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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to _______
Commission file number 0-15366
ALLIANCE FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
New York 16-1276885
(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.)
MONY Tower II, 18th Floor, 120 Madison Street, Syracuse, NY 13202 13202
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number including area code: (315) 475-4478
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Alliance Financial Corporation Common Stock, $1.00 Per Share
(Title of Class)
Nasdaq National Market
(Name of Each Exchange on Which Registered)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
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 amendment to this
Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |X| No |_|
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on June 28, 2002, determined using a per share closing price on that
date of $25.50, as quoted on the Nasdaq National Market was $81,792,117.
The number of outstanding shares of the Registrant's common stock on March 18,
2003: 3,478,128 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual shareholders meeting to be held
on May 13, 2003 (the "Proxy Statement"), are incorporated by reference in Part
III.
1
TABLE OF CONTENTS
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED
DECEMBER 31, 2002
ALLIANCE FINANCIAL CORPORATION
Page
----
PART I
Item 1. Description of the Business 3
Item 2. Properties 6
Item 3. Legal Proceedings 7
Item 4. Submission of Matters to a Vote of Security Holders 8
PART II
Item 5. Market for the Registrant's Common Stock and
Related Shareholder Matters 9
Item 6. Selected Financial Data 10
Item 7. Management's Discussion & Analysis of the Results of
Operations and Financial Condition 11
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 24
Item 8. Financial Statements and Supplementary Data 26
Item 9. Changes In and Disagreements with Accountants on
Accounting and Financial Disclosure 46
PART III
Item 10. Directors and Executive Officers of the Registrant 46
Item 11. Executive Compensation 46
Item 12. Security Ownership of Certain Beneficial Owners and
Management 46
Item 13. Certain Relationships and Related Transactions 46
Item 14. Controls and Procedures
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports 46
on Form 8-K
2
PART I
This Annual Report on Form 10-K contains certain forward-looking
statements with respect to the financial condition, results of operations and
business of Alliance Financial Corporation and its subsidiary. These
forward-looking statements, within the meaning of the Private Securities
Litigation Reform Act of 1995, involve certain risks and uncertainties. Factors
that may cause actual results to differ materially from those contemplated by
such forward-looking statements include, among others, the following
possibilities: (1) an increase in competitive pressure in the banking industry;
(2) changes in the interest rate environment reduce margins; (3) changes in the
regulatory environment; (4) general economic conditions, either nationally or
regionally, are less favorable than expected, resulting in, among other things,
a deterioration in credit quality; (5) changes in business conditions and
inflation; (6) changes in the securities markets; (7) the ability to maintain
and increase market share and control expenses; and (8) other factors detailed
from time to time in the Company's SEC filings.
The Company maintains a website at Alliancebankna.com. Annual reports on
Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and
amendments to those reports, are available on the Company's website free of
charge as soon as reasonably practicable following the filing of those reports
with the Securities and Exchange Commission.
Item 1 -- Description of the Business
General
Alliance Financial Corporation (the "Company") is a New York registered
bank holding company formed on November 25, 1998 as a result of the merger of
Cortland First Financial Corporation and Oneida Valley Bancshares, Inc., which
were incorporated in May 30, 1986 and October 31, 1984, respectively. The
Company is the parent holding company of Alliance Bank, N.A. (the "Bank"), which
was formed as the result of a merger of First National Bank of Cortland and
Oneida Valley National Bank as of the close of business, April 16, 1999. Unless
the context otherwise provides, references herein to the "Company" mean Alliance
Financial Corporation, Alliance Bank, N.A., and the Bank's subsidiaries Alliance
Preferred Funding Corp. and Alliance Leasing, Inc.
The Company's administrative offices are located on the 18th Floor, MONY
Tower II, 120 Madison St., Syracuse, N.Y. Banking services are provided at the
administrative offices, as well as at main offices located at 65 Main Street,
Cortland, N.Y. and 160 Main Street, Oneida, N.Y., and 16 customer service
facilities located in Cortland, Madison, Onondaga, northern Broome, and western
Oneida counties.
At December 31, 2002, the Company had 253 full-time employees and 24
part-time employees.
The Bank is a member of the Federal Reserve System and the Federal Home
Loan Bank System, and deposits are insured by the Federal Deposit Insurance
Corporation up to applicable limits.
Services
The Company offers full service banking with a broad range of financial
products to meet the needs of its commercial, retail, government, and trust
customers. Depository account services include interest and non-interest bearing
checking accounts, money market accounts, savings accounts, time deposit
accounts, and individual retirement accounts. The Company's lending activities
include the making of residential and commercial mortgage loans, business lines
of credit, working capital facilities and business term loans, as well as
installment loans, home equity loans, student loans, and personal lines of
credit to individuals. Trust and investment department services include personal
trust, employee benefit trust, investment management, custodial, and financial
planning. The Company also offers safe deposit boxes, travelers checks, money
orders, wire transfers, collection services, drive-up banking facilities,
24-hour night depositories, automated teller machines, 24-hour telephone
banking, and on-line internet banking. Commercial leasing services are offered
through Alliance Leasing, Inc., a subsidiary of the Bank.
Competition
The Company's business is extremely competitive. The Company competes not
only with other commercial banks but also with other financial institutions such
as thrifts, credit unions, money market and mutual funds, insurance companies,
brokerage firms, and a variety of other companies offering financial services.
3
Supervision and Regulation
The following discussion summarizes some of the laws and regulations
applicable to bank holding companies and national banks and provides certain
specific information relevant to the Company. This regulatory framework
primarily is intended for the protection of depositors and the deposit insurance
funds that insure bank deposits, and not for the protection of shareholders or
creditors of bank holding companies and banks. To the extent that the following
information describes statutory and regulatory provisions, it is qualified in
its entirety by reference to those provisions. Moreover, Congress, state
legislatures and regulatory agencies frequently propose changes to the law and
regulations affecting the banking industry. The likelihood and timing of any
changes and the impact such changes might have on the Company are impossible to
accurately predict. A change in the statutes, regulations, or regulatory
policies applicable to the Company or its subsidiaries may have a material
adverse effect on their business.
The Company is a bank holding company registered under the Bank Holding
Company Act of 1956, as amended, and is subject to supervision, regulation and
examination by the Board of Governors of the Federal Reserve System (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. 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. 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. 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 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. 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.
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. The Federal Reserve Board may charge the bank
holding company with engaging in unsafe and unsound practices for failure to
commit resources to a subsidiary bank when required. Any capital loans by the
Company to its subsidiary bank would be subordinate in right of payment to
depositors and to certain other indebtedness of the subsidiary bank.
The Company's ability to pay dividends to its shareholders is largely
dependent on the ability of the Bank, the Company's bank subsidiary, to pay
dividends to the Company. The ability of both the Company and the Bank to pay
dividends are limited by federal statutes, regulations and policies. For
example, 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. Furthermore, the Bank must
obtain regulatory approval for the payment of dividends if the total of all
dividends declared in any calendar year would exceed the total of the Bank's net
profits, as defined by applicable regulations, for that year, combined with its
retained net profits for the preceding two years. The Bank may not pay a
dividend in an amount greater than its undivided profits then on hand after
deducting its losses and bad debts, as defined by applicable regulations.
The Federal Reserve Board has established risk-based capital guidelines
that are applicable to bank holding companies. The guidelines established a
framework intended to make regulatory capital requirements more sensitive to
differences in risk profiles among banking organizations and take off-balance
sheet exposures into explicit account in assessing capital adequacy. The Federal
Reserve Board guidelines define the components of capital, categorize assets
into different risk classes, and include certain off-balance sheet items in the
calculation of risk-weighted assets. At least half of the total capital must be
comprised of common equity, retained earnings and a limited amount of perpetual
preferred stock, less goodwill ("Tier I capital"). Banking organizations that
are subject to the guidelines are required to maintain a ratio of Tier I capital
to risk-weighted assets of at least 4.00% and a ratio of total capital to
risk-weighted assets of at least 8.00%. The appropriate regulatory authority may
set higher capital requirements when an organization's particular circumstances
warrant. The remainder ("Tier 2 capital") may consist of a limited amount of
subordinated debt, limited-life preferred stock, certain other instruments and a
limited amount of loan and lease loss reserves. The sum of Tier I capital and
Tier 2 capital is "total risk-based capital." The Company's Tier I and total
risk-based capital ratios as of December 31, 2002 were 12.94% and 14.09%,
respectively.
In addition, the Federal Reserve Board has established a minimum leverage
ratio of Tier 1 capital to quarterly average assets less goodwill ("Tier I
leverage ratio") of 3.00% for bank holding companies that meet certain specified
criteria, including that they have the highest regulatory rating. All other
bank holding companies are required to maintain a Tier I leverage ratio of 3.00%
plus an additional cushion of at least 100 to 200 basis points. The Company's
Tier I Leverage ratio as of December 31, 2002 was 7.41%, which exceeded its
regulatory requirement of 4.00%. The guidelines 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.
4
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. 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
Federal Reserve Board as a "financial holding company" by meeting certain higher
standards for capital adequacy and management, with heavy penalties for
non-compliance. 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. Bank holding companies that wish to engage
in expanded activities but do not wish to become financial holding companies may
elect to establish "financial subsidiaries," which are subsidiaries of national
banks with expanded powers. Gramm-Leach permits financial subsidiaries to engage
in the same types of activities permissible for non-bank subsidiaries of
financial holding companies, with the exception of merchant banking, insurance
and annuity underwriting and real estate investment and development. Merchant
banking may be permitted after a five-year waiting period under certain
regulatory circumstances. Gramm-Leach also provides new protections against the
transfer and use by financial institutions of consumers' nonpublic, personal
information. At this time, the Company has not elected to become a financial
holding company.
Transactions between the holding company and its subsidiary bank are
subject to Section 23A of the Federal Reserve Act. In general, Section 23A
imposes limits on the amount of such transactions, and also requires certain
levels of collateral for loans to affiliated parties. It also limits the amount
of advances to third parties which are collateralized by the securities or
obligations of the Company or its subsidiaries. Affiliate transactions are also
subject to Section 23B of the Federal Reserve Act which generally requires that
certain transactions between the holding company and its affiliates be on terms
substantially the same, or at least as favorable to the banks, as those
prevailing at the time for comparable transactions with or involving other
nonaffiliated persons. The restrictions on loans to directors, executive
officers, principal shareholders and their related interests (collectively
referred to herein as "insiders") contained in the Federal Reserve Act and
Regulation O apply to all insured institutions and their subsidiaries and
holding companies. These restrictions include limits on loans to one borrower
and conditions that must be met before such a loan can be made. There is also an
aggregate limitation on all loans to insiders and their related interests.
Insiders are subject to enforcement actions for knowingly accepting loans in
violation of applicable restrictions.
As a national bank, the Bank is subject to primary supervision,
regulation, and examination by the Office of the Comptroller of the Currency
("OCC") and secondary regulation by the FDIC and the Federal Reserve Board. The
Bank is subject to federal statutes and regulations that significantly affect
its business and activities. The Bank must file reports with its regulators
concerning its activities and financial condition and obtain regulatory approval
to enter into certain transactions. Other applicable statutes and regulations
relate to insurance of deposits, allowable investments, loans, acceptance of
deposits, trust activities, mergers, consolidations, payment of dividends,
capital requirements, reserves against deposits, establishment of branches and
certain other facilities, limitations on loans to one borrower and loans to
affiliated persons, and other aspects of the business of banks. In addition,
federal legislation has instructed federal agencies to adopt standards or
guidelines governing banks' internal controls, information systems, loan
documentation, credit underwriting, interest rate exposure, asset growth,
compensation and benefits, asset quality, earnings and stock valuation, and
other matters. Regulatory authorities have broad flexibility to initiate
proceedings designed to prohibit banks from engaging in unsafe and unsound
banking practices.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") substantially revised the depository institution regulatory and
funding provisions of the Federal Deposit Insurance Act and made revisions to
several other federal banking statures. Among other things, federal banking
regulators are required to take prompt corrective action in respect of
depository institutions that do not meet minimum capital requirements. FDICIA
identifies the following capital categories for financial institutions: well
capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. Rules adopted by the federal
banking agencies under FDICIA provide that an institution is deemed to be well
capitalized if the institution has a total risk-based capital ratio of 10.0% or
greater, a Tier I risk-based ratio of 6.0% or greater, and a leverage ratio of
5.0% or greater, and the institution is not subject to an order, written
agreement, capital directive, or prompt corrective action directive to meet and
maintain a specific level for any capital measure. FDICIA imposes progressively
more restrictive constraints on operation, management, and capital
distributions, depending on the capital category in which an institution is
classified. At December 31, 2002, the Company and the Bank were in the
well-capitalized category based on the ratios and guidelines noted above.
The Bank must pay assessments to the FDIC for federal deposit insurance
protection. The FDIC has adopted a risk-based assessment system as required by
FDICIA. Under this system, FDIC-insured depository institutions pay insurance
premiums at rates based on their risk classification. Institutions assigned to
higher risk classifications pay assessments at higher rates than institutions
that pose a lower risk. An institution's risk classification is assigned based
on its capital level and the level of supervisory concern the institution poses
to the regulators. In addition, the FDIC can impose special assessments in
certain instances. Under FDIC regulations, no FDIC-insured bank can accept
brokered deposits unless it is well capitalized, or is adequately capitalized
and receives a waiver from the FDIC. In addition, these regulations prohibit any
bank that is not well capitalized from paying an interest rate on brokered
deposits in excess of three-quarters of one percentage point over certain
prevailing market rates.
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. The Financial Institutions Reform, Recovery,
and Enforcement Act of 1989 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
5
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.
The Bank is also subject to certain consumer laws and regulations that are
designed to protect consumers in transactions with banks. 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.
The earnings of the Company are significantly affected by the monetary and
fiscal policies of governmental authorities, including the Federal Reserve
Board. Among the instruments of monetary policy used by the Federal Reserve
Board to implement these objectives are open-market operations in U.S.
Government securities and federal funds, changes in the discount rate on member
bank borrowings and changes in reserve requirements against member bank
deposits. These instruments of monetary policy are used in varying combinations
to influence the overall level of bank loans, investments and deposits, and the
interest rates charged on loans and paid for deposits. The Federal Reserve Board
frequently uses these instruments of monetary policy, especially its open-market
operations and the discount rate, to influence the level of interest rates and
to affect the strength of the economy, the level of inflation or the price of
the dollar in foreign exchange markets. The monetary policies of the Federal
Reserve Board have had a significant effect on the operating results of banking
institutions in the past and are expected to continue to do so in the future. It
is not possible to predict the nature of future changes in monetary and fiscal
policies, or the effect that they may have on the Company's business and
earnings.
On July 30, 2002, Congress enacted the Sarbanes-Oxley Act of 2002, a law
that addresses, among other issues, corporate governance, auditing and
accounting, executive compensation, and enhanced and timely disclosure of
corporate information. The Nasdaq Stock Market has also proposed corporate
governance rules that were presented to the Securities and Exchange Commission
for review and approval.
Item 2 -- Properties
The Company operates the following branches:
Name of Office Location County Date Established
- -------------- -------- ------ ----------------
Home Office 65 Main Street Cortland March 1, 1869
Cortland, NY
Administrative Office MONY Tower II, 18th Floor Onondaga August 27, 2001
120 Madison St.
Syracuse, NY
Baldwinsville Route 31 & Willet Pkwy. Onondaga August 28, 2000
Baldwinsville, NY
Canastota Stroud Street & Route 5 Madison December 7, 1974
Canastota, NY
Cincinnatus 2743 NYS Route 26 Cortland January 1, 1943
Cincinnatus, NY
Fairmount West Genesee St. Onondaga October 30, 2000
Syracuse, NY
Groton Avenue 1125 Groton Avenue Cortland June 22, 1987
Cortland, NY
Hamilton 1 Madison Street Madison December 7, 1949
Hamilton, NY
Hamilton 38-40 Utica Street Madison January 26, 1976
Drive-Up Hamilton, NY
6
Lyndon Corners 6930 E. Genesee St. Onondaga July 20, 2000
Fayetteville, NY
Manlius 201 Fayette Street Onondaga October 19, 1994
Manlius, NY
Marathon 14 E. Main Street Cortland August 15, 1957
Marathon, NY
Park Place 300 South State Street Onondaga July 19, 1999
Syracuse, NY
Oneida 160 Main Street Madison December 12, 1851
Oneida, NY
Sherrill 628 Sherrill Road Oneida April 2, 1954
Sherrill, NY
TOPS Plaza Route 5 and Route 46 Madison January 7, 1988
Oneida, NY
Tully Route 80 at I-81 Onondaga January 26, 1989
Tully, NY
Whitney Point 2950 NYS Route 11 Broome April 7, 1994
Whitney Point, NY
Wal-Mart 872 NYS Route 13 Cortland March 10, 1997
(Cortland) Cortland, NY
The offices at Fairmount, Lyndon Corners, MONY Tower II, Park Place, TOPS Plaza,
Tully, Whitney Point, and the Wal-Mart store are leased. The other banking
premises are owned.
Item 3 -- Legal Proceedings
In December of 1998, the Oneida Indian Nation ("The Nation") and the U.S.
Justice Department filed a motion to amend a long-standing land claim against
the State of New York to include a class of 20,000 unnamed defendants who own
real property in Madison County and Oneida County. An additional motion sought
to include the Company as a representative of a class of landowners. On
September 25, 2000, the United States District Court of Northern New York
rendered a decision denying the motion to include the landowners as a group, and
thus, excluding the Company and many of its borrowers from the litigation. The
State of New York, the County of Madison and the County of Oneida remain as
defendants in the litigation. This ruling may be appealed by The Nation, and
does not prevent The Nation from suing landowners individually, in which case
the litigation could involve assets of the Company. On August 3, 2001, the
Justice Department moved to amend its complaint to drop landowners as
defendants.
In February 2002, the State of New York, the Nation and the Counties of
Madison and Oneida announced that they have reached a tentative agreement to
settle the land claim. Among other things, this settlement would pay the three
Oneida tribes $500 million for their lost land. However, the proposed settlement
would require the approval of governments from county legislatures to the United
States Congress. Even if such approvals are received, a final agreement is
expected to be years away as the parties work out numerous details. Moreover,
the other two Oneida tribes, from Wisconsin and Ontario, which did participate
in the settlement negotiations, have indicated that they do not intend to go
along with the settlement. The Wisconsin tribe subsequently filed new law suits
against individual landowners, and have publicly stated its intention to
continue to file other new suits against landowners. Management believes that,
ultimately, the State of New York will be held responsible for these claims and
this matter will be settled without adversely impacting the Company.
7
There are no other pending legal proceedings, other than routine
litigation incidental to the business of the Bank, to which the Company or the
Bank is a party or to which their property is the subject. In management's
opinion, no pending action, if adversely decided, would materially affect the
Company's financial condition.
Item 4 -- Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of the Company's security holders during the
fourth quarter of the year ended December 31, 2002.
8
PART II
Item 5 -- Market for Registrant's Common Stock and Related Shareholder Matters
Common Stock Data:
The common stock of the Company is listed for quoting in the Nasdaq National
Market System under the symbol "ALNC". Market makers for the stock are Ryan,
Beck & Company (800-342-2325), Sandler O'Neill & Partners, LP (800-635-6851),
McConnell Budd & Romano (800-538-6957), and Dain Rauscher (800-343-3036). There
were 796 shareholders of record as of December 31, 2002. The following table
presents stock prices for the Company for 2002 and 2001. Stock prices below are
based on daily high and low closing prices for the quarter, as reported on the
Nasdaq National Market System. These over-the-counter market quotations reflect
inter-dealer prices, without retail mark-up, mark-down, or commission and may
not necessarily represent actual transactions.
2002 High Low Dividend Paid
---- --- -------------
1st Quarter $24.45 $23.10 $0.190
2nd Quarter 26.50 23.20 0.200
3rd Quarter 26.50 24.25 0.200
4th Quarter 28.00 25.51 0.200
2001 High Low Dividend Paid
---- --- -------------
1st Quarter $20.06 $17.38 $0.185
2nd Quarter 19.50 18.80 0.185
3rd Quarter 21.00 18.80 0.185
4th Quarter 24.40 19.52 0.290 *
* Includes an extra cash dividend of $0.10 per share
The transfer agent for the Company's stock is American Stock Transfer & Trust
Company ("ASTC"). ASTC can be contacted at the following address:
Registrar and Transfer Agent
American Stock Transfer & Trust Company
59 Maiden Lane
New York, NY 10038
Automatic Dividend Reinvestment Plan
The Company has an automatic dividend reinvestment plan. This plan is
administered by ASTC, as agent. It offers a convenient way for shareholders to
increase their investment in the Company. The plan enables certain shareholders
to reinvest cash dividends on all or part of their common stock in additional
shares of the Company's common stock without paying brokerage commissions or
service charges. Shareholders who are interested in this program may receive a
Plan Prospectus and enrollment card by calling ASTC Dividend Reinvestment at
1-800-278-4353, or writing to the following address:
Dividend Reinvestment
American Stock Transfer & Trust Company
59 Maiden Lane
New York, NY 10038
The Company has historically 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 Bank, future
dividends will depend upon the earnings of the Bank, its financial condition and
its need for funds. Furthermore, there are a number of federal banking policies
and regulations that would restrict the Company's ability to pay dividends. In
particular, because the Bank is a depository institution whose deposits are
insured by the FDIC, it may not pay dividends or distribute capital assets if it
is in default on any assessment due the FDIC. Also, as a national bank, the Bank
is subject to OCC regulations which impose certain minimum capital requirements
that would affect the amount of cash available for distribution to the Company.
In addition, under Federal Reserve policy, the Company is required to maintain
adequate regulatory capital, is expected to serve as a source of financial
strength to the Bank and to commit resources to support the Bank. These policies
and regulations may have the effect of reducing the amount of dividends that the
Company can declare to its shareholders.
9
Item 6 - Selected Financial Data
Five-Year Comparative Summary
(Dollars in thousands except per-share data)
ASSETS AND DEPOSITS 2002 2001 2000 1999 1998
Loans and Leases $409,204 $371,260 $312,378 $282,025 $250,295
Investment Securities 314,994 272,690 223,078 194,382 172,237
Deposits 546,653 499,292 474,899 435,074 413,594
Total Assets 774,950 692,871 580,787 519,197 471,705
Trust Department Assets
(Book value, not included in
Total Assets) 214,318 245,234 236,496 185,972 147,244
SHAREHOLDERS' EQUITY
Capital, Surplus, and Undivided Profits 62,953 53,463 53,035 49,245 51,168
OPERATING INCOME AND EXPENSES
Total Interest Income 42,714 43,124 40,062 34,508 32,213
Total Interest Expense 15,944 19,965 19,467 14,220 13,398
-------- -------- -------- -------- --------
Net Interest Income 26,770 23,159 20,595 20,288 18,815
Provision for Loan and Lease Losses 1,895 2,455 1,150 975 770
-------- -------- -------- -------- --------
Net Interest Income after Provision for
Loan and Lease Losses 24,875 20,704 19,445 19,313 18,045
Other Operating Income 6,764 6,991 6,649 4,558 3,989
-------- -------- -------- -------- --------
Total Operating Income 31,639 27,695 26,094 23,871 22,034
Salaries and Related Expense 12,518 11,264 10,414 9,112 8,712
Occupancy and Equipment Expense 3,443 3,153 2,861 2,587 2,607
Other Operating Expense 6,416 5,550 5,362 4,926 6,178
-------- -------- -------- -------- --------
Total Operating Expense 22,377 19,967 18,637 16,625 17,497
Income Before Taxes 9,262 7,728 7,457 7,246 4,537
Provision for Income Taxes 2,351 1,717 2,032 1,844 1,104
-------- -------- -------- -------- --------
Net Income $ 6,911 $ 6,011 $ 5,425 $ 5,402 $ 3,433
-------- -------- -------- -------- --------
Per-Share Data
Net Income - Diluted $ 1.98 $ 1.70 $ 1.52 $ 1.51 $ 0.95
Book Value at Year End 18.23 15.51 14.70 13.97 14.23
Cash Dividends Declared $ 0.79 $ 0.85 $ 0.71 $ 0.70 $ 0.67
-------- -------- -------- -------- --------
10
Item 7 - Management's Discussion & Analysis of the Results of Operations and
Financial Condition
Introduction
The Company is a New York corporation, which was formed in November 1998
as a result of the merger of Cortland First Financial Corporation and Oneida
Valley Bancshares, Inc.. The Company is a bank holding company that operates one
wholly owned subsidiary, Alliance Bank, N.A., which provides a full range of
financial services in the Central New York marketplace.
The following discussion and analysis reviews the Company's business, and
provides information that is intended to provide the reader with a further
understanding of the consolidated financial condition and results of operations
of the Company and its operating subsidiaries. This discussion should be read in
conjunction with the consolidated financial statements and accompanying notes,
and other information included elsewhere in this Annual Report on Form 10-K.
RESULTS OF OPERATIONS
Net income for 2002 was $6,911,000, an increase of $900,000, or 15%,
compared to net income of $6,011,000 in 2001. Earnings per share for 2002, on a
fully diluted basis, were $1.98, an increase of $0.28 per share compared to
$1.70 per share in 2001. Basic earnings per share of $2.00 for the year ended
December 31, 2002, compared to $1.71 for the year ended December 31, 2001. The
annualized return on average equity for 2002 increased to 11.96% from 11.14% in
2001.
Strong growth in earning assets continued in 2002 with average loans up
13.2% and average investments up 19.9%. The significant increase in earning
assets, combined with a net interest margin that was comparable with the prior
year, resulted in net interest income growth of 15.6%. Record net income for
2002 was also attributable to improvement in the quality of the loan and lease
portfolio, allowing a reduction of 22.8% in the 2002 provision for loan and
lease loss expense.
Selected Performance Measures
Return on average assets, return on average equity, dividend payout, and
equity to asset ratios for the years indicated are as follows:
2002 2001 2000
---- ---- ----
Percentage of net income to average total assets 0.93% 0.93% 0.98%
Percentage of net income to average shareholders' equity 11.96% 11.14% 10.86%
Percentage of dividends declared to net income 39.43% 49.15% 46.70%
Percentage of average shareholders' equity to average total assets 7.79% 8.32% 9.03%
Net Interest Income
Net interest income is the Company's principal source of operating income
for payment of overhead and providing for loan and lease losses. It is the
amount that interest and fees on loans and leases, investments, and other
earning assets exceeds the cost of deposits and other interest-bearing
liabilities.
Net interest income increased $3,611,000, or 15.6%, to $26,770,000 in
2002. The growth in net interest income in 2002 primarily resulted from
increases in average earning assets during the year.
Interest income for 2002 at $42,714,000, was $410,000 less than 2001, with
the 2002 tax-equivalent yield on average earning assets at 6.35%, declining 101
basis points during the 12 months ended December 31, 2002. Asset yields declined
throughout the year as new loans and investments were booked during the year at
market rates significantly lower than the yields on assets that matured or
prepaid during the year. Average earning assets for 2002 were $693,554,000, up
$89,503,000, or 14.8%, compared to 2001, and represented 93.4% of total average
assets in 2002. By comparison, average earning assets increased $85,152,000, or
16.4%, in 2001 compared to 2000, and for the comparable periods, the
tax-equivalent yield on average earning assets declined 58 basis points. Average
earning assets in 2001 were 93.1% of total average assets.
Loans and leases continued to represent the majority of the Company's
interest earning assets and have remained stable at 58% of earning assets over
the past three years. Average loans and leases increased $46,736,000 in 2002
with yields declining 118 basis points to 7.04%. The Company's residential
mortgage loan portfolio reported an increase of $19,783,000, or 15.3%, in
average loans when comparing the year 2002 to 2001. The average yield on the
residential mortgage loan portfolio declined 50 basis points from 7.88% in 2001
to 7.39% in 2002, influenced by newly originated loans, and an increased
refinancing of existing portfolio loans, being booked at the lower market rates
in effect in 2002. Average consumer loans for the comparable periods increased
12.7%, or $6,226,000, on strong growth in home equity lines of credit. The
average yield declined 203 basis points from 9.10% to 7.07% in 2002, influenced
significantly by new home equity lines that were indexed to the prime rate and
booked at discounted introductory rates throughout the year. Average indirect
auto loans for the
11
comparable periods increased 27%, or $13,338,000. Average yields declined 116
basis points in 2002 compared to 2001, as the new loan volume, again originated
at the lower market rates in 2002, pushed the average yield lower. Average
commercial loans and leases for 2002 increased $7,241,000, or 5.7%, when
compared to the prior year. The growth rate declined, compared to an increase of
17.8% in 2001, as weakness in the economy slowed demand for loans and leases in
2002. The commercial portfolio, which primarily reprices with short-term market
rate indexes, reported a decline in the average yield of 160 basis points, from
8.05% to 6.45%.
Average loans and leases in 2001 increased $54,782,000 compared to 2000
while average loan and lease yields declined 72 basis points. Interest income on
loans and leases was up $2,327,000, or 8.7%, in 2001 compared to 2000. For the
comparable periods, average residential mortgage loans increased $13,269,000, or
11.5%, average consumer loans increased $2,448,000, or 5.3%, average indirect
auto loans increased $19,589,000, or 65.5%, and average commercial loans and
leases increased $19,026,000, or 17.8%.
Average investments in 2002 increased by $48,481,000, with tax-equivalent
interest income from investments up $827,000, or 5.5%, compared to 2001. In
comparison, average investment securities increased $27,577,000 in 2001 compared
to 2000, with tax-equivalent interest income up $794,000, or 5.6%. The average
tax-equivalent yield of the portfolio declined 74 basis points, from 6.18% in
2001 to 5.43% in 2002. The average tax-equivalent yield on the portfolio had
declined 41 basis points in 2001, when compared to 2000. Interest income in 2002
from the sale of federal funds, in the amount of $30,000, declined $353,000
compared to 2001, as the Company reduced its average federal funds sold balances
throughout 2002.
During 2002, average interest-bearing liabilities increased by
$87,551,000, or 16.4%, to $622,286,000. As a result of lower market interest
rates and repricing characteristics associated with the Company's liabilities,
the average cost of interest-bearing liabilities declined 117 basis points from
3.73% in 2001 to 2.56% in 2002. The Company's interest expense, which is a
function of the volume of and rates paid for interest-bearing liabilities,
declined $4,021,000, or 20.1%, in 2002 compared to 2001. The significant decline
in interest expense resulted as significantly lower rates paid on deposits and
borrowings throughout 2002 more than offset the costs associated with the
liability growth.
By comparison, interest expense increased $498,000, or 2.6%, in 2001
compared to 2000, resulting primarily from a higher level of borrowings, in the
form of Federal Home Loan Bank advances and collateralized repurchase agreements
with brokers. Average interest-bearing liabilities increased $90,544,000, or
20.4%, during the 12 months ended December 31, 2001. The average cost of
interest-bearing liabilities declined 65 basis points during the 12 months ended
December 31, 2001.
The Company's net interest margin (federal tax-equivalent net interest
income divided by average earning assets) for 2002 at 4.05% was unchanged from
the margin reported in 2001. The margin was relatively stable for the last three
quarters of 2002, after falling from 4.16% in the first quarter of 2002. During
2001, the margin had increased from a 3.76% average for the first quarter, to a
4.22% average for the fourth quarter.
12
The following table sets forth information concerning average
interest-earning assets and interest-bearing liabilities and the yields and
rates thereon. Interest income and yield information is adjusted for items
exempt from federal income taxes and assumes a 34% tax rate. Nonaccrual loans
have been included in the average balances. Securities are shown at average
amortized cost.
Average Balances and Net Interest Income
YEARS ENDED DECEMBER 31, 2002 2001 2000
---- ---- ----
AVG. AVG. AVG.
YIELD/ YIELD/ YIELD/
AVG. AMT. OF RATE AVG. AMT. OF RATE AVG. AMT. OF RATE
BALANCE INTEREST PAID BALANCE INTEREST PAID BALANCE INTEREST PAID
------- -------- ---- ------- -------- ---- ------- -------- ----
(DOLLARS IN THOUSANDS)
Assets:
Interest-earning assets:
Federal funds sold $ 1,593 $ 30 1.88% $ 7,307 $ 383 5.24% $ 4,514 $ 286 6.34%
Taxable investment securities 236,198 11,890 5.03% 190,463 11,161 5.86% 168,581 10,826 6.42%
Nontaxable investment securities 55,724 3,965 7.12% 52,978 3,867 7.30% 47,283 3,408 7.21%
Loans and Leases
(net of unearned discount) 400,039 28,177 7.04% 353,303 29,028 8.22% 298,521 26,701 8.94%
------- ----- ---- --------- ------ ---- ------- ------ ----
Total interest-earning assets 693,554 44,062 6.35% 604,051 44,439 7.36% 518,899 41,221 7.94%
Noninterest-earning assets:
Other assets 47,583 45,181 41,275
Less: Allowance for loan and
lease losses (4,898) (3,954) (3,587)
Net unrealized gains/(losses) on
available-for-sale portfolio 6,052 3,391 (3,441)
--------- --------- --------
Total $ 742,291 $ 648,669 $553,146
--------- --------- --------
Liabilities and Shareholders' Equity:
Interest-bearing liabilities:
Demand deposits $ 78,263 $ 399 0.51% $ 71,627 $ 752 1.05% $ 62,928 $ 960 1.53%
Savings and money
market deposits 180,533 2,533 1.40% 160,382 4,315 2.69% 152,573 5,176 3.39%
Time deposits 220,862 7,960 3.60% 219,756 11,006 5.01% 189,535 10,841 5.72%
------- ----- ---- --------- ------ ---- ------- ------ ----
Borrowings 142,628 5,052 3.54% 82,970 3,892 4.69% 39,155 2,490 6.36%
Total interest-bearing liabilities 622,286 15,944 2.56% 534,735 19,965 3.73% 444,191 19,467 4.38%
Noninterest-bearing liabilities:
Demand deposits 54,213 52,871 54,800
Other liabilities 7,996 7,118 4,220
Shareholders' equity 57,796 53,945 49,935
--------- --------- --------
Total $ 742,291 $648,669 $553,146
--------- --------- --------
Net interest earnings $28,118 $ 24,474 $21,754
------- -------- -------
Net yield on interest-earning assets 4.05% 4.05% 4.19
Federal tax exemption on non-taxable
investment securities included in
interest income $ 1,348 $ 1,315 $ 1,159
13
The following table sets forth the dollar volume of increase (decrease) in
interest income and interest expense resulting from changes in the volume of
earning assets and interest-bearing liabilities, and from changes in rates.
Volume changes are computed by multiplying the volume difference by the prior
year's rate. Rate changes are computed by multiplying the rate difference by the
prior year's balance. The change in interest due to both rate and volume has
been allocated equally between the volume and rate variances.
Volume and Rate Variances
2002 COMPARED TO 2001 2002 COMPARED TO 2000
-------------------------------------- --------------------------------------
\ INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
VOLUME RATE NET CHANGE VOLUME RATE NET CHANGE
------ ---- ---------- ------ ---- ----------
(IN THOUSANDS)
Interest earned on:
Federal funds sold $ (203) $ (150) $ (353) $ 162 $ (65) $ 97
Taxable investment securities 2,495 (1,766) 729 1,342 (1,007) 335
Nontaxable investment securities 197 (99) 98 414 46 460
Loans and leases (net of unearned discount) 3,580 (4,431) (851) 4,687 (2,361) 2,326
------- ------- ------- ------ ------- -------
Total interest-earning assets $ 6,069 $(6,446) $ (377) $6,605 $(3,387) $ 3,218
------- ------- ------- ------ ------- -------
Interest paid on:
Interest-bearing demand deposits $ 52 $ (405) $ (353) $ 114 $ (322) $ (208)
Savings and money market deposits 415 (2,197) (1,782) 236 (1,097) (861)
Time deposits 53 (3,099) (3,046) 1,620 (1,455) 165
Borrowings 2,456 (1,296) 1,160 2,420 (1,018) 1,402
------- ------- ------- ------ ------- -------
Total interest-bearing liabilities $ 2,976 $(6,997) $(4,021) $4,390 $(3,892) $ 498
------- ------- ------- ------ ------- -------
Net interest earnings (FTE) $ 3,093 $ 551 $ 3,644 $2,215 $ 505 $ 2,720
NonInterest Income
The Company's noninterest income is primarily comprised of its core
components that include service charges on deposits, trust department fees, and
other recurring operating income fees from normal banking operations, along with
non-core components that primarily consist of net gains or losses from sales of
investment securities.
The following table sets forth certain information on noninterest income
for the years indicated:
NonInterest Income
Years ended December 31, 2002 2001 2000
---- ---- ----
(In thousands)
Service charges on deposit accounts $2,281 $2,370 $1,993
Trust department services 1,343 1,405 1,393
Bank owned life insurance 485 475 469
Gain on sale of loans 226 47 6
Other operating income 1,634 1,396 1,543
----- ----- -----
Core noninterest income $5,969 $5,693 $5,404
Investment security gains 791 1,495 711
Gain/(loss) on disposal of assets 4 (197) 2
Pension plan termination - - 532
----- ----- -----
Total noninterest income $6,764 $6,991 $6,649
----- ----- -----
Noninterest income in 2002 declined 3.2% compared to 2001, as a result of
changes in non-core items. The Company's core noninterest income increased 4.8%
for the comparable periods. Significant contributions to the Company's core
noninterest income in 2002 were derived from other operating income sources that
included recurring electronic banking and other customer service fees, as well
as gains associated with an increased volume of mortgage loans sold to the
secondary market. Compared to 2001, other operating income increased $238,000,
or 17%, with gains on mortgage sales up $179,000, or 381% in 2002. Income from
service charges on deposits at $2,281,000 declined $89,000, or 3.8%, in 2002 as
a result of a lower volume of overdrafts and the associated fees. Income from
trust and brokerage services was negatively impacted primarily by poor
performance in the equity markets in 2002, and declined 4.4% compared to the
prior year.
14
In non-core components, investment security gains in 2002 declined by
$704,000 compared to 2001, as the Company's total return to portfolio management
approach indicated a greater benefit resulted from holding higher coupon
investments during 2002's low interest rate environment.
Noninterest income increased 5.1% in 2001 compared to 2000, as a result of
a $289,000, or 5.3%, increase in core noninterest income. The increase was a
result of growth in service charge revenues resulting from pricing increases.
Nonrecurring items were comparable for the periods, with the Company reporting a
one-time loss in 2001 of $163,000 in connection with the closing of an in-store
branch, and booking a $532,000 one-time gain on the termination of the former
Oneida Valley National Bank defined benefit pension plan in 2000. Investment
security gains for the periods reflected opportunities associated with
management for total return.
NonInterest Expense
The following table sets forth certain information on noninterest expense
for the years indicated:
Noninterest Expense
YEARS ENDED DECEMBER 31, 2002 2001 2000
---- ---- ----
(In thousands)
Salaries, wages, and employee benefits $12,518 $11,264 $10,414
Building, occupancy, and equipment 3,443 3,153 2,861
Other operating expense 6,416 5,550 5,362
------- ------- -------
Total noninterest expense $22,377 $19,967 $18,637
------- ------- -------
Operating expense of $22,377,000 for the 12 months ended December 31,
2002, increased $2,410,000, or 12.1%, when compared to 2001. The increase
compared to a $1,330,000, or 7.1%, increase, when comparing 2001 to 2000.
Salaries and associated benefit expenses in 2002 were up $1,254,000, or 11.1%,
compared to a 8.2% increase in 2001 over 2000, and represented a little over
half of the 2002 increase in total expense. The increase in salary and benefits
expense primarily reflects enhancements completed in the first quarter of 2002
to the Company's non-officer compensation program, moving salaries to
competitive market levels to better insure the Company's ability to attract and
retain high performing employees. The Company expects that the enhanced
compensation program will promote continuation of high customer service levels
with improved efficiency. At year-end 2002, improvements in staffing efficiency
resulted in a reduction of 4% in the Company's total staff compared to year-end
2001. The Company also experienced higher costs in connection with providing
post retirement health care benefits, primarily resulting from recent increases
in the overall cost of health care and the expectation that the trend of such
increases will continue. The 2002 costs of the Company's self-insured medical
plan covering active employees, however, reflected no increase over the costs
reported in 2001. The Company's occupancy and equipment expense increased
$290,000, or 9.2%, in 2002 compared to 2001, following a 10.2% increase in the
prior year. The increase in 2001 was primarily the result of increased lease
expense associated with the Company's opening of new administrative offices in
Syracuse, N.Y. in the second half of 2001. The higher expense in 2002 also
reflected increased depreciation expense in connection with the purchase and
development of imaging technology systems designed to provide improved customer
service. The increase in occupancy expense in 2001 compared to 2000, primarily
reflected the full year costs in 2001 of three new branches opened in the last
half of 2000. Other operating expense in 2002 increased $866,000, or 15.6%,
compared to the prior year. Significant increases in other operating expenses in
2002 related to the Company's development and launch of a new corporate branding
campaign, including a change in Company logo and image. Campaign costs included
a comprehensive survey of both customers and non-customers in the Company's
markets, development of a new corporate logo as well as corporate and product
advertising campaigns, and changes to collateral materials including stationary
and supplies. The Company expects the investment to improve the effectiveness of
its marketing, and development of customer relationships. The Company's 2002
costs associated with audits and examinations were also higher than in 2001,
reflecting the continued commitment to a strong program of internal controls.
The growth in other operating expense also continues to reflect the costs
associated with servicing the growth in average assets, which increased 14% in
2002 following a 17% increase in 2001. In 2001, other operating expense
increased $188,000, or 3.5%, compared to 2000.
Provision For Income Tax
The Company's 2002 provision for income taxes increased by $634,000, or
36.9%, when compared to the 2001 expense, as result of higher pretax earnings
and a higher effective tax rate. The 2002 expense of $2,351,000 resulted in an
effective tax rate of 25.4%, compared to the 2001 expense of $1,717,000 that
reflected an effective tax rate of 22.2%. The lower effective tax rate in 2001
resulted from a higher level of non-taxable investment income as a percentage of
pretax income.
15
ANALYSIS OF FINANCIAL CONDITION
Investment Securities
The investment portfolio is designed to provide a favorable total return
utilizing low-risk, high quality investments while at the same time assisting in
meeting the liquidity needs of the Bank's loan and deposit operations, and
supporting the Company's interest risk objectives. The Company classifies the
majority of its investment securities as available-for-sale. The Company does
not engage in securities trading or derivatives activities in carrying out its
investment strategies.
The book value of the Company's investment debt securities increased
$33,964,000, or 12.8%, in the 12 months ended December 31, 2002, to a total of
$298,771,000, compared to an increase of $47,020,000, or 21.6%, during the year
2001. The average tax-equivalent yield of the portfolio in 2002 declined 75
basis points, to 5.43% from 6.18% in 2001. On a comparative basis, the portfolio
yield declined 41 basis points in 2001 compared to 2000. When comparing year-end
2001 to year-end 2002, the tax-equivalent portfolio yield declined 55 basis
points, from 5.76% to 5.21%.
The decline in interest rates, which causes an increase in the market
value of fixed-rate investment securities, resulted in the Company's
available-for-sale investment securities reflecting a market value that was
3.68% greater than the portfolios' book value. In compliance with SFAS 115, the
Company reflects net unrealized gains and losses on its available-for-sale
portfolio in its financial statement investment securities total, as well as the
after-tax effect of the gains and losses in the accumulated other comprehensive
income section of its shareholders' equity. The Company's December 31, 2002
investment portfolio reflects an unrealized gain on available-for-sale
securities of $10,778,000, with an after-tax effect of $6,467,000 being
reflected as an increase in shareholders' equity. At December 31, 2001, the
Company reported unrealized gains in its available-for-sale portfolio of
$2,071,000 and an increase in shareholders' equity of $1,243,000. Based on
amortized cost, the Company classified 97% of its investment portfolio as
available-for-sale at year-end 2001.
The following table sets forth the amortized cost and market value for the
Company's held-to-maturity investment securities portfolio:
YEARS ENDED DECEMBER 31, 2002 2001 2000
-------------------- -------------------- -------------------
AMORTIZED MARKET AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE COST VALUE
--------- ------ --------- ------ --------- ------
(IN THOUSANDS)
Obligations of states and
political subdivisions $6,188 $7,628 $7,371 $8,158 $10,223 $10,365
------ ------ ------ ------ ------- -------
Total $6,188 $7,628 $7,371 $8,158 $10,223 $10,365
------ ------ ------ ------ ------- -------
The following table sets forth the amortized cost and market value for the
Company's available-for-sale debt securities within the investment portfolio:
YEARS ENDED DECEMBER 31, 2002 2001 2000
-------------------- -------------------- -------------------
AMORTIZED MARKET AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE COST VALUE
--------- ------ --------- ------ --------- ------
(IN THOUSANDS)
U.S. Treasury and other
U.S. government agencies $ 98,233 $ 102,796 $ 61,430 $ 62,228 $ 50,911 $ 51,538
Mortgage-backed securities 138,072 140,833 146,484 147,151 93,447 93,413
Obligations of states and
political subdivisions 56,278 59,732 48,009 48,687 44,289 44,996
Other securities -- -- 1,513 1,441 18,917 18,788
-------- -------- -------- -------- -------- --------
Total $292,583 $303,361 $257,436 $259,507 $207,564 $208,735
-------- -------- -------- -------- -------- --------
Net unrealized gains/(losses)
on available-for-sale
debt securities $ 10,778 $ 2,071 $ 1,171
-------- -------- --------
Total Carrying Value $303,361 $259,507 $208,735
-------- -------- --------
16
The following table sets forth as of December 31, 2002, the maturities of
investment securities and the weighted-average yields of such securities, which
have been calculated on the basis of the cost, weighted for scheduled maturity
of each security, and adjusted to a fully tax-equivalent basis:
AT DECEMBER 31, 2002
-----------------------------------------------------------------------------------------
AMOUNT AMOUNT
AMOUNT MATURING AFTER MATURING AFTER AMOUNT
MATURING WITHIN ONE YEAR BUT FIVE YEARS BUT MATURING AFTER
ONE YEAR OR LESS WITHIN FIVE YEARS WITHIN TEN YEARS TEN YEARS TOTAL COST
---------------- ----------------- ---------------- --------- ----------
(DOLLARS IN THOUSANDS)
Held-To-Maturity Portfolio
Obligations of states and
political subdivisions $ 2,958 $ 1,517 $ 683 $ 1,030 $ 6,188
------- ------- ----- ------- -------
Total held-to-maturity
portfolio value $ 2,958 $ 1,517 $ 683 $ 1,030 $ 6,188
------- ------- ----- ------- -------
Weighted average yield
at year end (1) 5.78% 8.32% 6.81% 8.89% 7.00%
Available-for-Sale Portfolio
U.S. Treasury and other
U.S. government agencies -- $ 60,151 $32,183 $ 5,899 $ 98,233
Mortgage-backed securities 63,368 55,925 11,234 7,545 138,072
Obligations of states and
political subdivisions 3,311 7,539 22,791 22,637 56,278
Other securities -- -- -- -- --
------- ------- ----- ------- -------
Total available-for-sale
portfolio value $66,679 $123,615 $66,208 $36,081 $292,583
------- ------- ----- ------- -------
Weighted average yield
at year end (1) 5.40% 4.59% 5.78% 6.20% 5.24%
(1) Weighted average yields on the tax-exempt obligations have been computed
on a fully tax-equivalent basis assuming a marginal federal tax rate of
34%. These yields are an arithmetic computation of interest income divided
by average balance and may differ from the yield to maturity which
considers the time value of money.
Loans and leases
The loan and lease portfolio is the largest component of the Company's
earning assets and accounts for the greatest portion of total interest income.
The Company provides a full range of credit products delivered through its
branch network. Consistent with the focus on providing community banking
services, the Company generally does not attempt to diversify geographically by
making a significant amount of loans or leases to borrowers outside of the
primary service area. Loans and leases are internally generated and lending
activity is primarily confined to Cortland, Madison, Onondaga, northern Broome,
and western Oneida Counties of New York. The Company does not engage in highly
leveraged transactions or foreign lending activities.
The following table sets forth the composition of the Company's loan and
lease portfolio at the dates indicated:
Composition of the Loan and Lease Portfolio
YEARS ENDED DECEMBER 31, 2002 2001 2000 1999 1998
-------------- --------------- --------------- --------------- ---------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(DOLLARS IN THOUSANDS)
Commercial and Lease $134,584 32.9% $126,801 34.2% $108,447 34.7% $105,169 37.3% $ 80,121 32.0%
Residential Real Estate 153,148 37.4% 142,307 38.3% 119,948 38.4% 114,450 40.6% 113,570 45.4%
Indirect Auto 68,811 16.8% 56,371 15.2% 42,065 13.5% 20,246 7.2% - -
Consumer 57,734 14.1% 50,363 13.5% 45,652 14.6% 46,632 16.5% 61,817 24.7%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Gross Loans and Leases 414,277 101.2% 375,842 101.2% 316,112 101.2% 286,497 101.6% 255,508 102.1%
Less:
Unearned discount (54) (0.0%) (104) (0.0%) (364) (0.1%) (1,060) (0.4%) (2,212) (0.9%)
Allowance for loan
and lease losses (5,019) (1.2%) (4,478) (1.2%) (3,370) (1.1%) (3,412) (1.2%) (3,001) (1.2%)
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Net Loans and Leases $409,204 100.0% $371,260 100.0% $312,378 100.0% $282,025 100.0% $250,295 100.0%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
17
On December 31, 2002, gross loans and leases were $414,277,000, increasing
$38,435,000, or 10.2%, during the year. By comparison, loans increased
$59,730,000, or 18.9%, in 2001. The Company reported slight changes in the mix
of its loan portfolio during 2002, with indirect auto and consumer loans
increasing as a percentage of total loans, while commercial and lease loans, and
residential mortgage loans declined as a percentage of total loans. The Company
continued to report growth in all components of the loan portfolio during 2002.
Residential mortgage loans, which represented 37.4% of gross loans at
December 31, 2002, increased $10,841,000, or 7.6%, during 2002 compared to an
increase of $22,359,000, or 18.6%, in 2001. The mortgage portfolio at December
31, 2002 consists of 79% in fixed-rate loans, and 21% in loans that have
adjustable-rate features. The Company originated $53,439,000 in residential
mortgage loans in 2002 compared to $47,664,000 in 2001. The growth in 2002
originations resulted as the Company increased its mortgage business in Onondaga
County, while at the same time it continued a strong level of originations in
Cortland and Madison Counties. The Company continued to target the percentage of
residential mortgage loans to total loans at 38% during 2002, and as a result of
the increased level of originations, increased the amount of loans sold during
2002. As of December 31, 2002, the Company was servicing mortgage loans sold in
the secondary market with balances of $25,614,000. The total of mortgage loans
being serviced at December 31, 2001 was $16,142,000.
Loans and leases in the commercial category consist primarily of
short-term and/or floating-rate loans, lines of credit, as well as commercial
mortgage loans, and commercial leases made to small- and medium-sized companies.
Commercial loans and leases in 2002 increased $7,783,000, or 6.1%, to
$134,584,000. By comparison, commercial loans and leases increased $18,354,000,
or 16.9%, in 2001. In spite of a weak Central New York state economy during
2002, with little demand for commercial credit, the Company reported growth
compared to 2001, in its Cortland, Madison, and Onondaga County markets. In the
first quarter of 2002, Alliance Leasing, Inc. was formed as a subsidiary of the
Bank. The leasing company specializes in information technology, municipal,
health care, energy and utilities, education, and equipment leases, that are
expected to complement products and services offered to the Bank's customers as
well as generate new relationships. At December 31, 2002, the leasing company
reported net lease receivables of $1,977,000.
Consumer loans, which include home equity lines of credit, direct
installment, and revolving credit loans, increased 14.6%, or $7,371,000, in
2002. During 2002, the Company focused on building a high credit quality
consumer loan portfolio, promoting its home equity line of credit product.
Throughout 2002, the Company offered the variable prime rate based product, at a
discounted introductory rate for six months. As a result, the Company increased
home equity line of credit outstanding balances by $12,009,000, or 58%, in 2002
compared to 2001. Offsetting some of the growth in home equity line balances,
direct installment consumer loans, with a higher risk profile, declined
$3,854,000, or 15.6% in 2002 compared to 2001. The Company's consumer loan
portfolio does not contain credit card loans.
Indirect auto loans in 2002 increased $12,440,000, or 22.1%, over the
prior year, following an increase of $14,306,000, or 34%, in 2001 compared to
2000. The rate of growth in 2002 continued strong without compromising or
reducing credit quality standards, in the face of a weak economy and strong
incentives offered by the automotive manufacturer's financing program
alternatives. The Company originated loans from, and provides service to, a
network of more than 150 Central New York auto dealers.
The following table shows the amount of loans outstanding as of December
31, 2002, which, based on remaining scheduled payments of principal, are due in
the periods indicated:
MATURING MATURING
MATURING WITHIN AFTER ONE BUT AFTER FIVE BUT MATURING AFTER
AT DECEMBER 31, 2002 ONE YEAR OR LESS WITHIN FIVE YEARS WITHIN TEN YEARS TEN YEARS TOTAL
---------------- ----------------- ---------------- --------- -----
(IN THOUSANDS)
Commercial/Lease $54,555 $ 39,794 $22,330 $17,905 $134,584
Residential Real Estate 13,450 31,854 36,818 71,026 153,148
Indirect 18,932 49,652 179 48 68,811
Other Consumer, net of unearned 9,126 15,096 29,966 3,492 57,680
discount ------ ------ ------ ------ -------
Total loans and leases net of
unearned discount $96,063 $136,396 $89,293 $92,471 $414,223
------ ------ ------ ------ -------
The following table sets forth the sensitivity of the loan amounts due
after one year to changes in interest rates:
AT DECEMBER 31, 2002 FIXED RATE VARIABLE RATE
---------- -------------
(IN THOUSANDS)
Due after one year, but within five years $88,655 $47,741
Due after five years $87,431 $94,333
18
Loan Quality and the Allowance for Loan and Lease Losses
The following table represents information concerning the aggregate amount
of nonperforming assets:
YEARS ENDED DECEMBER 31, 2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
Loans and leases accounted for on a
nonaccrual basis $ 853 $ 736 $ 686 $ 682 $ 552
Accruing loans and leases which are
contractually past due 90 days or more
as to principal or interest payments 539 623 781 409 298
Other real estate owned and other
repossessed assets 198 320 354 269 257
------ ------ ------ ------ ------
Total nonperforming loans, leases and assets $1,590 $1,679 $1,821 $1,360 $1,107
------ ------ ------ ------ ------
Ratio of allowance for loan and lease
losses to period-end nonperforming
loans and leases 360.56% 329.51% 229.72% 312.74% 353.06%
Ratio of nonperforming assets to
period-end total loans and leases, other real
estate owned, and repossessed assets 0.38% 0.45% 0.58% 0.48% 0.44%
------ ------ ------ ------ ------
Nonperforming assets, defined as nonaccruing loans and leases plus loans
and leases 90 days or more past due, along with other real estate owned and
other repossessed assets as of December 31, 2002 were $1,590,000, declining
$89,000, or 5.3%, compared to year-end 2001. The ratio of nonperforming assets
to year-end loans and leases, other real estate owned, and other repossessed
assets improved to 0.38% at December 31, 2002 from 0.45% at December 31, 2001.
The ratio of nonperforming loans and leases to total loans and leases, in
the amount of 0.34% at December 31, 2002, also showed improvement when compared
to a ratio of 0.36% at December 31, 2001. The year-end ratio compares very
favorably to the most recent peer bank data contained in the Uniform Bank
Performance Report for all banks with total assets between $500,000,000 and
$1,000,000,000, as published by the Federal Reserve Board's Division of Banking
Supervision and Regulation, which as of September 30, 2002 reported a peer
average of 0.83%. Approximately 50% of the Company's nonperforming loans and
leases at year-end 2002 are either secured by residential real estate or are
substantially guaranteed by the Small Business Administration, with loss
potential expected to be minimal. The allowance to nonperforming loans and
leases ratio improved to 361% at year-end 2002 compared to 330% at year-end
2001. Total delinquencies, defined as loans and leases 30 days or more past due
and nonaccruing, were 1.13% of total loans and leases outstanding as of December
31, 2002, compared to 1.85% at the end of 2001. Strong collection efforts
throughout 2002 held delinquency rates well below 2001 levels.
The Company has a loan and lease review program that it believes takes a
conservative approach to evaluating nonperforming loans and leases and the loan
and lease portfolio in general. The loan and lease review program continually
audits the loan and lease portfolio to confirm management's loan and lease risk
rating system and track problem loans and leases, to insure compliance with loan
and lease policy underwriting guidelines, and to evaluate the adequacy of the
allowance for loan and lease losses.
The Company's policy is to place a loan or lease on nonaccrual status and
recognize income on a cash basis when a loan or lease is more than ninety days
past due, unless in the opinion of management, the loan or lease is well secured
and in the process of collection. The impact of interest not recognized on
nonaccrual loans and leases was immaterial in 2002. The Company considers a loan
and lease impaired when, based on current information and events, it is probable
that the Company will be unable to collect the scheduled payments of principal
and interest when due according to the contractual terms of the loan or lease
agreement. The measurement of impaired loans and leases is generally based upon
the present value of future cash flows discounted at the historical effective
interest rate, except that all collateral-dependent loans and leases are
measured for impairment based on fair value of the collateral. As of December
31, 2002, there were no impaired loans or leases for which specific valuation
allowances had been recorded.
The allowance for loan and lease losses represents management's best
estimate of probable loan and lease losses in the Company's loan and lease
portfolio. Management's quarterly evaluation of the allowance for loan and lease
losses is a comprehensive analysis that builds a total reserve by evaluating the
risks within each loan and lease type, or pool, of similar loans and leases. The
Company uses a general allocation methodology for all residential and consumer
loan pools. This methodology estimates a reserve for each pool based on the most
recent three-year loss rate, adjusted to reflect the expected impact that
current trends regarding loan growth, delinquency, losses, economic conditions,
and current interest rates are likely to have. For commercial loan and lease
pools, the Company establishes a specific reserve allocation for all loans and
leases, which have been risk rated under the Company's risk rating system, as
substandard, doubtful, or loss. The
19
specific allocation is based on the most recent valuation of the loan or lease
collateral and the customer's ability to pay. For all other commercial loans and
leases, the Company uses the general allocation methodology that establishes a
reserve for each risk rating category. The general allocation methodology for
commercial loans and leases considers the same factors that are considered when
evaluating residential mortgage and consumer loan pools. The combination of
using both the general and specific allocation methodologies reflects
management's best estimate of the probable loan and lease losses in the
Company's loan and lease portfolio. Loans and leases are charged against the
allowance for loan and lease losses, in accordance with the Company's loan and
lease policy, when they are determined by management to be uncollectible.
Recoveries on loans and leases previously charged-off are credited to the
allowance for loan and lease losses when they are received. When management
determines that the allowance for loan and lease losses is less than adequate to
provide for potential losses, a direct charge is made to operating income.
The allowance for loan and lease losses account at December 31, 2002 was
$5,019,000, or 1.21% of loans and leases outstanding, compared to $4,478,000, or
1.19% of loans and leases outstanding, at December 31, 2001. The 2002 increase
of $541,000, or 12.1%, in the reserve for loan and lease losses was funded by a
$1,895,000 provision expense that was equal to 1.4 times the amount of net loan
and lease losses for 2002. The Company increased the reserve in connection with
its 2002 loan growth. Although net loans and leases charged-off reported a
slight increase from $1,347,000 in 2001 to $1,354,000 in 2002, the ratio of net
charge-offs to average loans and leases outstanding declined to 0.34% in 2002
from 0.38% in 2001. The majority of the Company's 2002 net loan and lease losses
(61%) were in the indirect auto loan category, similar with 2001 results, and
related to loans originated prior to 2001 with dealerships that the Company has
since terminated relationships with. In the second half of 2001, the Company
tightened its indirect auto loan underwriting guidelines, and continues to
report improved quality in the portfolio. Net loans and leases charged off,
other than indirect auto loans, continued at low levels, with commercial loan
and lease losses in 2002 representing 21% of total net losses, equivalent to 21
basis points of average commercial loans and leases outstanding in 2002.
Commercial loan and lease losses were comparable with those reported for 2001.
The Company's net losses in its residential mortgage loan portfolio were
negligible again in 2002.
The following table summarizes loan and lease balances at the end of each
period indicated and the daily average amount of loans and leases. Also
summarized are changes in the allowance for loan and lease losses arising from
loans and leases charged-off and recoveries on loans and leases previously
charged-off and additions to the allowance, which have been charged to expense.
Summary of Loan and Lease Loss Allowance
YEARS ENDED DECEMBER 31, 2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Amount of loans and leases outstanding at
end of period (gross loans and leases
less unearned discount) $414,223 $375,738 $315,748 $285,437 $253,296
-------- -------- -------- -------- --------
Daily average amount of loans and leases
(net of unearned discount) $400,039 $353,303 $298,521 $263,961 $244,649
-------- -------- -------- -------- --------
Balance of allowance for loan and
lease losses at beginning of period $ 4,478 $ 3,370 $ 3,412 $ 3,001 $ 2,957
Loans and leases charged-off:
Commercial/lease 367 326 780 73 218
Real estate mortgage 63 1 56 38 29
Indirect 1,061 1,019 370 166 --
Other consumer 303 376 251 471 693
-------- -------- -------- -------- --------
Total loans and leases charged-off 1,794 1,722 1,457 748 940
Recoveries of loans and leases
previously charged-off:
Commercial/lease 82 32 74 21 111
Real estate mortgage 9 2 1 1 --
Indirect 235 228 127 42 --
Other consumer 114 113 63 120 103
-------- -------- -------- -------- --------
Total recoveries 440 375 265 184 214
Net loans and leases charged-off 1,354 1,347 1,192 564 726
-------- -------- -------- -------- --------
Additions to allowance charged
to expense 1,895 2,455 1,150 975 770
Balance at end of period $ 5,019 4,478 $ 3,370 $ 3,412 $ 3,001
-------- -------- -------- -------- --------
losses to period-end loans and leases 1.21% 1.19% 1.07% 1.20% 1.18%
Ratio of net charge-offs to
average loans and leases outstanding 0.34% 0.38% 0.40% 0.21% 0.30%
20
The allowance for loan and lease losses is allocated according to the
amount deemed to be reasonably necessary to provide for the probable losses
within each category of loans and leases. During 2002, the majority of the
increase in the allowance for loans and leases was credited to the indirect loan
category as recommended in the quarterly analysis evaluating the adequacy of the
allowance. The percentage of the allowance allocated to the indirect loan
category increased to 30.9% of the total allowance at year-end 2002, from 24% at
year-end 2001, with the balance of the indirect category increasing $476,000, or
44.3%, during 2002. The majority of the indirect loan category provides for
probable losses in connection with loans originated during a 12-month period
that ended May 2001.
The allowance for loan and lease losses has been allocated within the
following categories of loans and leases at the dates indicated:
Allocation of the Allowance for Loan and Lease Losses
YEARS ENDED DECEMBER 31, 2002 2001 2000 1999 1998
------------------- ------------------ ------------------ ------------------ ------------------
AMT. OF AMT. OF AMT. OF AMT. OF AMT. OF
ALLOWANCE PERCENT ALLOWANCE PERCENT ALLOWANCE PERCENT ALLOWANCE PERCENT ALLOWANCE PERCENT
--------- ------- --------- ------- --------- ------- --------- ------- --------- -------
(DOLLARS IN THOUSANDS)
Commercial/Leases $2,575 51.31% $2,588 57.79% $1,625 48.22% $1,857 54.43% $1,159 38.62%
Real estate mortgage 361 7.19% 305 6.81% 276 8.19% 391 11.46% 482 16.06%
Indirect 1,551 30.90% 1,075 24.01% 819 24.30% * *
Other consumer 532 10.60% 510 11.39% 650 19.29% 1,164 34.11% 698 23.26%
Unallocated -- -- -- -- -- -- -- -- 662 22.06%
------ ----- ------ ----- ------ ----- ------ ----- ------- -----
Total $5,019 100.0% $4,478 100.0% $3,370 100.0% $3,412 100.0% $3,001 100.0%
------ ----- ------ ----- ------ ----- ------ ----- ------- -----
*Allocation for indirect loans for 1999 and 1998 are contained within the
other consumer loan category for those years.
Deposits and Other Borrowings
The Company's deposit accounts represent its primary source of funds. The
deposit base is comprised of demand deposit, savings and money market accounts,
and other time deposits, that are primarily provided by individuals, businesses,
and local governments within the communities served. The Company continuously
monitors market pricing, competitors' rates, and internal interest rate spreads
to maintain and promote growth and profitability.
Average deposits during 2002 increased $29,235,000, or 5.8%, compared to a
$44,800,000, or 9.7%, increase in 2001. Compared to December 31, 2001, deposits
as of December 31, 2002, in the amount of $546,653,000, were up $47,361,000, or
9.5%. Deposit growth in 2002 was the result of new account acquisition and
retention, expanded product offerings, and a general shift in customer
preference away from equity markets and into insured bank deposits. Average
commercial deposits in 2002 were up 16.4% compared to the prior year, with the
strong growth resulting from the Company's product lines that assisted
businesses in improving their cash management. Average consumer deposits
increased 4.9% over the prior year, with increases most dramatic in the NOW
account and money market product offerings. Average deposits also increased
during 2002 as the Company acquired brokered certificates of deposit, with rates
and maturities that were preferential to other deposit alternatives. During
2002, pressures on local government budgets along with very competitive pricing
in the local markets for municipal deposits, pushed average balances on public
funds lower by 16.2% compared to 2001. In the last quarter of 2002, the premium
pricing structure of competitors, offered particularly on money market type
products, began to ease and the Company's balances increased.
The Company's average deposit mix in 2002, compared to 2001, reflected a
slight shift from higher cost time deposit accounts to lower cost demand
deposit, and savings and money market accounts. The Company's average demand
deposits in 2002, including both interest-bearing and noninterest-bearing
accounts, were 24.8% of total average deposits, comparable with 2001, following
a decline of 1% in the prior year. This group of average deposits increased
$7,978,000, or 6.4%, when comparing 2002 to 2001. These core transactional
accounts continue to represent a significant percentage of total deposits and
provide the Company with an important low-cost source of funds. The Company's
savings and money market average deposit balances increased $20,151,000, or
12.6%, during 2002 primarily on the growth in the Company's money market type
products offered to all business lines. As a percentage of total deposits,
savings and money market accounts increased by 2% compared to 2001. Average time
deposits in 2002 increased $1,106,000, less than 1% compared to 2001, following
an increase of $30,221,000, or 15.9%, when comparing 2001 to 2000.
Commercial deposits ended the year with strong growth, up $8,938,000, or
11.9% in 2002 compared to 2001, following an increase of $11,437,000, or 18%,
compared to 2000. Consumer deposits were up $20,773,000, or 7%, at December 31,
2002 compared to year-end 2001, following a $3,136,000, or 1.1%, increase
compared to year-end 2001. Comparing year-ends, the majority of the 2002
increase in consumer deposits was in the time deposit category. The Company's
total municipal deposits of $103,465,000 on December 31, 2002 represented 18.9%
of total deposits, down from 20.2%, or $100,817,000, of total deposits on
December 31, 2001. Brokered certificates of deposit in the amount of
$41,742,000, represented 17.9% of time deposits, and 7.6% of total deposits at
December 31, 2002. Brokered certificates of deposits increased $15,000,000, or
56.1%, during 2002.
Time deposits in excess of $100,000, which are more volatile and sensitive
to interest rates, totaled $73,086,000 at year-end 2002, representing 31.3% of
total time deposits, and 13.4% of total deposits. On a comparative basis, these
deposits totaled $68,520,000, representing 33.9% of total time deposits, and
13.7% of total deposits at year-end 2001.
21
The average daily amount of deposits, the average rate paid, and the
percentage of deposits on each of the following deposit categories are
summarized below for the years indicated:
2002 2001 2000
-------------------------- -------------------------- --------------------------
AVG. PERCENT AVG. PERCENT AVG. PERCENT
AVG. RATE OF AVG. RATE OF AVG. RATE OF
BALANCE PAID DEPOSITS BALANCE PAID DEPOSITS BALANCE PAID DEPOSITS
------- ---- -------- ------- ---- -------- ------- ---- --------
(DOLLARS IN THOUSANDS)
Noninterest-bearing
demand deposits $ 54,213 0.00% 10.15% $ 52,871 0.00% 10.48% $ 54,800 0.00% 11.92%
Interest-bearing
demand deposits 78,263 0.51% 14.66% 71,627 1.05% 14.19% 62,928 1.53% 13.68%
Savings and money
market deposits 180,533 1.40% 33.82% 160,382 2.69% 31.78% 152,573 3.39% 33.18%
Time deposits 220,862 3.60% 41.37% 219,756 5.01% 43.55% 189,535 5.72% 41.22%
-------- ---- ------ -------- ---- ------ -------- ---- ------
Total average daily amount
of deposits $533,871 2.04% 100.00% $504,636 3.19% 100.00% $459,836 3.69% 100.00%
-------- ---- ------ -------- ---- ------ -------- ---- ------
The following table indicates the amount of the Company's time deposits of
$100,000 or more by time remaining until maturity as of December 31, 2002:
(In thousands)
Less than three months $28,360
Three months to six months 13,656
Six months to one year 13,228
Over one year 17,842
-------
Total $73,086
-------
The Company offers retail repurchase agreements primarily to its larger
business customers. Under the terms of the agreements, the Company sells
investment portfolio securities to the customer and agrees to repurchase the
securities at a specified later date. The Company views the arrangement as a
deposit alternative for its business customers. As of December 31, 2002, retail
repurchase agreement balances amounted to $16,167,000 compared to balances of
$17,412,000 at December 31, 2001. During 2002, the Company utilized
collateralized repurchase agreements with various brokers and advances from the
Federal Home Loan Bank of New York (FHLB), as alternative sources of funding and
as a liability management practice. At December 31, 2002, the combination of
repurchase agreements and FHLB advances were $130,000,000, compared to
$115,013,000 at December 31, 2001.
Capital
In 2002, the Company added $6,911,000 into equity through net income and
returned $2,725,000 to its shareholders in the form of cash dividends, retaining
$4,186,000 in undivided profits. During the year, the Company's equity increased
$223,000 in connection with the issue of 12,500 shares of stock in connection
with the exercise of stock options. The Company repurchased 6,000 shares of its
common stock during the year at a cost of $143,000 in connection with a stock
repurchase program. Total shareholders' equity also reflects an adjustment for
the change in market value of the Company's available-for-sale investment
securities. As previously discussed in the Investment Securities section, the
after-tax effect of the net unrealized gains and losses is reported as the
Accumulated Other Comprehensive Income component of shareholders' equity, and
reflects an increase in total shareholders' equity of $5,224,000 for the year
ended December 31, 2002. The Company's ratio of shareholders' equity to total
assets of 8.12% at December 31, 2002 compares to 7.72% at December 31, 2001. The
Company's goal is to maintain a strong capital position, consistent with the
risk profile of its subsidiary bank, that supports growth and expansion
activities while at the same time exceeding regulatory standards. Capital
adequacy in the banking industry is evaluated primarily by the use of ratios
which measure capital against total assets, as well as against total assets that
are weighted based on defined risk characteristics. At December 31, 2002, the
Company exceeded all regulatory required minimum capital ratios and met the
regulatory definition of a "well-capitalized institution." A more comprehensive
analysis of regulatory capital requirements, including ratios for the Company
and its subsidiary bank, is included in Note 16 in the Consolidated Financial
Statements section of this report.
The Company declared cash dividends equal to $0.79 per share in 2002
compared to $0.845 in 2001. The Company increased its regular quarterly dividend
from $0.19 to $0.20 per share in 2002, paying the higher rate since the second
quarter of the year. During the fourth quarter of 2001, the Company paid an
extra cash dividend of $0.10 per share, in addition to its then regular dividend
of $0.19 per share.
The 2002 dividend pay-out ratio was 39% compared to a 49% pay-out ratio in
2001. It is the Company's intention to maintain a dividend pay-out ratio at or
about 40%, subject to applicable regulatory restrictions.
22
Liquidity
The Company's liquidity reflects its ability to provide funds to meet loan
and lease requests, to accommodate possible outflows in deposits, and to take
advantage of market interest rate opportunities. Funding of loan and lease
requests, providing for liability outflows, and management of interest rate
fluctuations requires continuous analysis in order to match the maturities of
specific categories of short-term loans and leases and investments with specific
types of deposits and borrowings. Liquidity is normally considered in terms of
the nature and mix of the Bank's sources and uses of funds. The Asset Liability
Management Committee (ALCO) of the Bank is responsible for implementing the
policies and guidelines for the maintenance of prudent levels of liquidity.
Management believes, as of December 31, 2002, that liquidity as measured by the
Company is in compliance with its policy guidelines.
The Bank's principal sources of funds for operations are cash flows
generated from earnings, deposits, loan and lease repayments, borrowings from
the FHLB, and securities sold under repurchase agreements. During the twelve
months ended December 31, 2002, cash and cash equivalents decreased by $152,000,
as net cash used by investing activities of $74,124,000, exceeded the net cash
provided by operating activities and financing activities of $73,972,000. Net
cash provided by financing activities reflects a net increase in deposits of
$47,361,000, and a net increase in borrowings of $22,242,000. Brokered deposits
increased in the amount of $15,000,000 during the year ended December 31, 2002.
Net cash used in investing activities reflects a net increase in loans of
$39,839,000, and a net increase in investment securities of $33,161,000.
As a member of the FHLB, the Bank is eligible to borrow up to an
established credit limit against certain residential mortgage loans that have
been pledged as collateral. As of December 31, 2002, the Bank's credit limit
with the FHLB was $106,595,000, with outstanding borrowings in the amount of
$73,500,000.
Application of Critical Accounting Policies
The Company's consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States and follow
practices within the banking industry. Application of these principles requires
management to make estimates, assumptions, and judgements that affect the
amounts reported in the financial statements and accompanying notes. These
estimates, assumptions, and judgements are based on information available as of
the date of the financial statements; accordingly, as this information changes,
the financial statements could reflect different estimates, assumptions, and
judgements. Certain policies inherently have a greater reliance on the use of
estimates, assumptions, and judgements and as such have a greater possibility of
producing results that could be materially different than originally reported.
Estimates, assumptions, and judgements are necessary when assets and liabilities
are required to be recorded at fair value or when an asset or liability needs to
be recorded contingent upon a future event. Carrying assets and liabilities at
fair value inherently results in more financial statement volatility. The fair
values and information used to record valuation adjustments for certain assets
and liabilities are based on quoted market prices or are provided by other
third-party sources, when available. When third party information is not
available, valuation adjustments are estimated in good faith by management.
The most significant accounting policies followed by the Company are
presented in Note 1 to the consolidated financial statements included elsewhere
in this Annual Report on Form 10-K. 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 valued in the
financial statements and how those values are determined. Based on the valuation
techniques used and the sensitivity of financial statement amounts to the
methods, assumptions, and estimates underlying those amounts, management has
identified the determination of the allowance for loan and lease losses and
accrued income taxes to be the accounting areas that require the most subjective
and complex judgements, and as such could be the most subject to revision as new
information becomes available.
The allowance for loan and lease losses represents management's estimate
of probable loan and lease losses inherent in the loan and lease portfolio.
Determining the amount of the allowance for loan and lease losses is considered
a critical accounting estimate because it requires significant judgement and the
use of estimates related to the amount and timing of expected future cash flows
on impaired loans and leases, estimated losses on pools of homogeneous loans and
leases based on historical loss experience, and consideration of current
economic trends and conditions, all of which may be susceptible to significant
change. The loan and lease portfolio also represents the largest asset type on
the consolidated balance sheet. Note 1 to the consolidated financial statements
describes the methodology used to determine the allowance for loan and lease
losses, and a discussion of the factors driving changes in the amount of the
allowance for loan and lease losses is included in this report.
The Company estimates its tax expense based on the amount it expects to
owe the respective tax authorities. Taxes are discussed in more detail in Note 9
of the Consolidated Financial Statements on page 37. Accrued taxes represent the
net estimated amount due or to be received from taxing authorities. In
estimating accrued taxes, management assesses the relative merits and risks of
the appropriate tax treatment of transactions taking into account statutory,
judicial and regulatory guidance in the context of the Corporation's tax
position. If the final resolution of taxes payable differs from our estimates
due to regulatory determination or legislative or judicial actions, adjustments
to tax expense may be required.
23
Item 7A - Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss in a financial instrument arising from
adverse changes in market rates or prices such as interest rates, foreign
currency exchange rates, commodity prices, and equity prices. The Company's
market risk arises principally from interest rate risk in its lending, deposit
and borrowing activities. Other types of market risks do not arise in the normal
course of the Company's business activities. The ALCO is responsible for
reviewing the interest rate sensitivity position and establishing policies to
monitor and limit exposure to interest rate risk. The policies and guidelines
established by ALCO are reviewed and approved by the Company's Board of
Directors.
Interest rate risk is monitored primarily through the use of two complementary
measures: earnings simulation modeling and net present value estimation. Both
measures are highly assumption dependent and change regularly as the balance
sheet and business mix evolve; however, taken together they represent a
reasonably comprehensive view of the magnitude of interest rate risk, the
distribution of risk along the yield curve, the level of risk through time, and
the amount of exposure to changes in certain interest rate relationships. The
key assumptions employed by these measures are analyzed regularly and reviewed
by ALCO.
Earnings Simulation Modeling
Net interest income is affected by changes in the absolute level of interest
rates and by changes in the shape of the yield curve. In general, a flattening
of the yield curve would result in a decline in earnings due to the compression
of earning asset yields and funding rates, while a steepening of the yield curve
would result in increased earnings as investment margins widen. The model
requires management to make assumptions about how the balance sheet is likely to
evolve though time in different interest rate environments. Loan and deposit
growth rate assumptions are derived from historical analysis and management's
outlook, as are the assumptions used to project yields and rates for new loans
and deposits. Securities portfolio maturities and prepayments are assumed to be
reinvested in similar instruments. Mortgage loan prepayment assumptions are
developed from industry median estimates of prepayment speeds in conjunction
with the historical prepayment performance of the Company's own loans.
Non-contractual deposit growth rates and pricing are modeled on historical
patterns. Interest rates of the various assets and liabilities on the balance
sheet are assumed to change proportionally, based on their historic relationship
to short-term rates. The Company's guidelines for risk management call for
preventative measures to be taken if the simulation modeling demonstrates that
an instantaneous 2% increase or decrease in short-term rates over the next
twelve months would adversely affect net interest income over the same period by
more than 15% when compared to the stable rate scenario. The low level of
short-term interest rates at December 31, 2002, necessitated a modification of
the standard 2% rate change scenario, to an instantaneous decrease of 1%
scenario over the next twelve months with an adverse effect no greater than
7.5%. At December 31, 2002, based on the results of our simulation model, and
assuming that management does not take action to alter the outcome, the Company
would expect net interest income to decrease 6.5% if short term interest rates
increase by 2%, and decrease 1.1% if short term interest rates decline by 1%.
Net Present Value Estimation
The Net Present Value of Equity (NPV) measure is used for discerning levels of
risk present in the balance sheet that might not be taken into account in the
earnings simulation model due to the shorter time horizon used by that model.
The NPV of the balance sheet, at a point in time, is defined as the discounted
present value of the asset cash flows minus the discounted value of liability
cash flows. Interest rate risk analysis using NPV involves changing the interest
rates used in determining the cash flows and in discounting the cash flows. The
Company's NPV analysis models both an instantaneous 2% increasing and 2%
decreasing interest rate scenario comparing the NPV in each scenario to the NPV
in the current rate scenario. The resulting percentage change in NPV is an
indication of the longer-term repricing risk and options risk embedded in the
balance sheet. The NPV measure assumes a static balance sheet versus the growth
assumptions that are incorporated into the earnings simulation measure, and an
unlimited time horizon instead of the one-year horizon applied in the earnings
simulation model. As with earnings simulation modeling, assumptions about the
timing and the variability of balance sheet cash flows are critical in NPV
analysis. Particularly important are assumptions driving mortgage prepayments in
both the loan and investment portfolios, and changes in the noncontractual
deposit portfolios. These assumptions are applied consistently in both models.
Based on the December 31, 2002 NPV estimation, a 2% instantaneous increase in
interest rates was estimated to decrease NPV by 1.7%. NPV was estimated to
decline 5.6% if rates immediately declined by 1%. Policy guidelines limit the
amount of the estimated decline to 25% in a 2% rate change scenario, and 12.5%
in a 1% rate change scenario. As with the earnings simulation modeling, due to
the low level of interest rates at December 31, 2002, the Company modified its
standard decreasing rate scenario to a 1% rate decline at year end.
24
The following table shows the Company's financial instruments that are
sensitive to changes in interest rates, categorized by expected maturity, and
the instruments' fair values at December 31, 2002:
Expected Maturity/Principal Repayments at December 31, 2002
AVERAGE
THERE- INTEREST FAIR
2003 2004 2005 2006 2007 AFTER TOTAL RATE VALUE
---- ---- ---- ---- ---- ----- ----- ---- -----
(DOLLARS IN THOUSANDS)
Rate Sensitive Assets
Loans and leases $143,511 $ 93,885 $ 53,593 $ 32,328 $ 14,534 $ 71,353 $409,204 6.89% $421,024
Investments 61,462 54,767 67,354 15,917 11,804 103,690 314,994 4.63% 316,434
-------- --------- -------- -------- -------- -------- -------- ---- --------
Total rate sensitive assets $204,973 $ 148,652 $120,947 $ 48,245 $ 26,338 $175,043 $724,198 $737,458
-------- --------- -------- -------- -------- -------- -------- ---- --------
Rate Sensitive Liabilities
Savings, money market, and
NOW accounts $ 54,786 $ 54,786 $ 54,786 $36,761 $23,959 $ 33,994 $259,070 1.30% $259,070
Time deposits 139,185 61,238 15,602 3,164 9,190 5,089 233,470 3.17% 236,021
Borrowings 77,542 30,000 10,000 10,000 -- 27,125 154,667 3.24% 158,799
-------- --------- -------- -------- -------- -------- -------- ---- --------
Total rate sensitive
liabilities $271,513 $ 146,024 $ 80,388 $ 49,925 $ 33,149 $ 66,208 $647,207 $653,890
-------- --------- -------- -------- -------- -------- -------- ---- --------
Expected maturities are contractual maturities adjusted for prepayments of
principal. The Company uses certain assumptions to estimate fair values and
expected maturities. For assets, expected maturities are based upon contractual
maturity, projected repayments and prepayment of principal. The prepayment
experience reflected herein is based on the Company's historical experience. The
actual maturities and run-off of loans and leases could vary substantially if
future prepayments differ from the Company's historical experience. For
liabilities, expected maturities are contractual maturities for time deposits
and borrowings. Non-maturity liabilities have estimated maturities based on an
analysis that considers the historic stability of the balances and the
competitiveness of the Company's pricing, for each account type.
25
Item 8 - Financial Statements and Supplemental Data
Consolidated Statements of Condition (Dollars in thousands)
Assets Dec. 31, 2002 Dec. 31, 2001
Cash and due from banks $ 21,474 $ 21,626
Federal funds sold -- --
-------- --------
Total Cash and Cash Equivalents 21,474 21,626
Held-to-maturity investment securities 6,188 7,371
Available-for-sale investment securities 308,806 265,319
-------- --------
Total Investment Securities 314,994 272,690
(fair value--$316,434 for 2002 and $273,477 for 2001)
Total Loans and Leases 414,277 375,842
Less: Unearned income 54 104
Less: Allowance for loan & lease losses 5,019 4,478
-------- --------
Net Loans and Leases 409,204 371,260
Bank premises, furniture, and equipment 10,280 10,621
Accrued interest receivable 4,159 4,085
Other assets 14,839 12,589
-------- --------
Total Assets $774,950 $692,871
-------- --------
Liabilities and Shareholders' Equity
Noninterest-bearing deposits $ 54,113 $ 57,044
Interest-bearing deposits 492,540 442,248
-------- --------
Total Deposits 546,653 499,292
Borrowings 154,667 132,425
Other liabilities 10,677 7,691
-------- --------
Total Liabilities 711,997 639,408
-------- --------
Shareholders' equity:
Preferred stock--par value $25.00 a share;
1,000,000 shares authorized, none issued;
Common stock--par value $1.00 a share;
10,000,000 shares authorized, 3,827,805 and
3,815,305 shares issued, and 3,453,713 and 3,447,213
shares outstanding for 2002 and 2001, respectively 3,828 3,815
Surplus 7,306 7,096
Undivided profits 53,272 49,086
Accumulated other comprehensive income 6,467 1,243
Treasury stock, at cost; 374,092 and 368,092 shares,
respectively (7,920) (7,777)
-------- --------
Total Shareholders' Equity 62,953 53,463
-------- --------
Total Liabilities and Shareholders' Equity $774,950 $692,871
-------- --------
The accompanying notes are an integral part of the consolidated financial
statements.
26
Consolidated Statements of Income (Dollars in thousands)
Interest Income Years Ended Dec. 31, 2002 Dec. 31, 2001 Dec. 31, 2000
Interest and fees on loans & leases $28,177 $29,028 $26,701
Interest on investment securities:
U.S. Government and
Agency obligations 11,555 9,898 9,261
Obligations of states and
political subdivisions 2,678 2,649 2,411
Other 274 1,166 1,403
Interest on federal funds sold 30 383 286
------- ------- -------
Total Interest Income 42,714 43,124 40,062
Interest Expense
Interest on deposits 10,892 16,073 16,977
Interest on borrowings 5,052 3,892 2,490
------- ------- -------
Total Interest Expense 15,944 19,965 19,467
------- ------- -------
Net Interest Income 26,770 23,159 20,595
Provision for loan & lease losses 1,895 2,455 1,150
------- ------- -------
Net Interest Income After Provision
For Loan & Lease Losses 24,875 20,704 19,445
Other Income
Trust and brokerage services 1,343 1,405 1,393
Service charges on deposit accounts 2,281 2,370 1,993
Investment securities gains 791 1,495 711
Gain on the sale of loans 226 47 6
Other operating income 2,123 1,674 2,546
------- ------- -------
Total Other Income 6,764 6,991 6,649
------- ------- -------
Total Operating Income 31,639 27,695 26,094
Other Expenses
Salaries, wages, and employee benefits 12,518 11,264 10,414
Building, occupancy, and equipment 3,443 3,153 2,861
Other operating expense 6,416 5,550 5,362
------- ------- -------
Total Other Expenses 22,377 19,967 18,637
------- ------- -------
Income Before Income Taxes 9,262 7,728 7,457
Provision for income taxes 2,351 1,717 2,032
------- ------- -------
Net Income $ 6,911 $ 6,011 $ 5,425
------- ------- -------
Net Income Per Common Share
Basic $ 2.00 $ 1.71 $ 1.52
Diluted $ 1.98 $ 1.70 $ 1.52
------- ------- -------
The accompanying notes are an integral part of the consolidated financial
statements.
27
Consolidated Statements of Changes in Shareholders' Equity (Dollars in
thousands)
ACCUMULATED
ISSUED OTHER
FOR THE YEARS ENDED COMMON COMMON UNDIVIDED COMPREHENSIVE TREASURY
DEC. 31, 2002, 2001, 2000 SHARES STOCK SURPLUS PROFITS INCOME STOCK TOTAL
------ ----- ------- ------- ------ ----- -----
Balance at January 1, 2000 3,641,035 $3,641 $3,641 $46,768 $(2,086) $(2,719) $49,245
--------- ------ ------ ------- ------- ------- -------
Comprehensive income
Net income 5,425 5,425
Other comprehensive income,
net of taxes:
Unrealized appreciation in
available for sale securities,
net of reclassification adjustment 2,788 2,788
-----
Comprehensive income 8,213
Cash dividends, $.71 per share (2,534) (2,534)
Treasury stock purchased (1,889) (1,889)
5% stock dividend 174,270 174 3,455 (3,629) --
--------- ------ ------ ------- ------- ------- -------
Balance at December 31, 2000 3,815,305 3,815 7,096 46,030 702 (4,608) 53,035
--------- ------ ------ ------- ------- ------- -------
Comprehensive income
Net income 6,011 6,011
Other comprehensive income,
net of taxes:
Unrealized appreciation in
available for sale securities,
net of reclassification adjustment 541 541
---
Comprehensive income 6,552
Cash dividends, $.845 per share (2,955) (2,955)
Treasury stock purchased (3,169) (3,169)
--------- ------ ------ ------- ------- ------- -------
Balance at December 31, 2001 3,815,305 3,815 7,096 49,086 1,243 (7,777) 53,463
--------- ------ ------ ------- ------- ------- -------
Comprehensive income
Net income 6,911 6,911
Other comprehensive income,
net of taxes:
Unrealized appreciation in
available for sale securities,
net of reclassification adjustment 5,224 5,224
-----
Comprehensive income 12,135
Stock options exercised 12,500 13 210 223
Cash dividends, $.79 per share (2,725) (2,725)
Treasury stock purchased (143) (143)
--------- ------ ------ ------- ------- ------- -------
Balance at December 31, 2002 3,827,805 $3,828 $7,306 $53,272 $ 6,467 $(7,920) $62,953
--------- ------ ------ ------- ------- ------- -------
The accompanying notes are an integral part of the consolidated financial
statements.
28
Consolidated Statements of Cash Flows (Dollars in thousands)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Operating Activities Years Ended Dec. 31, 2002 2001 2000
Net income $ 6,911 $ 6,011 $ 5,425
Adjustments to reconcile net income to net cash provided by operating
activities: Provision for loan losses 1,895 2,455 1,150
Provision for depreciation 1,469 1,346 1,208
Increase in surrender value of life insurance (485) (300) (469)
Benefit for deferred income taxes (245) (385) (225)
Amortization (accretion) of investment security discounts and premiums, net 355 (183) 168
Realized investment security gains (791) (1,495) (711)
Proceeds from the sale of mortgage loans 14,752 2,774 1,206
Origination of loans held-for-sale (14,526) (2,727) (1,200)
Change in other assets and liabilities (1,782) (372) 183
-------- -------- -------
Net Cash Provided by Operating Activities 7,553 7,124 6,735
-------- -------- -------
Investing Activities
Proceeds from maturities of investment securities, available-for-sale 63,726 67,362 29,667
Proceeds from maturities of investment securities, held-to-maturity 2,862 8,216 6,697
Proceeds from sales of investment securities 33,074 51,147 33,668
Purchase of investment securities, available-for-sale (131,145) (168,393) (89,067)
Purchase of investment securities, held-to-maturity (1,679) (5,364) (4,471)
Net increase in loans (40,065) (61,384) (31,509)
Purchases of premises and equipment (1,128) (1,296) (2,991)
-------- -------- -------
Net Cash Used by Investing Activities (74,354) (109,712) (58,006)
-------- -------- -------
Financing Activities
Net increase (decrease) in demand deposits, NOW accounts, and savings accounts 15,841 35,977 (5,930)
Net increase (decrease) in time deposits 31,520 (11,584) 45,755
Net increase (decrease) in short-term borrowings 7,242 16,339 (139)
Net increase in long-term borrowings 15,000 70,000 15,000
Proceeds from the exercise of stock options 223 - -
Treasury stock purchased (143) (3,169) (1,889)
Cash dividends (3,034) (2,623) (2,483)
-------- -------- -------
Net Cash Provided by Financing Activities 66,649 104,940 50,314
-------- -------- -------
(Decrease) increase in Cash and Cash Equivalents (152) 2,352 (957)
Cash and cash equivalents at beginning of year 21,626 19,274 20,231
-------- -------- -------
Cash and Cash Equivalents at End of Year $ 21,474 $ 21,626 $ 19,274
-------- -------- -------
Supplemental Disclosures of Cash Flow Information:
Cash paid during the year for:
Interest on deposits and borrowings $ 15,790 $ 20,131 $ 18,990
Income taxes 3,085 2,020 2,362
Noncash investing activities:
Increase in net unrealized gain/losses on available-for-sale securities (8,707) (901) (4,647)
Noncash financing activities:
Dividend declared and unpaid 691 1,000 668
-------- -------- -------
The accompanying notes are an integral part of the consolidated financial
statements.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Nature of Operations: Alliance Financial Corporation (the Company) is a bank
holding company, which owns and operates Alliance Bank, N.A. The Company
provides financial services primarily to individuals, small- to medium-sized
businesses and government customers from 19 customer service facilities in
Broome, Cortland, Madison, Oneida, and Onondaga counties. The Bank has a
substantially wholly owned subsidiary, Alliance Preferred Funding Corp., which
is engaged in residential real estate activity and a wholly owned subsidiary,
Alliance Leasing, Inc., which is engaged in commercial leasing activity.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiary after elimination of
inter-company accounts and transactions.
Critical Accounting Estimates and Policies: The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Management has identified the allowance for loan and lease losses and accrued
income taxes to be the accounting areas that require the most subjective and
complex judgements, and as such could be the most subject to revision as new
information becomes available.
Risk and Uncertainties: In the normal course of its business, the Company
encounters economic and regulatory risks. There are three main components of
economic risk: interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different speeds, or on different bases, from
its interest-earning assets. The Company's primary credit risk is the risk of
default on the Company's loan portfolio that results from the borrowers'
inability or unwillingness to make contractually required payments. Market risk
reflects potential changes in the value of collateral underlying loans, the fair
value of investment securities, and loans held for sale. The Company is subject
to regulations of various governmental agencies. These regulations can and do
change significantly from period to period. The Company also undergoes periodic
examinations by the regulatory agencies which may subject it to further changes
with respect to asset valuations, amounts of required loan and lease loss
allowances, and operating restrictions resulting from the regulators' judgements
based on information available to them at the time of their examinations.
Reclassification: Certain amounts from prior years have been reclassified to
conform to the current year presentation. These reclassifications had no effect
on net income as previously reported.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, amounts due from banks, and federal funds
sold. Generally, federal funds are purchased and sold for one-day periods.
Investment Securities: The Company classifies investment securities as
held-to-maturity or available-for-sale. Held-to-maturity securities are those
that the Company has the positive intent and ability to hold to maturity, and
are reported at cost, adjusted for amortization of premiums and accretion of
discounts. Investment securities not classified as held-to-maturity are
classified as available-for-sale and are reported at fair value, with net
unrealized holding gains and losses reflected as a separate component of
shareholders' equity, net of the applicable income tax effect. None of the
Company's investment securities have been classified as trading securities.
Gains and losses on the sale of investment securities are based on the specific
identification method. Premiums and discounts on securities are amortized and
accreted into income using the interest method over the life of the security.
Investment securities are reviewed regularly for other than temporary
impairment. Where there is other than temporary impairment, the carrying value
of the investment security is reduced to the estimated fair value, with the
impairment loss recognized in the consolidated statements of income.
Securities Sold under Agreements to Repurchase: Repurchase agreements are
accounted for as collateralized borrowings, and the obligations to repurchase
securities sold are reflected as a liability in the statement of financial
condition, since the Company maintains effective control over the transferred
securities. The securities underlying the agreements remain in the investment
account. The fair value of the collateral provided to a third party is
continually monitored and additional collateral is provided to the third party,
or surplus collateral is returned to the Company as deemed appropriate.
Loans & Leases: Loans and direct financing leases are stated at unpaid principal
balances less the allowance for loan and lease losses, unearned interest income
and net deferred loan origination fees and costs. Unearned income on certain
installment loans is taken into income on the actuarial method. Interest on all
other loans is based upon the principal amount outstanding. Interest on loans is
accrued except when in management's opinion the collectibility of interest is
doubtful, at which time the accrual of interest on the loan is discontinued.
Loan origination fees and certain direct loan origination costs are deferred and
the net amount is amortized as a yield adjustment over the life of the
30
loan. The Company is generally amortizing these amounts over the contractual
life of the related loans. However, for certain fixed-rate mortgage loans that
are generally made for a 20-year term, the Company has anticipated prepayments
and used an estimated life of 7.5 years.
Operating leases are stated at cost of the equipment less depreciation.
Equipment on Operating leases is depreciated on a straight-line basis to its
estimated residual value over the lease term. Operating lease income is
recognized on a straight-line basis over the term of the lease. Income
attributable to direct financing leases is initially recorded as unearned income
and subsequently recognized as finance income at level rates of return over the
term of the leases. The recorded residual values of the Company's leased assets
are estimated at the inception of the lease to be the expected fair market value
of the assets at the end of the lease term. On a quarterly basis, the Company
reassesses the realizable value of its lease residual values. In accordance with
generally accepted accounting principles, anticipated increases in specific
future residual values are not recognized before realization. Anticipated
decreases in specific future residual values that are considered to be other
than temporary are recognized immediately.
Allowance for Loan and Lease Losses: The allowance for loan and lease losses
represents management's best estimate of probable loan and lease losses in the
Company's loan portfolio. Management's quarterly evaluation of the allowance for
loan and lease losses is a comprehensive analysis that builds a total reserve by
evaluating the risks within each loan type, or pool, of similar loans and
leases. The Company uses a general allocation methodology for all residential
and consumer loan pools. This methodology estimates a reserve for each pool
based on the most recent three-year loss rate, adjusted to reflect the expected
impact that current trends regarding loan and lease growth, delinquency, losses,
economic conditions, and current interest rates are likely to have. For
commercial loan and lease pools, the Company establishes a specific reserve
allocation for all loans and leases, which have been risk rated under the
Company's risk rating system, as substandard, doubtful, or loss. The specific
allocation is based on the most recent valuation of the loan collateral and the
customer's ability to pay. For all other commercial loans, the Company uses the
general allocation methodology that establishes a reserve for each risk rating
category. The general allocation methodology for commercial loans and leases
considers the same factors that are considered when evaluating residential
mortgage and consumer loan pools. The combination of using both the general and
specific allocation methodologies reflects management's best estimate of the
probable loan and lease losses in the Company's loan portfolio.
A loan or lease is considered impaired, based on current information and events,
if it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan or lease agreement. The measurement of impaired loans or leases is
generally discounted at the historical effective interest rate, except that all
collateral-dependent loans or leases are measured for impairment based on fair
value of the collateral.
Income Recognition on Impaired and Nonaccrual Loans and Leases: Loans and
leases, including impaired loans or leases, are generally classified as
nonaccrual if they are past due as to maturity of payment of principal or
interest for a period of more than 90 days unless they are well secured and are
in the process of collection. While a loan or lease is classified as nonaccrual
and the future collectibility of the recorded loan or lease balance is doubtful,
collections of interest and principal are generally applied as a reduction to
principal outstanding.
Other Real Estate: Other real estate is comprised of real estate acquired
through foreclosure and is recorded at the lower of cost or fair value (net of
estimated costs to sell) at the date of acquisition.
Bank Premises, Furniture, and Equipment: Bank premises, furniture, and equipment
are stated at cost less accumulated depreciation computed principally using the
straight-line method over the estimated useful lives of the assets. Maintenance
and repairs are charged to operating expenses as incurred. The asset cost and
accumulated depreciation are removed from the accounts for assets sold or
retired and any resulting gain or loss is included in the determination of the
income.
Stock-Based Compensation: The Company's stock-based compensation plan is
accounted for based on the intrinsic value method set forth in Accounting
Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees, and
related interpretations. Compensation expense for employee stock options is
generally not recognized if the exercise price of the option equals or exceeds
the fair value of the stock on the date of the grant. Compensation expense for
restricted share awards is ratably recognized over the period of service,
usually the restricted period, based on the fair value of the stock on the grant
date.
31
The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
123, Accounting for Stock-Based Compensation, to stock option awards granted on
Alliance Financial Corporation common stock.
2002 2001 2000
---- ---- ----
Net Income (in thousands):
As reported $6,911 $6,011 $5,425
Less pro forma expense related to
options granted (381) (271) (313)
------ ------ ------
Pro forma net income $6,530 $5,740 $5,112
------ ------ ------
Pro forma net income per share:
Basic - as reported $ 2.00 $ 1.71 $ 1.52
Basic - pro forma 1.89 1.63 1.43
Diluted - as reported 1.98 1.70 1.52
Diluted - pro forma 1.87 1.62 1.43
The per share weighted average fair value of stock options granted during 2002,
2001, and 2000 was $5.27, $4.77, and $6.45, respectively.
The fair values of the stock options granted were estimated at the date of the
grant using a Black-Scholes option pricing model using the following
assumptions:
2002 2001 2000
---- ---- ----
Risk-free interest rate 4.52% 4.62% 6.23%
Expected dividend yield 3.40% 3.00% 3.00%
Volatility 29.86% 31.70% 31.20%
The expected life for options vesting upon the attainment of certain stock
targets is two years after the performance target is attained and the option is
vested, or nine years if the targets are not met.
In December 2002, the FASB issued SFAS 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, which provides alternative methods of
transition for an entity that voluntary changes to the fair value based method
of accounting for stock-based employee compensation. It also amends the
disclosure provisions of FASB Statement No. 123 to require prominent disclosure
about the effects on reported net income of an entity's accounting policy
decisions with respect to stock-based employee compensation. This statement also
amends APB Opinion No. 28, Interim Financial Reporting, to require disclosure
about those effects in interim financial information. The Company will continue
to account for stock-based compensation in accordance with Accounting Principles
Board (APB) Opinion 25, Accounting for Stock Issued to Employees.
Income Taxes: Provision for income taxes is based on taxes currently payable or
refundable and deferred income taxes on temporary differences between the tax
basis of assets and liabilities and their reported amount in the financial
statements. Deferred tax assets and liabilities are reported in the financial
statements at currently enacted income tax rates applicable to the period in
which the deferred tax assets and liabilities are expected to be realized or
settled.
Trust Department Assets: Assets held in fiduciary or agency capacities for
customers are not included in the accompanying consolidated statements of
condition, since such items are not assets of the Company. Fees associated with
providing trust management services are recorded on a cash basis of income
recognition and are included in Other Income.
Earnings Per Share: Basic earnings per share is computed by dividing net income
by the weighted average number of common shares outstanding throughout each
year; 3,448,431, 3,523,127, and 3,569,073 for 2002, 2001, and 2000,
respectively. Diluted earnings per share gives the effect to weighted average
shares which would be outstanding assuming the exercise of options using the
treasury stock method. Weighted average shares outstanding adjusted for the
effect of the assumed exercise of stock options were 3,482,809, 3,532,494, and
3,579,114 for the years 2002, 2001, and 2000, respectively. For the years ending
December 31, 2002 and 2001, basic earnings per share were $2.00 and $1.71,
respectively and diluted earnings per share were $1.98 and $1.70, respectively.
For the year ending December 31, 2000, both basic and diluted earnings per share
were $1.52.
32
2. INVESTMENT SECURITIES
The amortized cost and approximate fair value of investment securities at
December 31 are as follows:
(Dollars in Thousands)
AMORTIZED GROSS UNREAL- GROSS UNREAL- ESTIMATED
Held-to-Maturity--2002 COST IZED GAINS IZED LOSSES FAIR VALUE
--------- ------------- ------------- ----------
Obligations of states and political subdivisions $ 6,188 $ 1,440 $ -- $ 7,628
-------- -------- ------ ---------
Total $ 6,188 $ 1,440 $ -- $ 7,628
-------- -------- ------ ---------
Available-for-Sale--2002
U.S. Treasury and other U.S. government agencies $ 98,233 $ 4,563 $ -- $ 102,796
Obligations of states and political subdivisions 56,278 3,473 19 59,732
Mortgage-backed securities 138,072 2,811 50 140,833
Other securities -- -- -- --
-------- -------- ------ ---------
Total $292,583 $ 10,847 $ 69 $ 303,361
-------- -------- ------ ---------
Stock Investments
Federal Home Loan Bank 4,425 -- -- 4,425
Federal Reserve Bank and others 1,020 -- -- 1,020
-------- -------- ------ ---------
Total stock investment 5,445 -- -- 5,445
Total available-for-sale $298,028 $ 10,847 $ 69 $ 308,806
-------- -------- ------ ---------
Net unrealized gain on available-for-sale 10,778
-------- -------- ------ ---------
Grand total carrying value $314,994
-------- -------- ------ ---------
Held-to-Maturity--2001
Obligations of states and political subdivisions $ 7,371 $ 787 $ -- $ 8,158
-------- -------- ------ ---------
Total $ 7,371 $ 787 $ -- $ 8,158
-------- -------- ------ ---------
Available-for-Sale--2001
U.S. Treasury and other U.S. government agencies $ 61,430 $ 1,146 $ 348 $ 62,228
Obligations of states and political subdivisions 48,009 910 232 48,687
Mortgage-backed securities 146,484 1,279 612 147,151
Other securities 1,513 33 105 1,441
-------- -------- ------ ---------
Total $257,436 $ 3,368 $1,297 $ 259,507
-------- -------- ------ ---------
Stock Investments
Federal Home Loan Bank 4,830 -- -- 4,830
Federal Reserve Bank and others 982 -- -- 982
-------- -------- ------ ---------
Total stock investment 5,812 -- -- 5,812
-------- -------- ------ ---------
Total available-for-sale $263,248 $ 3,368 $1,297 $ 265,319
-------- -------- ------ ---------
Net unrealized gain on available-for-sale 2,071
-------- -------- ------ ---------
Grand total carrying value $272,690
-------- -------- ------ ---------
The carrying value and estimated market value of debt securities at
December 31, 2002 by contractual maturity are shown below. The maturities of
mortgage-backed securities are based on average life of the security. All other
expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
(Dollars In Thousands)
HELD-TO-MATURITY AVAILABLE-FOR-SALE
ESTIMATED ESTIMATED
AMORTIZED COST FAIR VALUE AMORTIZED COST FAIR VALUE
-------------- ---------- -------------- ----------
Due in one year or less $2,958 $3,646 $ 66,679 $ 68,184
Due after one year through five years 1,517 1,870 123,615 127,542
Due after five years through ten years 683 842 66,208 69,852
Due after ten years 1,030 1,270 36,081 37,783
------ ------ -------- --------
Total debt securities $6,188 $7,628 $292,583 $303,361
------ ------ -------- --------
At December 31, 2002 and 2001, investment securities with a carrying value
of $246,088 and $242,777, respectively, were pledged as collateral for certain
deposits and other purposes as required or permitted by law.
33
The Company recognized gross gains of $835, $1,513, and $738 for 2002,
2001, and 2000, respectively, and gross losses of $44, $18, and $27 for 2002,
2001, and 2000, respectively.
3. LOANS AND LEASES
Major classifications of loans and leases at December 31 are as follows:
(Dollars In Thousands)
2002 2001
---- ----
Commercial loans and leases $134,584 $126,801
Real estate loans 153,148 142,307
Indirect loans 68,811 56,371
Other consumer loans 57,734 50,363
-------- --------
Total 414,277 375,842
-------- --------
Less: Unearned income 54 104
Less: Allowance for loan & lease losses 5,019 4,478
-------- --------
Net loans & leases $409,204 $371,260
-------- --------
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid balances of mortgage
loans serviced for others were $25,614, $16,142, and $15,766 at December 31,
2002, 2001, and 2000, respectively.
Substantially all of the Bank's loans and leases are granted to borrowers
concentrated primarily within Cortland, Madison, Oneida, and Onondaga Counties.
4. ALLOWANCE FOR LOAN AND LEASE LOSSES
Changes in the allowance for loan and lease losses for the years ended December
31 are summarized as follows:
(Dollars In Thousands)
2002 2001 2000
---- ---- ----
Balance at January 1 $4,478 $3,370 $3,412
Provision for loan and lease losses 1,895 2,455 1,150
Recoveries credited 440 375 265
------ ------ ------
Subtotal 6,813 6,200 4,827
Less: Loans and leases charged-off 1,794 1,722 1457
------ ------ ------
Balance at December 31 $5,019 $4,478 $3,370
------ ------ ------
The average recorded investment in impaired loans or leases was zero for the
years ended December 31, 2002, 2001, and 2000. The amount of nonaccrual loans
and leases for the years ended December 31, 2002, 2001, and 2000 was $853, $736,
and $686, respectively.
5. RELATED PARTY TRANSACTIONS
Directors and executive officers of the Company and their affiliated companies
were customers of, and had other transactions with, the Company in the ordinary
course of business during 2002. It is the Company's policy that all loans and
commitments included in such transactions are made on substantially the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with other persons, and do not involve more than
normal risk of collectibility or present other unfavorable features. Loan
transactions with related parties are summarized as follows:
(Dollars In Thousands)
2002 2001
---- ----
Balance at beginning of year $9,692 $9,825
New loans and advances 1,220 1,229
Loan payments (1,949) (1,362)
------ ------
Balance at end of year $8,963 $9,692
------ ------
34
6. BANK PREMISES, FURNITURE, AND EQUIPMENT
Bank premises, furniture, and equipment at December 31 consist of the following:
(Dollars In Thousands)
2002 2001
---- ----
Land $ 1,078 $ 1,223
Bank premises 9,734 9,756
Furniture and equipment 14,347 13,161
------- -------
Subtotal 25,159 24,140
------- -------
Less: Accumulated depreciation 14,879 13,519
------- -------
Balance at end of year $10,280 $10,621
------- -------
7. DEPOSITS
The carrying amounts of deposits consisted of the following at December 31:
(Dollars In Thousands)
2002 2001
---- ----
Noninterest-bearing checking $ 54,113 $ 57,044
Interest-bearing checking 80,835 74,782
Savings accounts 68,643 68,538
Money market accounts 109,592 96,978
Time deposits 233,470 201,950
-------- --------
Total deposits $546,653 $499,292
-------- --------
The following table indicates the maturities of the Company's time deposits at
December 31:
2002 2001
---- ----
Due in one year $139,186 $147,691
Due in two years 61,238 41,248
Due in three years 15,602 9,558
Due in four years 3,164 2,554
Due in five years or more 14,280 899
-------- --------
Total time deposits $233,470 $201,950
-------- --------
Total time deposits in excess of $100 as of December 31, 2002 and 2001 were
$73,086 and $68,520, respectively.
35
8. BORROWINGS
The following is a summary of borrowings outstanding at December 31:
2002 2001
---- ----
Short-term:
Federal Home Loan Bank overnight advances $ 8,500 $ --
Securities sold under repurchase agreements 16,167 17,412
Federal Home Loan Bank term advances 10,000 --
Repurchase agreements 15,000 25,013
-------- --------
Total short-term borrowings 49,667 42,425
-------- --------
Long-term:
Federal Home Loan Bank term advances 55,000 40,000
Repurchase agreements 50,000 50,000
-------- --------
Total long-term borrowings 105,000 90,000
-------- --------
Total borrowings $154,667 $132,425
-------- --------
The principal balance, interest rate and maturity of the preceding borrowings at
December 31, 2002 is as follows:
Incurred
Term Date Principal Rates
-------- --------- -----
Short-term:
Federal Home Loan Bank overnight advances 12/31/02 $ 8,500 1.35%
Securities sold under repurchase agreements 12/31/02 16,167 1.22%
-------- -------- ----
Total overnight borrowings 24,667
Federal Home Loan Bank term advances
original term - 1 year 3/1/02 10,000 1.42%
-------- -------- ----
Total advances 10,000
Repurchase agreements
original term - 35 days 12/26/02 10,000 1.43%
original term - 97 days 12/26/02 5,000 1.43%
-------- -------- ----
Total repurchase agreements 15,000
-------- -------- ----
Total short-term borrowings $ 49,667
-------- -------- ----
Long-term:
Federal Home Loan Bank term advances
original term - 10 years 7/20/00 $ 5,000 5.92%
original term - 10 years 7/26/00 5,000 6.30%
original term - 2 years 1/24/01 5,000 5.48%
original term - 2 years 2/1/01 5,000 5.12%
original term - 10 years 4/27/01 5,000 4.13%
original term - 3 years 5/22/01 10,000 5.26%
original term - 2.25 years 12/24/02 5,000 1.50%
original term - 2.75 years 12/24/02 5,000 1.50%
original term - 3.25 years 12/24/02 5,000 1.50%
original term - 3.75 years 12/24/02 5,000 1.51%
-------- --------- ----
Total advances 55,000
Repurchase agreements
original term - 2 years 7/18/01 10,000 4.53%
original term - 3 years 7/18/01 10,000 4.99%
original term - 3 years 8/20/01 10,000 4.64%
original term - 2 years 9/26/01 20,000 3.49%
-------- --------- ----
Total repurchase agreements 50,000
-------- --------- ----
Total long-term borrowings $ 105,000
-------- --------- ----
36
Information related to borrowings at December 31 is as follows:
2002 2001
---- ----
Maximum outstanding at any month end $ 156,692 $132,425
Average amount outstanding during the year $ 142,628 $ 82,970
--------- --------
Average interest rate during the year 3.54% 4.69%
--------- --------
Average amounts outstanding and average interest rates are computed using
monthly averages.
The Company offers retail repurchase agreements primarily to its larger
business customers. Under the terms of the agreement, the Company sells
investment portfolio securities to the customer agreeing to repurchase the
securities at a specified later date. The Company views the borrowing as a
deposit alternative for its business customers. The Company at December 31, 2002
had securities with a carrying value of $22,921 pledged as collateral for these
agreements.
At December 31, 2002 and 2001, the Company had available an overnight line
of credit and a one-month overnight repricing line of credit with the Federal
Home Loan Bank of New York (FHLB), that totaled $70,210 and $56,990,
respectively, of which $8,500 and $0 was outstanding as of December 31, 2002 and
2001, respectively. The Company also has access to the FHLB's Term Advance
Program under which it can borrow at various terms and interest rates.
Residential mortgage loans in the amount of $149,087 have been pledged by the
Company under a blanket collateral agreement to secure the Company's line of
credit and term borrowings. At December 31, 2002, the Company's total borrowing
capacity with the FHLB was $106,595.
Repurchase agreements outstanding at December 31, 2002 are at interest
rates ranging from 1.43% to 4.99%. The face value at December 31, 2002 of
investment securities pledged under repurchase agreements and other borrowings
approximated $68,900.
At December 31, 2002 and 2001, the Company had available $15,000 of lines
of credit with other financial institutions which were unused.
9. INCOME TAXES
The provision for income taxes for the years ended December 31 is summarized as
follows:
(Dollars In Thousands)
2002 2001 2000
---- ---- ----
Current tax expense $2,596 $2,102 $2,257
Deferred tax benefit (245) (385) (225)
------ ------ ------
Total provision for income taxes $2,351 $1,717 $2,032
------ ------ ------
The provision for income taxes includes the following:
2002 2001 2000
---- ---- ----
Federal income tax $1,993 $1,422 $1,746
New York State franchise tax 358 295 286
------ ------ ------
Total $2,351 $1,717 $2,032
------ ------ ------
The components of deferred income taxes, included in other liabilities, at
December 31, are as follows:
2002 2001
---- ----
Assets:
Allowance for loan and lease losses $1,796 $1,518
Postretirement benefits 1,127 1,075
Deferred compensation 1,032 1,090
Other 73 63
------ ------
Total Assets $4,028 $3,746
------ ------
Liabilities:
Investment securities $4,362 $ 845
Depreciation 343 341
Other 221 187
------ ------
Total Liabilities $4,926 $1,373
------ ------
Net deferred tax (liability) asset $ (898) $2,373
------ ------
37
A reconciliation between the statutory federal income tax rate and the effective
income tax rate for 2002, 2001, and 2000 is as follows:
2002 2001 2000
---- ---- ----
Statutory federal income tax rate 34.0% 34.0% 34.0%
State franchise tax, net of federal tax benefit 1.1% 0.7% 1.7%
Tax exempt income (10.8%) (12.0%) (11.0%)
Other, net 1.1% (0.5%) 2.6%
----- ----- -----
Total 25.4% 22.2% 27.3%
----- ----- -----
10. RETIREMENT PLANS AND POSTRETIREMENT BENEFITS
The Company provides retirement benefits through a defined contribution 401(k)
plan that covers substantially all of its employees. Contributions to the
Company's 401(k) plan are determined by the Board of Directors and are based on
percentages of compensation for eligible employees. Contributions are funded
following the end of the plan (calendar) year. Company contributions to the plan
were $475, $461, and $470 in 2002, 2001, and 2000, respectively. Prior to July
1, 1999, a group of employees were covered by a noncontributory defined benefit
pension plan. That plan was terminated effective June 30, 1999 and following a
satisfactory review by the Internal Revenue Service, distributions of plan
participants benefit obligations were completed during the third quarter of
2000, and there were no assets remaining at December 31, 2000. The pension plan
had net periodic costs of $458 in 2000.
The Company also provides postretirement medical and life insurance benefits to
qualifying employees. Benefits are available to full-time employees who have
worked 15 years and attained age 55. Retirees and certain active employees with
more than 20 years of service to the Company continue to receive benefits in
accordance with plans that existed at First National Bank of Cortland and Oneida
Valley National Bank, prior to the merger of the banks in 1999.
The following tables set forth the changes in the postretirement plans, fair
value of plan assets, and accrued benefit cost as of December 31, 2002 and 2001:
(Dollars In Thousands)
2002 2001
---- ----
Change in benefit obligation:
Benefit obligation at beginning of year $ 3,755 $ 3,096
Service cost 108 65
Interest cost 288 226
Amendments 451 --
Actuarial loss/(gain) 548 521
Benefits paid (255) (153)
------- -------
Benefit obligation at end of year $ 4,895 $ 3,755
------- -------
2002 2001
---- ----
Components of prepaid/accrued benefit cost:
Unfunded status $(4,895) $(3,755)
Unrecognized prior service cost/(benefit) 349 (73)
Unrecognized actuarial net loss 1,677 1,168
------- -------
Accrued benefit obligation at
end of year $(2,869) $(2,660)
------- -------
The weighted average discount rate used in determining the benefit
obligation as of December 31, 2002 and 2001 was 6.50% and 7.00%, respectively.
For measurement purposes, with respect to the postretirement benefit
plans, a 10.0 percent annual rate of increase in the per capita cost of covered
health care benefits is assumed for 2003. The rate is assumed to decrease
gradually to 4.5 percent by the year 2011 and remain at that level thereafter.
38
The composition of the plan's net periodic cost for the years ended December 31
is as follows:
(Dollars In Thousands)
2002 2001 2000
---- ---- ----
Service cost $108 $ 65 $ 54
Interest cost 288 226 223
Amortization of unrecognized prior
service cost 69 8 15
---- ---- ----
Net periodic cost $465 $299 $292
---- ---- ----
Assumed health care cost trend rates have a significant effect on the amounts
reported for health care plans. A one percentage point change in assumed health
care cost trend rates would have the following effects:
ONE PERCENTAGE ONE PERCENTAGE
POINT INCREASE POINT DECREASE
-------------- --------------
Effect on total service and interest
cost components 43 (35)
Effect on postretirement plan obligations 468 (393)
11. DEFERRED COMPENSATION AND SUPPLEMENTAL RETIREMENT PLANS
The Company maintains optional deferred compensation plans for its directors,
whereby fees normally received are deferred and paid by the Company upon the
retirement of the director. At December 31, 2002 and 2001 other liabilities
included approximately $1,114 and $1,238, respectively, relating to deferred
compensation. Deferred compensation expense for the years ended December 31,
2002, 2001, and 2000 approximated $218, $242, and $162, respectively.
The Company has supplemental executive retirement plans for certain
employees. Included in other assets, the Company has segregated assets of $911
and $1,038 at December 31, 2002 and 2001, respectively, to fund the estimated
benefit obligation. At December 31, 2002 and 2001, other liabilities included
approximately $1,535 and $1,538 accrued under these plans. The benefit
obligation, service cost, and actuarial gain/(loss) were $1,697, $254, and
($79), respectively, at December 31, 2002 and $1,624, $277, and ($8),
respectively, at December 31, 2001. Compensation expense includes approximately
$223, $302, and $138 relating to these plans at December 31, 2002, 2001, and
2000, respectively.
12. STOCK OPTION PLAN
The Company has a long-term incentive compensation plan that has been approved
by the shareholders authorizing the use of 550,000 shares of authorized but
unissued common stock of the Company. Under the plan, the Board of Directors may
grant incentive stock options, non-qualified stock options, and restricted stock
awards to officers, employees, and certain other individuals. Of the 346,196
options outstanding at December 31, 2002, 320,196 of the options were issued
with a 10-year term, vesting one year after the issue date, and exercisable
based on the Company achieving specified stock prices. 20,000 of the options
issued vest and become exercisable ratably over a three-year period. 6,000 of
the options were issued with a five-year term and vested on issuance.
39
Activity in the plan for 2002, 2001, and 2000 was as follows:
RANGE OF WEIGHTED AVERAGE
OPTIONS OPTION PRICE SHARES EXERCISE PRICE OF
OUTSTANDING PER SHARE EXERCISABLE OPTIONS OUTSTANDING
----------- ------------ ----------- -------------------
2000
Granted 296,914 $17.75-$24.75 0 $ 22.66
Exercised 0 0 0 0
Forfeited 100,000 0 (33,334) $29.125
Ending balance 306,914 $17.75-$24.75 3,334 $ 22.63
2001
Granted 21,500 $18.25-$20.25 0 $ 19.08
Exercised 0 0 0 0
Forfeited 11,541 0 0 $ 24.75
Ending balance 316,873 $17.75-$24.75 71,750 $ 22.31
2002
Granted 63,900 $23.50 0 $ 23.50
Exercised 12,500 $17.75-$18.25 0 $ 17.79
Forfeited 22,077 $17.75-$24.75 0 $ 24.11
Ending balance 346,196 $17.75-$24.75 104,042 $ 22.58
As of December 31, 2002, 10,000 of the options issued in 1999 were exercisable
at an exercise price of $21.75. The options have a remaining life of 6.20 years.
As of December 31, 2002, 36,667 and 40,500 options issued in 2000 were
exercisable at an exercise price of $18.50 and $17.75, respectively. These
options have a remaining life of 7 years. As of December 31, 2002, 6,000, 6,750
and 4,125 options issued in 2001 were exercisable at an exercise price of
$18.25, $19.00 and $20.25, respectively. These options have a remaining life
ranging from 3 to 8 years. As of December 31, 2002, none of the 63,900 options
issued in 2002 were exercisable. These options have a remaining life of 9 years.
13. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments consist primarily of commitments to extend credit
and letters of credit which involve, to varying degrees, elements of credit risk
in excess of amounts recognized in the consolidated statements of condition. The
contract amount of those commitments and letters of credit reflects the extent
of involvement the Company has in those particular classes of financial
instruments. The Company's exposure to credit loss in the event of
nonperformance by the counterparty to the financial instrument for commitments
to extend credit and letters of credit is represented by the contractual amount
of the instruments. The Company uses the same credit policies in making
commitments and letters of credit as it does for on-balance-sheet instruments.
Financial instruments whose contract amounts represent credit risk:
(Dollars In Thousands)
CONTRACT AMOUNT
2002 2001
---- ----
Commitments to
extend credit $70,738 $63,374
Standby letters of credit $ 4,031 $ 1,067
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payments of a fee. Since some of the commitment amounts are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements.
Standby letters of credit written are conditional commitments issued by
the Company to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements, including bond financing and similar transactions.
The credit risk involved in issuing letters of credit is essentially the
same as that involved in extending loan facilities to customers. Since the
letters of credit are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
40
For both commitments to extend credit and letters of credit, the amount of
collateral obtained, if deemed necessary by the Company upon the extension of
credit, is based on management's credit evaluation of the counterparty.
Collateral held varies, but includes residential and commercial real estate.
Principal operating leases are for bank premises. At December 31, 2002,
aggregate future minimum lease payments under noncancelable operating leases
with initial or remaining terms equal to or exceeding one year consisted of the
following: 2003-$419; 2004-$348; 2005-$339; 2006-$339; 2007-$331; and $1,536
thereafter. Total rental expenses amounted to $426 in 2002, $242 in 2001, and
$241 in 2000.
The Company is required to maintain a reserve balance as established by
the Federal Reserve Bank of New York. The required average total reserve for the
14-day maintenance period ended December 31, 2002 was $4,872.
14. DIVIDENDS AND RESTRICTIONS
The primary source of cash to pay dividends to the Company's shareholders is
through dividends from its banking subsidiary. The Federal Reserve Board and the
Office of the Comptroller of the Currency are authorized to determine certain
circumstances that the payment of dividends would be an unsafe or unsound
practice and to prohibit payment of such dividends. The payment of dividends
that deplete a bank's capital base could be deemed to constitute such an unsafe
or unsound practice. Banking organizations may generally only pay dividends from
the combined current year and prior two years net income less any dividends
previously paid during that period. At December 31, 2002, approximately $4,800
was available for the declaration of dividends by the Bank. There were no loans
or advances from the subsidiary Bank to the Company at December 31, 2002.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures About Fair
Value of Financial Instruments," requires disclosure of fair value information
of financial instruments, whether or not recognized in the statement of
condition, for which it is practicable to estimate that value. In cases where
quoted market prices are not available, fair values are based on estimates using
present value or other valuation techniques. Those techniques are significantly
affected by the assumptions used, including the discount rate and estimates of
future cash flows. In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases, could not
be realized in immediate settlement of the instrument. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
the Company.
The carrying amounts and estimated fair values of financial instruments are as
follows:
DEC. 31, 2002 DEC. 31, 2002 DEC. 31, 2001 DEC. 31, 2001
CARRYING AMOUNT FAIR VALUE CARRYING AMOUNT FAIR VALUE
--------------- ------------- --------------- ----------
Financial Assets:
Cash and cash equivalents $ 21,474 $ 21,474 $ 21,626 $ 21,626
Investment securities 314,994 316,434 272,690 273,477
Net loans 409,204 421,024 371,260 377,841
-------- -------- -------- --------
Total Financial Assets $745,672 $758,932 $665,576 $672,944
-------- -------- -------- --------
Financial Liabilities:
Deposits $546,653 $549,205 $499,292 $500,980
Borrowings 154,667 158,799 132,425 138,772
-------- -------- -------- --------
Total Financial Liabilities $701,320 $708,004 $631,717 $639,752
-------- -------- -------- --------
The fair value of commitments to extend credit and standby letters of credit is
not significant.
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
Cash and Cash Equivalents: The carrying amounts reported in the consolidated
statements of condition for cash and short-term instruments approximate those
assets' fair value.
Investment Securities: Fair values for investment securities are based on quoted
market prices or dealer quotes.
Loans: Fair values for loans are estimated using discounted cash flow analysis,
based on interest rates approximating those currently being offered for loans
with similar terms and credit quality. The fair value of accrued interest
approximates carrying value.
Deposits: The fair values disclosed for noninterest-bearing accounts and
accounts with no stated maturity are, by definition, equal to the amount payable
on demand at the reporting date. The fair value of time deposits was estimated
by discounting expected monthly maturities at interest rates approximating those
currently being offered on time deposits of similar terms. The fair value of
accrued interest approximates carrying value.
41
Borrowings: The carrying amounts of short-term borrowings approximate their fair
value. The fair value of long-term borrowings are estimated using discounted
cash flow analysis, based on interest rates approximating those currently being
offered for borrowings with similar terms.
Off-balance-sheet Instruments: Off-balance-sheet financial instruments consist
of commitments to extend credit and standby letters of credit, with fair value
based on fees currently charged to enter into agreements with similar terms and
credit quality.
16. REGULATORY MATTERS
The Company and its banking subsidiary are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company must meet specific capital guidelines that involve quantitative measures
of the Company's assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Company's capital amounts
and classifications are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors. Quantitative measures
established by regulation to ensure capital adequacy require the Company and its
subsidiary bank to maintain minimum amounts and ratios (set forth in the tables
below) of total and Tier 1 Capital (as defined in the regulations) to
risk-weighted assets (as defined) and of Tier 1 Capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2002, that the
Company and its subsidiary Bank met all capital adequacy requirements to which
they are subject. As of September 30, 2001, the most recent notification from
the Office of the Comptroller of the Currency categorized the Bank as
"well-capitalized," under the regulatory framework for prompt corrective action.
To be categorized as "well-capitalized," the Bank must maintain total
risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the
tables below. There are no conditions or events since that notification that
management believes have changed the institution's category. The Company's
actual capital amounts and ratios are presented in the following table:
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ADEQUACY PURPOSES ACTION PROVISIONS
----------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
As of December 31, 2002
Total Capital (to Risk-Weighted Assets) $61,505 14.09% $34,930 >/=8.00% $43,662 >/=10.00%
Tier I Capital (to Risk-Weighted Assets) 56,486 12.94% 17,465 >/=4.00% 26,198 >/= 6.00%
Tier I Capital (to Average Assets) 56,486 7.41% 30,484 >/=4.00% 38,105 >/= 5.00%
------- ----- ------- ------- ------- --------
As of December 31, 2001
Total Capital (to Risk-Weighted Assets) $56,698 13.08% $34,842 >/=8.00% $43,553 >/=10.00%
Tier I Capital (to Risk-Weighted Assets) 52,220 12.05% 17,421 >/=4.00% 26,132 >/= 6.00%
Tier I Capital (to Average Assets) 52,220 7.53% 25,947 >/=4.00% 32,433 >/= 5.00%
------- ----- ------- ------- ------- --------
17. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial information for the years ended December 31, 2002
and 2001 is as follows:
THREE MONTHS ENDED 3/31/02 6/30/02 9/30/02 12/31/02 3/31/01 6/30/01 9/30/01 12/31/01
------- ------- ------- -------- ------- ------- ------- --------
Total interest income $10,455 $10,786 $10,798 $10,675 $10,571 $10,528 $11,211 $10,814
Total interest expense 3,876 4,108 4,105 3,855 5,609 5,073 4,944 4,339
Net interest income 6,579 6,678 6,693 6,820 4,962 5,455 6,267 6,475
Provision for loan losses 561 534 480 320 590 490 585 790
Noninterest income 1,572 1,710 1,875 1,607 2,017 1,698 1,362 1,914
Noninterest expense 5,433 5,607 5,717 5,620 4,915 4,912 4,983 5,157
Income before
income taxes 2,157 2,247 2,371 2,487 1,474 1,751 2,061 2,442
Provision for
income taxes 535 554 608 654 309 391 459 558
Net Income 1,622 1,693 1,763 1,833 1,165 1,360 1,602 1,884
Earnings per share:
Basic $ 0.47 $ 0.49 $ 0.51 $ 0.53 $ 0.32 $ 0.38 $ 0.46 $ 0.55
Diluted $ 0.47 $ 0.49 $ 0.51 $ 0.52 $ 0.32 $ 0.38 $ 0.46 $ 0.54
------- ------- ------- ------- ------- ------- ------- -------
42
18. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial statement information of Alliance Financial Corporation is
as follows:
Balance Sheets
Assets DEC. 31, 2002 DEC. 31, 2001
------------- -------------
Investment in subsidiary Bank $60,228 $53,343
Cash 3,178 919
Investment securities 238 201
------- -------
Total Assets $63,644 $54,463
------- -------
Liabilities
Dividends payable 691 1,000
------- -------
Total Liabilities 691 1,000
------- -------
Shareholders' Equity
Common stock 3,828 3,815
Surplus 7,306 7,096
Undivided profits 53,272 49,086
Accumulated other comprehensive income 6,467 1,243
Treasury stock (7,920) (7,777)
------- -------
Total Shareholders' Equity $62,953 $53,463
------- -------
Total Liabilities and Shareholders' Equity $63,644 $54,463
------- -------
Statements of Income
YEARS ENDED DEC. 31, 2002 DEC. 31, 2001 DEC. 31, 2000
------------------------- ------------- -------------
Dividend income from subsidiary Bank $5,000 $4,000 $4,500
Investment income 4 6 9
Gain on the sale of securities 250 -- 181
Operating expenses (4) (29) (19)
------ ------ ------
5,250 3,977 4,671
Equity in undistributed income
of subsidiary 1,661 2,034 754
------ ------ ------
Net Income $6,911 $6,011 $5,425
------ ------ ------
43
Statements of Cash Flows
YEARS ENDED DEC. 31, 2002 DEC. 31, 2001 DEC. 31, 2000
------------------------- ------------- -------------
Operating Activities
Net Income $ 6,911 $ 6,011 $ 5,425
Adjustments to reconcile net income
to net cash provided by operating activities:
Equity in undistributed net income
of subsidiary (1,661) (2,034) (754)
Realized investment security gains (250) -- (181)
------- ------- -------
Net Cash Provided by Operating Activities 5,000 3,977 4,490
Investing Activities
Purchase of investment securities, available-for-sale (238) (173) (128)
Proceeds from sales of investment securities,
available-for-sale 451 -- 548
------- ------- -------
Net Cash Provided by (Used in) Investing Activities 213 (173) 420
Financing Activities
Treasury stock purchased (143) (3,169) (1,889)
Proceeds from the issuance of common stock 223 -- --
Cash dividends paid (3,034) (2,623) (2,483)
------- ------- -------
Net Cash Used in Financing Activities (2,954) (5,792) (4,372)
------- ------- -------
Increase (Decrease) in Cash and Cash Equivalents 2,259 (1,988) 538
------- ------- -------
Cash and Cash Equivalents at Beginning of Year 919 2,907 2,369
------- ------- -------
Cash and Cash Equivalents at End of Year $ 3,178 $ 919 $ 2,907
Supplemental Disclosures of Cash Flow Information:
Noncash financing activities:
Dividend declared and unpaid $ 691 $ 1,000 $ 668
On October 26, 2001 the Company's Board of Directors adopted a shareholders
rights plan. Under the plan, Series A Junior Participating Preferred Stock
Purchase Rights were distributed at the close of business on October 29, 2001 to
shareholders of record as of that date. The Rights trade with the Common Stock,
and are exercisable and trade separately from the Common Stock only if a person
or group acquires or announces a tender or exchange offer that would result in
such person or group owning 20 percent or more of the Common Stock of the
Company. In the event the person or group acquires a 20 percent Common Stock
position, the Rights allow other holders to purchase stock of the Company at a
discount to market value. The Company is generally entitled to redeem the Rights
at $.001 per Right at any time prior to the 10th day after a person or group has
acquired a 20 percent Common Stock position. The Rights will expire on October
29, 2011 unless the plan is extended or the Rights are earlier redeemed or
exchanged.
44
REPORT OF MANAGEMENT'S RESPONSIBILITY
Management is responsible for preparation of the consolidated financial
statements and related financial information contained in all sections of this
Annual Report on Form 10-K, including the determination of amounts that must
necessarily be based on judgments and estimates. It is the belief of management
that the consolidated financial statements have been prepared in conformity, in
all material respects, with generally accepted accounting principles appropriate
in the circumstances and that the financial information appearing throughout
this annual report is consistent, in all material respects, with the
consolidated financial statements.
Management depends upon the Company's system of internal accounting
controls in meeting its responsibility for reliable financial statements. This
system is designed to provide reasonable assurance that assets are safeguarded
and that transactions are executed in accordance with management's authorization
and are properly recorded.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets periodically with the Company's management, internal auditors
and independent auditors, PricewaterhouseCoopers LLP, to review matters relating
to the quality of financial reporting, internal accounting control, and the
nature, extent, and results of audit efforts. The internal auditors and
independent auditors have unlimited access to the Audit Committee to discuss all
such matters.
/s/ Jack H. Webb /s/ David P. Kershaw
- ---------------- --------------------
Chairman & CEO Chief Financial Officer & Treasurer
Syracuse, New York
March 28, 2003
REPORT OF INDEPENDENT ACCOUNTANTS
Audit and Compliance Committee and
Shareholders of Alliance Financial Corporation
In our opinion, the accompanying consolidated statement of condition and
the related consolidated statements of income, of changes in shareholders'
equity and of cash flows present fairly, in all material respects, the financial
position of Alliance Financial Corporation and Subsidiaries at December 31, 2002
and December 31, 2001, and the results of their operations and their cash flows
for each of the three years in the period ended December 31, 2002, in conformity
with accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
/s/ PricewaterhouseCoopers
Syracuse, New York
January 17, 2003
45
Item 9 -- Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable
PART III
Item 10 -- Directors and Executive Officers of the Registrant
The information required by this Item 10 is incorporated herein by reference to
the sections entitled "Information Concerning Nominees for Directors, Directors
Continuing in Office and Additional Executive Officers" and "Section 16 (a)
Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement.
Item 11 -- Executive Compensation
The information required by this Item 11 is incorporated herein by reference to
the section entitled "Executive Compensation" in the Company's Proxy Statement.
Item 12 -- Security Ownership of Certain Beneficial Owners and Management
The information required by this Item 12 is incorporated herein by reference to
the section entitled "Information Concerning Nominees for Directors, Directors
Continuing in Office and Additional Executive Officers" in the Company's Proxy
Statement.
Item 13 -- Certain Relationships and Related Transactions
The information required by this Item 13 is incorporated herein by reference to
the section entitled "Transactions with Management" in the Company's Proxy
Statement.
Item 14 - Controls and Procedures
The management of the Company is responsible for establishing and maintaining
effective disclosure controls and procedures, as defined under Rules 13a-14 and
15d-14 of the Securities Exchange Act of 1934. As of December 31, 2002, an
evaluation was performed under the supervision and with the participation of
management, including the Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of the Company's disclosure
controls and procedures. Based on that evaluation, management concluded that the
Company's disclosure controls and procedures as of December 31, 2002 were
effective in ensuring that information required to be disclosed in this Annual
Report on Form 10-K was recorded, processed, summarized, and reported within the
time period required by the United States Securities and Exchange Commission's
rules and forms.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect internal controls subsequent to
December 31, 2002. There were no significant deficiencies or material weaknesses
identified in the evaluation and therefore, no corrective actions were taken.
PART IV
Item 15 -- Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents filed as part of this report:
(1) The following financial statements are included in Item 8:
Consolidated Statements of Condition at December 31, 2002 and 2001.
Consolidated Statements of Income For Each of the Three Years in the
Period Ended December 31, 2002.
Consolidated Statements of Comprehensive Income For Each of the
Three Years in the Period Ended December 31, 2002.
Consolidated Statements of Shareholders' Equity For Each of the
Three Years in the Period Ended December 31, 2002.
Consolidated Statements of Cash Flows For Each of the Three Years in
the Period Ended December 31, 2002.
Notes to Consolidated Financial Statements.
Independent Accountants' Report.
Report of Management's Responsibility
46
(2) Financial statement schedules are omitted from this Form 10-K since
the required information is not applicable to the Company.
(3) Listing of Exhibits:
The following documents are filed as Exhibits to this Form 10-K or
are incorporated by reference to the prior filings of the Company
with the Securities and Exchange Commission.
FORM 10-K
Exhibit
Number Exhibit
- ------ -------
3.1 Amended and Restated Certificate of Incorporation of the Company(1)
3.2 Amended and Restated Bylaws of the Company(1)
10.1 Stock Option Agreement, dated as of July 10, 1998, between Cortland
First (as the issuer) and Oneida Valley (as the grantee)(2)
10.2 Stock Option Agreement, dated as of July 10, 1998, between Oneida
Valley (as the issuer) and Cortland First (as the grantee)(2)
10.3 Form of Voting Agreement, dated as of July 10, 1998, between Cortland
First Directors and Oneida Valley(2)
10.4 Form of Voting Agreement, dated as of July 10, 1998, between Oneida
Valley Directors and Cortland First(2)
10.5 Employment Agreement, dated as of November 25, 1998, between the
Company and David R. Alvord(1)
10.6 Employment Agreement, dated as of November 25, 1998, between the
Company and John C. Mott(1)
10.7 Alliance Financial Corporation 1998 Long Term Incentive Compensation
Plan(1)
10.8 Change of Control Agreement, dated as of February 16, 1999, by and
among the Company, First National Bank of Cortland, Oneida Valley
National Bank, and David P. Kershaw(3)
10.9 Change of Control Agreement, dated as of February 16, 1999, by and
among the Company, First National Bank of Cortland, Oneida Valley
National Bank, and James W. Getman(3)
10.10 Directors Compensation Deferral Plan of the Company(4)
10.11 Employment Agreement, dated as of May 1, 2000, by and among the
Company, Alliance Bank, N.A. and Jack H. Webb(5)
10.12 Supplemental Retirement Agreement, dated as of May 1, 2000, by and
among the Company, Alliance Bank, N.A. and Jack H. Webb(5)
10.13 First National Bank of Cortland Excess Benefit Plan for David R.
Alvord, dated December 31, 1991, and all amendments thereto(6)
10.14 Oneida Valley National Bank Supplemental Retirement Income Plan for
John C. Mott, dated September 1, 1997, and all amendments thereto(7)
21 List of the Company's Subsidiaries(8)
23 Consent of PricewaterhouseCoopers LLP(8)
99.1 Certification of Jack H. Webb, Chairman of the Board, President and
Chief Executive Officer of the Registrant, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002(8)
47
99.2 Certification of David P. Kershaw, Treasurer and Chief Financial
Officer of the Registrant,pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(8)
(1) Incorporated herein by reference to the exhibit with the same number
to the Registration Statement on Form S-4 (Registration No.
333-62623) of the Company previously filed with the Securities and
Exchange Commission (the "Commission") on August 31, 1998, as
amended.
(2) Incorporated herein by reference to the exhibit with the same number
to the Current Report on Form 8-K of the Company (File No. 0-15366)
filed with the Commission on July 22, 1998.
(3) Incorporated herein by reference to the exhibit numbers 10.1 and
10.2 to quarterly reports on Form 10-Q of the Company (File No.
0-15366) filed with the Commission on May 17, 1999.
(4) Incorporated herein by reference to the exhibit number 10.1 to
quarterly reports on Form 10-Q of the Company (File No. 0-15366)
filed with the Commission on August 13, 1999.
(5) Incorporated herein by reference to the exhibit number 10.1 and 10.2
to quarterly reports on Form 10-Q of the Company (File No. 0-15366)
filed with the Commission on August 14, 2000.
(6) Incorporated herein by reference to the exhibit number 10.13 to
annual reports on Form 10-K of the Company (File No. 0-15366) filed
with the Commission on March 30, 2001.
(7) Incorporated herein by reference to the exhibit number 10.14 to
annual reports on Form 10-K of the Company (File No. 0-15366) filed
with the Commission on March 29, 2002.
(8) Filed herewith
(b) Reports on Form 8-K
On December 17, 2002, the Company filed a Current Report on Form 8-K to
report that the Company authorized repurchase of up to an aggregate of
100,000 shares of its common stock.
(c) See Item 15 (a) (3) above.
(d) See Item 15 (a) (2) above.
48
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.
ALLIANCE FINANCIAL CORPORATION
(Registrant)
Date March 28, 2003 By /s/ Jack H. Webb
--------------------
Jack H. Webb, Chairman, President & CEO
(Principal Executive Officer)
Date March 28, 2003 By /s/ David P. Kershaw
--------------------
David P. Kershaw, Treasurer & CFO
(Principal Financial and Accounting Officer)
CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER
1. I, Jack H. Webb, have reviewed this annual report on Form 10-K of Alliance
Financial Corporation;
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 quarterly
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.
Dated: March 28, 2003
/s/ Jack H. Webb
--------------------
Name: Jack H. Webb
Title: Chairman of the Board, President and Chief
Executive Officer
49
CERTIFICATION OF THE CHIEF FINANCIAL OFFICER
1. I, David P. Kershaw, have reviewed this annual report on Form 10-K of
Alliance Financial Corporation;
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 quarterly
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.
Dated: March 28, 2003
/s/ David P. Kershaw
--------------------
Name: David P. Kershaw
Title: Treasurer and Chief Financial Officer
50
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant, and
in the capacities and on the dates indicated.
/s/ Mary Pat Adams Date March 25, 2003
- --------------------------------------------
Mary Pat Adams, Director
/s/ Donald S. Ames Date March 25, 2003
- --------------------------------------------
Donald S. Ames, Director
/s/ John H. Buck Date March 25, 2003
- --------------------------------------------
John H. Buck, Director
/s/ Donald H. Dew Date March 25, 2003
- --------------------------------------------
Donald H. Dew, Director
/s/ Peter M. Dunn Date March 25, 2003
- --------------------------------------------
Peter M. Dunn, Director
/s/ David P. Kershaw Date March 25, 2003
- --------------------------------------------
David P. Kershaw, Treasurer and Director
(Principal Financial and Accounting Officer)
/s/ Samuel J. Lanzafame Date March 25, 2003
- --------------------------------------------
Samuel J. Lanzafame, Director
/s/ Robert M. Lovell Date March 25, 2003
- --------------------------------------------
Robert M. Lovell, Director
/s/ Margaret G. Ogden Date March 25, 2003
- --------------------------------------------
Margaret G. Ogden, Director
/s/ Charles E. Shafer Date March 25, 2003
- --------------------------------------------
Charles E. Shafer, Director
/s/ Charles H. Spaulding Date March 25, 2003
- --------------------------------------------
Charles H. Spaulding, Director
/s/ Paul M. Solomon Date March 25, 2003
- --------------------------------------------
Paul M. Solomon, Director
/s/ David J. Taylor Date March 25, 2003
- --------------------------------------------
David J. Taylor, Director
/s/ Jack H. Webb Date March 25, 2003
- --------------------------------------------
Jack H. Webb, Chairman, President
& CEO and Director
(Principal Executive Officer)
Exhibit 21 -- Subsidiaries
Subsidiaries of the Registrant
Alliance Bank, N.A. is a wholly owned subsidiary of Alliance Financial
Corporation and is a national banking association organized under the laws of
the United States.
Alliance Preferred Funding Corp. is a substantially wholly owned
subsidiary of Alliance Bank, N.A. and is organized under the laws of the State
of Delaware.
Alliance Leasing Inc. is a wholly owned subsidiary of Alliance Bank, N.A.
and is organized under the laws of the State of New York.
51