement for its 2003
Annual Meeting of Shareholders to be filed with the U.S. Securities and Exchange
Commission is incorporated herein by reference thereto.
Item 11. Executive Compensation
Information regarding executive compensation on pages 8 through 10 of the
Registrant's Proxy Statement for its 2003 Annual Meeting of Shareholders to be
filed with the U.S. Securities and Exchange Commission is incorporated herein by
reference thereto.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Information regarding security ownership of certain beneficial owners of the
Company's management on page 5 of the Registrant's Proxy Statement for its 2003
Annual Meeting of Shareholders to be filed with the U.S. Securities and Exchange
Commission is incorporated herein by reference thereto.
Item 13. Certain Relationships and Related Transactions
Information regarding certain relationships and related transactions on pages 13
and 14 of the Registrant's Proxy Statement for its 2003 Annual Meeting of
Shareholders to be filed with the U.S. Securities and Exchange Commission is
incorporated herein by reference thereto.
PART IV
Item 14. Controls and Procedures
Within 90 days of the date of this report, the Company, under the supervision of
its Chief Executive Officer and Chief Financial Officer conducted an evaluation
of the effectiveness of disclosure controls and procedures. As part of this
review, the Company identified two control issues at a subsidiary bank that if
not corrected could impact the effectiveness of the Company's internal
disclosure controls and procedures. The two areas of concern at the subsidiary
bank were disclosure controls over the timing of problem loan identification and
disclosure controls over lending to insiders under Regulation O. Since the
identification of these issues, new procedures have been put in place to
evaluate and assess the process of loan grading and problem loan identification
at each subsidiary bank. The Company is also adding credit administration and
loan workout personnel at the holding company level to improve insider loan
reporting and to facilitate earlier intervention with respect to problem loans.
Based on their evaluation of the effectiveness of disclosure controls and
procedures, and following the implementation of the above described actions, the
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective in ensuring that all material
information required to be filed in the Company's periodic SEC reports is made
known to them in a timely fashion. Except, as described herein, there have been
no significant changes in the Company's internal controls, or in factors that
could significantly affect the Company's internal controls, subsequent to the
date the Chief Executive Officer and Chief Financial Officer completed their
evaluation.
74
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) List of Documents Filed as Part of this Report
(1) Financial Statements.
The financial statements listed below and the Independent
Auditors' Report are included in this Annual Report on Form
10-K:
Independent Auditors' Report
Consolidated Statements of Financial Condition as of
December 31, 2002 and 2001
Consolidated Statements of Income for the years ended
December 31, 2002, 2001 and 2000
Consolidated Statements of Changes in Shareholders'
Equity and Comprehensive Income for the years ended
December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows the years ended
December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements
(2) Schedules.
All schedules are omitted since the required information is
either not applicable, not required, or is contained in the
respective financial statements or in the notes thereto.
75
(3) Exhibits.
The following is a list of all exhibits filed or incorporated
by reference as part of this Registration Statement.
Exhibit No. Description Location
- ----------- -------------------------------------------------- -----------------------------------------
3.1 Amended and Restated Certificate of Contained in Exhibit 3.1 of the
Incorporation Registrant's Registration Statement
on Form S-1 dated June 25, 1999
(File No. 333-76865)
(The "S-1 Registration Statement")
3.2 Amended and Restated Bylaws Contained in Exhibit 3.1 of the Form 10-K
for the year ended December 31, 2001
dated March 11, 2002
10.1 1999 Management Stock Incentive Plan Contained in Exhibit 10.1
of the S-1 Registration Statement
10.2 1999 Directors Stock Incentive Plan Contained in Exhibit 10.2
of the S-1 Registration Statement
11 Statement of Computation of Per Share Earnings Contained in Note 14 of the
Registrant's Consolidated
Financial Statements Under
Item 8 Filed Herewith
21 Subsidiaries of Financial Institutions, Inc. Filed Herewith
23 Consent of KPMG LLP Filed Herewith
24 Power of Attorney Filed Herewith
99.1 Certification Pursuant to 18 U.S.C. Section 1350, Filed Herewith
As adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, Filed Herewith
As adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
The Company filed no Current Reports on Form 8-K during the quarter
ended December 31, 2002.
76
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FINANCIAL INSTITUTIONS, INC.
Date: March 14, 2003 By: /s/ Peter G. Humphrey
-------------------------------
Peter G. Humphrey
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the date indicated.
Signatures Title Date
---------- ----- ----
/s/ Peter G. Humphrey President, Chief Executive Officer March 14, 2003
- -------------------------- (Principal ExecutiveOfficer),
Peter G. Humphrey Chairman of the Board and Director
/s/ Ronald A. Miller Senior Vice President and March 14, 2003
- -------------------------- Chief Financial Officer
Ronald A. Miller (Principal Accounting Officer)
* Director March 14, 2003
- --------------------------
John E. Benjamin
* Director and Senior Vice President March 14, 2003
- --------------------------
Jon J. Cooper
* Director March 14, 2003
- --------------------------
Barton P. Dambra
* Director March 14, 2003
- --------------------------
Samuel M. Gullo
* Director March 14, 2003
- --------------------------
Pamela Davis Heilman
* Director March 14, 2003
- --------------------------
Susan R. Holliday
* Director March 14, 2003
- --------------------------
W.J. Humphrey, Jr.
* Director March 14, 2003
- --------------------------
H. Jack South
* Director March 14, 2003
- --------------------------
John R. Tyler, Jr.
* Director March 14, 2003
- --------------------------
Bryan G. vonHahmann
* Director March 14, 2003
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James H. Wyckoff
* The undersigned, acting pursuant to a power of attorney, has signed this
Annual Report on Form 10-K for and on behalf of the persons indicated above as
such persons' true and lawful attorney-in-fact and their names, places and
stead, in the capacities and on the date indicated above.
/s/ Ronald A. Miller
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Ronald A. Miller
Attorney-in-fact
77
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
CERTIFICATION
I, Peter G. Humphrey, certify that:
1. I have reviewed this annual report on Form 10-K of Financial Institutions,
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 period 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 periods 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 we 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 period 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 (or persons performing the equivalent function):
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 or not 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 14, 2003
/s/ Peter G. Humphrey
----------------------------
Peter G. Humphrey
Chief Executive Officer
78
CERTIFICATION
I, Ronald A. Miller, certify that:
1. I have reviewed this annual report on Form 10-K of Financial Institutions,
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 period 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 periods 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 we 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 period 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 (or persons performing the equivalent function):
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 or not 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 14, 2003
/s/ Ronald A. Miller
----------------------------
Ronald A. Miller
Chief Financial Officer
79