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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED] For the Fiscal Year Ended December 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transaction period from ________________ to ___________________
Commission File Number: 000-23975
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FIRST NIAGARA FINANCIAL GROUP, INC.
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(Exact Name of Registrant as specified in its Charter)
Delaware 42-1556195
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(State or Other Jurisdiction of Incorporation or (I.R.S. Employer
Organization Identification Number)
6950 South Transit Road, P.O. Box 514, Lockport, NY 14095-0514
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(Address of Principal Executive Officer) (Zip Code)
(716) 625-7500
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(Registrant's Telephone Number Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
None
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Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file reports) and (2) has been subject to such requirements for the
past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) Yes |X| No |_|
As of March 9, 2005, there were 117,240,621 outstanding shares of the
Registrant's Common Stock.
The aggregate market value of the 112,015,806 shares of voting stock held by
non-affiliates of the Registrant was $1,344,189,672 as computed by reference to
the last sales price on June 30, 2004, as reported by the NASDAQ National
Market. Solely for purposes of this calculation, all persons who are directors
and executive officers of the Registrant and all persons who are beneficial
owners of more than 10% of its outstanding stock have been deemed to be
affiliates.
DOCUMENTS INCORPORATED
BY REFERENCE
The following documents, in whole or in part, are specifically incorporated by
reference in the indicated Part of the Company's Proxy Statement:
Document Part
- ----------------------------------------------------------- ----------------------------------------------------------------
Proxy Statement for the 2005 Annual Meeting of Stockholders Part III, Item 10
"Directors and Executive Officers of the Registrant"
Part III, Item 11
"Executive Compensation"
Part III, Item 12
"Security Ownership of Certain Beneficial Owners and Management"
Part III, Item 13
"Certain Relationships and Related Transactions"
Part III, Item 14
"Principal Accountant Fees and Services"
2
TABLE OF CONTENTS
ITEM PAGE
NUMBER NUMBER
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PART I
1 Business...................................................................................................... 4
2 Properties.................................................................................................... 19
3 Legal Proceedings............................................................................................. 19
4 Submission of Matters to a Vote of Security Holders........................................................... 20
PART II
5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.. 20
6 Selected Financial Data ...................................................................................... 21
7 Management's Discussion and Analysis of Financial Condition and Results of Operations......................... 24
7A Quantitative and Qualitative Disclosures about Market Risk.................................................... 38
8 Financial Statements and Supplementary Data................................................................... 41
9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......................... 81
9A Controls and Procedures....................................................................................... 81
9B Other Information............................................................................................. 81
PART III
10 Directors and Executive Officers of the Registrant............................................................ 81
11 Executive Compensation........................................................................................ 81
12 Security Ownership of Certain Beneficial Owners and Management................................................ 81
13 Certain Relationships and Related Transactions................................................................ 81
14 Principal Accounting Fees and Services........................................................................ 82
PART IV
15 Exhibits, Financial Statement Schedules....................................................................... 82
Signatures.................................................................................................... 84
3
PART I
ITEM 1. BUSINESS
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GENERAL
First Niagara Financial Group, Inc.
First Niagara Financial Group, Inc. ("FNFG") is a Delaware corporation whose
principal executive offices are located at 6950 South Transit Road, Lockport,
New York. FNFG holds all of the capital stock of First Niagara Bank ("First
Niagara"), a federally chartered savings bank. FNFG and First Niagara are
hereinafter referred to collectively as "the Company." First Niagara is
positioned as one of the leading community banks in Upstate New York, providing
its customers with consumer and commercial banking services including
residential and commercial real estate loans, commercial business loans and
leases, consumer loans, and consumer and commercial deposit products.
Additionally, First Niagara offers risk management and wealth management
services.
FNFG was organized in April 1998 in connection with the conversion of First
Niagara from a New York State chartered mutual savings bank to a New York State
chartered stock savings bank and the reorganization to a two-tiered mutual
holding company (the "MHC"). In November 2002, FNFG converted First Niagara and
the MHC to a federal charter subject to Office of Thrift Supervision ("OTS")
regulation. On January 17, 2003, the MHC converted to stock form (the
"Conversion"), with the shares of FNFG common stock owned by the MHC being sold
to depositors and other investors (the "Offering"). Since 1998, the Company has
deployed the proceeds from these stock offerings through its "Buy and Build"
strategy, which has resulted in six whole-bank and eight non-bank acquisitions
and the opening of fourteen de novo branches in target market areas. This
strategy coupled with the Company's organic growth initiatives, which includes
an emphasis on expanding commercial operations and financial services
businesses, has resulted in a successful transition from a Western New York
traditional thrift to an Upstate New York community banking financial services
company.
On January 16, 2004, FNFG acquired Troy Financial Corporation ("TFC"), the
holding company of The Troy Savings Bank and The Troy Commercial Bank. TFC
operated twenty-one branch locations in the Capital Region of New York State and
added $1.4 billion of assets and $923.7 million of deposits. The acquisition
resulted in the issuance of 13.3 million shares of FNFG stock and cash payments
totaling $155.3 million. The transaction was accounted for under the purchase
method of accounting and resulted in the recording of $217.4 million of goodwill
and $17.2 million of core deposit intangibles. This acquisition expanded the
Company's market reach into the higher growth Capital Region in Eastern New York
State and furthered its strategic initiatives of increasing commercial
relationships and core deposits.
As of December 31, 2004, FNFG had $928.7 million of assets and $928.2 million of
stockholders' equity. FNFG neither owns nor leases any property, but uses the
premises and equipment of First Niagara. FNFG does not have any employees other
than certain officers of First Niagara who also serve as officers of FNFG.
First Niagara
First Niagara was organized in 1870, and is a multi-market community-oriented
savings bank that provides financial services to individuals, families and
businesses through its branch network located across Upstate New York. As of
December 31, 2004, First Niagara and all of its subsidiaries had $5.1 billion of
assets, deposits of $3.3 billion, $883.2 million of stockholders' equity,
employed approximately 1,300 people and operated through 71 branches, a loan
production office, 96 ATM's and several financial services subsidiaries.
At December 31, 2004, the following entities operate as subsidiaries of First
Niagara:
First Niagara Capital, Inc. First Niagara Capital, Inc. is licensed by the
Small Business Administration ("SBA") as a Small Business Investment
Company and offers small business loans and makes equity investments in
small businesses. At December 31, 2004, First Niagara Capital, Inc. had
$4.3 million of assets.
First Niagara Commercial Bank First Niagara Commercial Bank (the
"Commercial Bank") is a New York State chartered bank whose primary
purpose is to generate municipal deposits. Under New York State law,
municipal accounts cannot otherwise be accepted directly by First Niagara,
which is a federally chartered savings bank. At December 31, 2004, the
Commercial Bank had $194.0 million of assets and deposits of $159.7
million.
4
First Niagara Funding, Inc. First Niagara Funding, Inc. ("FNF") is a real
estate investment trust ("REIT") that holds commercial real estate loans,
residential mortgages, home equity loans and commercial business loans. At
December 31, 2004, FNF had $1.0 billion of assets.
First Niagara Leasing, Inc. First Niagara Leasing, Inc. ("FNL") provides
direct financing to the commercial small ticket lease market. On September
9, 2004 First Niagara acquired Adirondack Leasing Associates, Ltd. ("ALA")
an Eastern New York based leasing Company that originated approximately
$13.5 million direct financing equipment leases in 2004. Following
completion of the acquisition, the operations of ALA were merged into FNL.
At December 31, 2004, FNL had $28.1 million of assets.
First Niagara Portfolio Management, Inc. First Niagara Portfolio
Management, Inc. is a New York State Article 9A company, which primarily
invests in U.S. government agency and Treasury obligations. At December
31, 2004, First Niagara Portfolio Management, Inc. had $66.0 million of
assets.
First Niagara Realty, Inc. and TSB Real Property, Inc. First Niagara
Realty, Inc. and TSB Real Property, Inc. invest in real estate limited
partnerships. At December 31, 2004, these subsidiaries had $6.6 million of
assets.
First Niagara Risk Management, Inc. First Niagara Risk Management, Inc.
("FNRM") is a full service insurance agency engaged in the sale of
insurance products including business and personal insurance, surety
bonds, life, disability and long-term care coverage and other risk
management advisory services. FNRM serves commercial and personal clients
throughout the Company's market areas. FNRM's consulting and risk
management business includes alternative risk and self-insurance, claims
investigation and adjusting services, as well as third party
administration of self insured workers' compensation plans. In 2004, FNRM
had approximately $125 million of annual premium volume. At December 31,
2004, FNRM had $21.1 million of assets.
First Niagara Securities, Inc. First Niagara Securities, Inc. acts as an
agent for third-party companies to sell and service their insurance
products through First Niagara's branch network. At December 31, 2004,
First Niagara Securities, Inc. had $5.5 million of assets.
32 Second Street Corp. 32 Second Street Corp. holds a 90% percent
ownership interest in Altamont Avenue Associates, which owns a
multi-tenant retail shopping plaza located in the Company's market area.
The tenant mix includes some national companies as well as many smaller
locally owned businesses. At December 31, 2004, 32 Second Street Corp. had
$18.7 million of assets.
Acquisition of Hudson River Bancorp, Inc.
On January 14, 2005, FNFG acquired Hudson River Bancorp, Inc. ("HRB"), the
holding company of Hudson River Bank & Trust Company ("HRBT"), with total assets
of approximately $2.5 billion and fifty branch locations. Following completion
of the acquisition, HRBT locations were merged into First Niagara's branch
network. The acquisition resulted in the issuance of 35.7 million shares of FNFG
stock and cash payments totaling $126.8 million. As a result, the Company now
has nearly $8.0 billion of assets, $5.1 billion of deposits, and 115 branches
across Upstate New York including a leading market share in the Capital region
of the State.
In connection with the acquisition, Hudson River Funding Corp., C.W. Bostwick,
Inc. and Hudson River Commercial Bank, each wholly-owned subsidiaries of HRBT,
were merged into FNF, FNRM and the Commercial Bank, respectively, as they had
businesses that were substantially the same as those subsidiaries. However, the
following wholly-owned subsidiary of HRBT was retained as a separate subsidiary
of First Niagara:
First Niagara Associates, Inc. (formerly Hudson City Associates, Inc.) First
Niagara Associates, Inc. holds a 65% ownership interest in an insurance premium
financing partnership known as Premium Payment Plan LLC ("PPP"). PPP is
currently licensed to provide insurance premium financing in forty-two states,
but does business primarily in New York, New Jersey and Pennsylvania.
As a result of the acquisition of HRB, First Niagara now holds a 30% ownership
interest in Homestead Funding Corp. ("Homestead") a mortgage banker licensed in
the State of New York as well as other states. Effective with the closing of the
merger, First Niagara entered into an agreement with Homestead pursuant to which
First Niagara outsourced its Eastern New York residential mortgage loan
origination function to Homestead. While Homestead will market their services
under the First Niagara Mortgage brand, the loans are originated and closed in
Homestead's name. As part of the agreement, Homestead sells selected mortgages
to First Niagara as a correspondent.
5
OTHER INFORMATION
The Company maintains a website at www.fnfg.com. The Company makes available,
free of charge, through the website, its annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and all amendments to those
reports as soon as reasonably practicable after such material is electronically
filed with or furnished to the Securities and Exchange Commission ("SEC"). These
forms can be accessed within the Investor Relations portion of the Company's
website by clicking on "SEC Filings." Copies may also be obtained, without
charge, by written request to the Investor Relations Department, 6950 South
Transit Road, P.O. Box 514, Lockport, New York 14095-0514.
The Company has adopted a Code of Ethics that is applicable to the senior
financial officers of the Company, including the Company's Chief Executive
Officer, Chief Financial Officer and Corporate Controller, among others. The
Code of Ethics is available within the Investor Relations portion of the
Company's website along with any amendments to or waivers from that policy.
There were no amendments or waivers to the Code of Ethics for Senior Financial
Officers during 2004. Additionally, the Company has adopted a general Code of
Ethics that sets forth standards of ethical business conduct for all directors,
officers and employees of the Company. This Code of Ethics is also available at
the Company's website.
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), that involve substantial risks and uncertainties.
These forward-looking statements can be identified by the use of such words as
estimate, project, believe, intend, anticipate, plan, seek, expect and other
similar expressions. These forward-looking statements include: statements of the
Company's goals, intentions and expectations; statements regarding the Company's
business plans, prospects, growth and operating strategies; statements regarding
the asset quality of the Company's loan and investment portfolios; and estimates
of the Company's risks and future costs and benefits.
These forward-looking statements are subject to significant risks, assumptions
and uncertainties, including, among other things, the following important
factors that could affect the actual outcome of future events: general economic
conditions, either nationally or in the Company's market areas, that are worse
than expected; significantly increased competition among depository and other
financial institutions; inflation and changes in the interest rate environment
that reduce the Company's margins or fair value of financial instruments;
changes in laws or government regulations affecting financial institutions,
including changes in regulatory fees and capital requirements; the Company's
ability to enter new markets successfully and capitalize on growth
opportunities; the Company's ability to successfully integrate acquired
entities; changes in consumer spending, borrowing and savings habits; changes in
accounting policies and practices, as may be adopted by the bank regulatory
agencies, taxing authorities and the Financial Accounting Standards Board; and
changes in the Company's organization, compensation and benefit plans.
Because of these and other uncertainties, the Company's actual future results
may be materially different from the results indicated by these forward-looking
statements.
MARKET AREAS AND COMPETITION
The Company's primary lending and deposit gathering areas are generally
concentrated in the same counties as its branches. The Company faces significant
competition in both making loans and attracting deposits in its markets as the
Upstate New York region has a high density of financial institutions, some of
which are significantly larger and have greater financial resources than the
Company. The Company's competition for loans comes principally from commercial
banks, savings banks, savings and loan associations, mortgage banking companies,
credit unions, insurance companies and other financial services companies. Its
most direct competition for deposits has historically come from savings and loan
associations, savings banks, commercial banks and credit unions. The Company
faces additional competition for deposits from non-depository competitors such
as the mutual fund industry, securities and brokerage firms and insurance
companies.
The Company offers a variety of financial services to meet the needs of the
communities it serves and functions under a philosophy that includes a
commitment to customer service and the community. Giving effect to the
acquisition of HRB, the Company presently operates 115 branches in 24 counties
that span across Upstate New York. The four largest cities in the markets the
Company does business are Buffalo, Rochester, Syracuse and Albany, which have a
combined total population of nearly 4 million and are the top four Metropolitan
Statistical Areas in New York State outside of New York City.
6
LENDING ACTIVITIES
General. The Company's principal lending activity has been the origination of
commercial real estate loans, commercial business loans and leases and
residential mortgages to customers located within its primary market areas.
Consistent with its long-term customer relationship focus, the Company generally
retains the servicing rights on residential mortgage loans sold, which results
in monthly service fee income. The Company also originates for retention in its
portfolio various types of home equity and consumer loan products.
Commercial Real Estate and Multi-family Lending. The Company originates real
estate loans secured predominantly by first liens on apartment houses, office
buildings, shopping centers, industrial and warehouse properties and to a lesser
extent, by more specialized properties such as nursing homes, mobile home parks,
restaurants, motels/hotels and auto dealerships. The Company's current policy
with regard to such loans is to emphasize geographic distribution within its
market areas, diversification of property types and minimization of credit risk.
As part of the Company's ongoing strategic initiative to minimize interest rate
risk, commercial and multi-family real estate loans originated for the Company's
portfolio are generally limited to one, three or five year ARM products which
are priced at prevailing market interest rates. The initial interest rates are
subsequently reset after completion of the initial one, three or five year
adjustment period at new market rates that generally range between 200 and 275
basis points over the then, current one, three or five year U.S. Treasury
Constant Maturity Index or Federal Home Loan Bank ("FHLB") advance rate subject
to interest rate floors. The maximum term for commercial real estate loans is
generally not more than 10 years, with a payment schedule based on not more than
a 25-year amortization schedule for multi-family loans, and 20 years for
commercial real estate loans.
The Company also offers commercial real estate and multi-family construction
mortgage loans. Most construction loans are made as "construction/permanent"
loans, which provide for disbursement of loan funds during the construction
period and conversion to a permanent loan upon the completion of construction
and the attainment of either tenant lease-up provisions or prescribed debt
service coverage ratios. The construction phase of the loan is made on a
short-term basis, usually not exceeding 2 years, with floating interest rate
levels generally established at a spread in excess of either the LIBOR or prime
rate. The construction loan application process includes the same criteria which
are required for permanent commercial mortgage loans, as well as a submission to
the Company of completed plans, specifications and cost estimates related to the
proposed construction. These items are used as an additional basis to determine
the appraised value of the subject property. Construction loans involve
additional risks attributable to the fact that loan funds are advanced upon the
security of the project under construction, which is of uncertain value prior to
the completion of construction.
The Company continues to emphasize commercial real estate and multi-family
lending given their higher interest rates and that they are more sensitive to
interest rate changes but less susceptible to prepayment risk. Commercial real
estate and multi-family loans, however, entail significant additional risk as
compared with residential mortgage lending, as they typically involve larger
loan balances concentrated with a single borrower or groups of related
borrowers. In addition, the payment experience on loans secured by income
producing properties is typically dependent on the successful operation of the
related real estate project and thus, may be subject to a greater extent to
adverse conditions in the real estate market or to the general economy. To help
mitigate this risk, the Company has put in place concentration limits based upon
property types and maximum amounts that may be lent to an individual or group of
borrowers. The Company has not experienced a significant deterioration in credit
performance as a result of these higher risk loans, as the charge off rate for
commercial real-estate and multi-family loans has averaged less than 5 basis
points in recent years.
Commercial Business Loans. The Company offers commercial business term loans,
letters of credit, equipment leases and lines-of-credit to small and medium size
companies in its market areas, some of which are secured in part by additional
real estate collateral. Additionally, secured and unsecured commercial loans and
lines-of-credit are made for the purpose of financing equipment acquisition,
inventory, business expansion, working capital and other general business
purposes. The terms of these loans generally range from less than one year to
seven years. The loans are either negotiated on a fixed-rate basis or carry
variable interest rates indexed to the prime rate or LIBOR. Lines of credit
expire after one year and generally carry a variable rate of interest indexed to
the prime rate. The Company has a strategic emphasis on developing commercial
business relationships and allocates a greater portion of available funds and
personnel resources to both the commercial middle market and small business
lending markets. To facilitate the Company's expansion of these areas, the
Company offers additional commercial business products such as cash management,
merchant services, wire transfer capabilities, business credit and debit cards,
and Internet banking.
7
The Company offers installment direct financing "small ticket" equipment leases,
generally in amounts between $15 thousand and $125 thousand. Terms of these
leases are up to 60 months and are guaranteed by the principals of the lessee,
collateralized by the leased equipment and generally bear higher interest rates.
Given the Company's strategy to shift its loan portfolio mix to higher yielding
commercial loans, this product line continues to be an area of focus.
The Company also dedicates resources to commercial business and real-estate
loans which are 50% to 85% government guaranteed through the SBA. Terms of these
loans range from one year to twenty-five years and generally carry a variable
rate of interest indexed to the prime rate. This product allows the Company to
better meet the needs of its small business customers in the market areas it
serves, while protecting the Company from undue credit risk.
Commercial business lending is generally considered to involve a higher degree
of credit risk than secured real estate lending. The repayment of unsecured
commercial business loans are wholly dependent upon the success of the
borrower's business, while secured commercial business loans may be secured by
collateral that is not readily marketable.
Residential Real Estate Lending. The Company originates mortgage loans to enable
borrowers to finance residential, owner-occupied properties located in its
primary market areas. The Company offers conforming and non-conforming,
fixed-rate and adjustable-rate, monthly and bi-weekly, residential mortgage
loans with maturities up to 30 years and maximum loan amounts generally up to
$500 thousand. The Company's bi-weekly mortgages feature an accelerated
repayment structure and a linked deposit account.
The Company currently offers both fixed and adjustable rate conventional and
government guaranteed Federal Housing Administration and Veterans Administration
mortgage loans with terms of 10 to 30 years that are fully amortizing with
monthly or bi-weekly loan payments. Residential loans are generally underwritten
according to the Federal National Mortgage Association ("FNMA") and Federal Home
Loan Mortgage Corporation ("FHLMC") uniform guidelines. The Company generally
originates both fixed-rate and adjustable-rate loans in amounts up to the
maximum conforming loan limits as established by FNMA and FHLMC secondary market
standards. Private mortgage insurance ("PMI") and mortgage escrow accounts, from
which disbursements are made for real estate taxes and insurance, are required
for loans with loan-to-value ratios in excess of 80%.
The Company generally sells newly originated conventional, conforming 20 to 30
year monthly fixed, and 25 to 30 year bi-weekly loans in the secondary market to
government sponsored enterprises such as FNMA and FHLMC. The Company intends to
continue to sell into the secondary market certain of its newly originated fixed
rate loans to assist in asset and liability management. In addition to removing
a level of interest rate risk from the balance sheet, the operation of a
secondary marketing function provides cash flow to support loan growth.
In an effort to provide financing for low and moderate income buyers, the
Company actively participates in residential mortgage programs and products
sponsored by FNMA, FHLMC, and the State of New York Mortgage Agency ("SONYMA").
The SONYMA mortgage programs provide low and moderate income households with
fixed-rate loans which are generally set below prevailing conventional
fixed-rate mortgage loans and which allow below-market down payments. These
loans are sold by the Company to SONYMA, with the Company retaining the
contractual servicing rights.
The Company currently offers adjustable-rate monthly and bi-weekly mortgage loan
("ARM") products secured by residential properties. The residential ARMs are
offered with terms up to 30 years, with rates that adjust every one, five or
seven years. After origination, the interest rate on residential ARMs is reset
based upon a contractual spread or margin above a specified index (i.e. U.S.
Treasury Constant Maturity Index). The appropriate index utilized at each
interest rate change date corresponds to the initial one, five, or seven year
adjustment period of the loan.
ARMs are generally subject to limitations on interest rate increases of up to 2%
per adjustment period and an aggregate adjustment of up to 6% over the life of
the loan. The ARMs require that any payment adjustment resulting from a change
in the interest rate be sufficient to result in full amortization of the loan by
the end of the loan term, and thus, do not permit any of the increased payment
to be added to the principal amount of the loan, commonly referred to as
negative amortization.
8
The retention of ARMs in the Company's portfolio helps to reduce its exposure to
interest rate risk. However, ARMs generally pose credit risks different from the
credit risks inherent in fixed-rate loans primarily because, as interest rates
rise, the underlying debt service payments of the borrowers rise, thereby
increasing the potential for default. In order to minimize this risk, borrowers
of residential one year adjustable-rate loans are qualified at the rate which
would be in effect after the first interest rate adjustment, if that rate is
higher than the initial rate. The Company believes that these risks, which have
not had a material adverse effect on the Company to date, generally are less
onerous than the interest rate risks associated with holding long-term
fixed-rate loans. Certain of the Company's conforming ARMs can be converted at a
later date to a fixed-rate mortgage loan with interest rates based upon the
then-current market rates plus a predetermined margin or spread that was
established at the loan closing. The Company sells ARMs, which are converted to
25 to 30 year fixed-rate term loans, to either FNMA or FHLMC.
In conjunction with the HRB acquisition, the company entered into a marketing
agreement with its 30% owned affiliate Homestead Funding Corporation, a Mortgage
Banking enterprise based in Albany, New York, to provide residential mortgage
loans to the Company's customer base in Eastern New York. While Homestead
markets their services under the First Niagara Mortgage brand, the loans are
originated and closed in Homestead's name. As part of the agreement, Homestead
sells selected mortgages to First Niagara as a correspondent. The Company
generally purchases from Homestead ARMs and conventional fixed and bi-weekly
loans with terms less than 20 years at current market prices. These loans are
underwritten by First Niagara prior to Homestead making the loan.
Home Equity Lending. The Company offers fixed-rate, fixed-term, monthly and
bi-weekly home equity loans, and prime-based home equity lines of credit
("HELOCs") in its market areas. Both fixed-rate and floating rate home equity
products are offered in amounts up to 100% of the appraised value of the
property (including the first mortgage) with a maximum loan amount generally up
to $250 thousand. PMI is required for all fixed rate home equity loans and
HELOCs with combined first and second mortgage loan-to-value ratios in excess of
80%. Monthly fixed-rate home equity loans are offered with repayment terms up to
15 years and HELOCs are offered with terms up to 30 years. The line may be drawn
upon for 10 years, during which time principal and interest is paid on the
outstanding balance. Repayment of the remaining principal and interest is then
amortized over the remaining 20 years. Bi-weekly fixed-rate home equity loans
are offered with repayment terms up to 20 years, however, because the loan
amortizes bi-weekly and two additional half payments are made each year, actual
loan terms are significantly less. The Company offers an UltraFlex home equity
line of credit to complement its more traditional line of credit products. This
line of credit gives consumers flexibility with rates and terms and offers an
interest only payment option for the first five years. Additionally, this
product offers a card option to access funds and allows customers to convert
their variable rate line to a fixed rate loan up to three times over the term of
the line. The minimum line of credit is $10 thousand and the maximum is $250
thousand (up to $100 thousand if the loan to value exceeds 80%).
Consumer Loans. The Company originates a variety of fixed-rate installment and
variable rate lines-of-credit consumer loans, including indirect new and used
automobile loans, mobile home loans, education loans and personal secured and
unsecured loans.
Mobile home loans have shorter terms to maturity and higher yields than
traditional single-family residential mortgage loans. The Company generally
offers mobile home loans in New York, New Jersey and Delaware with fixed-rate,
fully amortizing loan terms of 10 to 20 years. The Company has contracted with
an independent third party to generate all mobile home loan applications.
However, prior to funding, all mobile home loan originations must be
underwritten and approved by designated Company underwriters. As part of a
negotiated servicing contract, the third party originator contacts borrowers who
become delinquent in their payments and when necessary, will oversee the
repossession and sale of mobile homes on the Company's behalf. For such services
the Company pays the originator a fee at loan funding, of which generally 50% is
deposited into a noninterest bearing escrow account, and is under the sole
control of the Company to compensate for early prepayments and future losses
which may be incurred on the loans.
The Company originates personal secured and unsecured fixed rate installment
loans and variable rate lines of credit. Terms of the loans range from 6 to 60
months and generally do not exceed $50 thousand. Secured loans are
collateralized by vehicles, savings accounts or certificates of deposit.
Unsecured loans are only approved for more creditworthy customers.
The Company continues to be an active originator of education loans.
Substantially all of the loans are originated under the auspices of the New York
State Higher Education Services Corporation ("NYSHESC") or the American Student
Association ("ASA"). Under the terms of these loans, no repayment is due until
the student graduates, with 98% of the principal guaranteed by NYSHESC or ASA.
The Company's general practice is to sell these education loans to Nelnet as the
loans reach repayment status. The Company generally receives a premium of 0.50%
to 1.50% on the sale of these loans.
9
Consumer loans generally entail greater risk of loss than residential mortgage
loans, particularly in the case of consumer loans that are unsecured or secured
by assets that tend to depreciate, such as automobiles and mobile homes. In such
cases, repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment for the outstanding loan and the remaining
deficiency often does not warrant further substantial collection efforts against
the borrower. In addition, consumer loan collections are dependent on the
borrower's continued financial stability, which can be adversely affected by job
loss, divorce, illness or personal bankruptcy.
As a result of the HRB acquisition, the Company is party to an agreement with
Tammac Corporation ("Tammac"), pursuant to which Tammac solicits manufactured
housing loan applications on behalf of the Company. Under the agreement, the
Company may refuse to accept applications referred to it by Tammac. Tammac also
provides certain collection, repossession and liquidation services, at the
direction of the Company, for certain delinquent loans. Tammac is paid a fixed
percentage of the amount financed by the borrower and does not receive
additional compensation for collection, repossession, or any other services
provided to the Company.
Manufactured housing loans are originated at a higher rate of interest than
residential mortgage loans, and generally have terms of up to 20 years that bear
fixed rates of interest. Because manufactured housing may decline in value due
to wear and tear following their initial sale, the value of the collateral
securing a manufactured housing loan may be less than the loan balance. At the
time of origination, inspections are made to substantiate current market values
on all manufactured homes. The Company is allowing its manufactured housing loan
portfolio to decrease from its current balance as it attempts to de-emphasize
this type of lending.
Another component of the Company's consumer loan portfolio acquired from HRB is
financed insurance premiums. The Company conducts such lending in New York, New
Jersey and Pennsylvania through its First Niagara Associates, Inc subsidiary
that holds a 65% ownership interest in PPP. The remaining 35% interest is held
by F.G.O. Corporation, which is responsible for the marketing of PPP's business.
First Niagara Associates, Inc. receives 65% of any profits but absorbs 100% of
any losses of PPP. No profit distributions are made to F.G.O. Corporation until
any past losses have been recouped. Management estimates that approximately 10%
of premiums financed are for non-standard and sub-standard (assigned risk)
personal automobile insurance and the remaining 90% are for various commercial
lines of insurance. Interest rates charged on these loans are substantially
higher than those charged on other types of loans, while terms on these loans
are generally for nine months.
Classification of Assets. Loans are reviewed on a regular basis and are placed
on nonaccrual status when, in the opinion of management, the collection of
interest is doubtful. Loans are generally placed on nonaccrual status when
payments are 90 days or more past due. At such time, interest accrued and unpaid
is reversed from interest income.
Consistent with regulatory guidelines, the Company provides for the
classification of loans considered to be of lesser quality as "substandard,"
"doubtful," or "loss" assets. A loan is considered substandard if it is
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. Substandard loans include those
characterized by the distinct possibility that the Company will sustain some
loss if the deficiencies are not corrected. Loans classified as doubtful have
all of the weaknesses inherent in those classified substandard with the added
characteristic that the weaknesses present make collection or liquidation in
full, on the basis of currently existing facts, conditions, and values, highly
questionable and improbable. Loans classified as loss are those considered
uncollectible and of such little value that their continuance as assets without
the establishment of a specific loss reserve is not warranted. Loans that do not
expose the Company to risk sufficient to warrant classification in one of the
aforementioned categories, but which possess some weaknesses, are designated
"watch" or "special mention."
When the Company classifies problem loans as either substandard or doubtful, it
establishes a specific valuation allowance in an amount deemed prudent by
management. General allowances represent loss allowances that have been
established to recognize the risk associated with outstanding loans, but which,
unlike specific allowances, have not been allocated to particular problem loans.
When the Company classifies problem loans as a loss, it either establishes a
specific allowance for losses equal to 100% of the amount of the loans
classified, or charges-off such amount against the allowance for credit losses.
The Company's determination as to the classification of its loans and the amount
of its allowance is subject to ongoing review by its regulatory agencies, which
can order the establishment of additional general or specific loss allowances.
The Company regularly reviews its loan portfolio to determine whether any loans
require classification in accordance with Company policy or applicable
regulations.
10
Allowance for Credit Losses. The allowance for credit losses is established
through a provision for credit losses based on management's evaluation of losses
in the loan portfolio. Such evaluation, which includes a review of all loans on
which full collectibility may not be reasonably assured, considers among other
matters, the estimated net realizable value or the fair value of the underlying
collateral, economic conditions, historical loan loss experience and other
factors that warrant recognition in determining the credit loss allowance. The
Company continues to monitor and modify the level of the allowance for credit
losses in order to include all losses at each reporting date that are both
probable and reasonable to estimate. In addition, various regulatory agencies,
as an integral part of their examination process, periodically review the
Company's allowance for credit losses.
Management's evaluation of the allowance for credit losses is based on a
continuing review of the loan portfolio. The methodology for determining the
amount of the allowance for credit losses consists of several elements. All
individual commercial real estate and business credits and/or total loan
concentrations to one borrower greater than $500 thousand are subject to a
formal review process. Single credits or concentrations of $5.0 million or more
are required to be reviewed every year; relationships between $1.0 million and
$5.0 million are reviewed every 18 months; and relationships between $500
thousand and $1.0 million are reviewed every 36 months. Non-accruing, impaired
and delinquent commercial loans are reviewed individually every month and the
value of any underlying collateral is considered in determining estimates of
losses on those loans and the need, if any, for a specific allowance. Another
element involves estimating losses in categories of smaller balance homogeneous
loans (residential, home equity, consumer) based primarily on historical loss
experience, industry trends, trends in the local real estate market and the
current business and economic environment in the Company's market areas. The
unallocated portion of the allowance for credit losses is based on management's
evaluation of various conditions, and involves a higher degree of uncertainty
because this component of the allowance for credit losses is not identified with
specific problem credits or portfolio segments. The conditions evaluated in
connection with this element include the following: industry and regional
conditions (primarily Upstate New York where the Company is subject to a high
degree of concentration risk); seasoning of the loan portfolio and changes in
the composition of and growth in the loan portfolio; the strength and duration
of the current business cycle; existing general economic and business conditions
in the lending areas; credit quality trends, including trends in nonaccruing
loans; historical loan charge-off experience; and the results of regulatory
examinations.
INVESTMENT ACTIVITIES
General. The Company's investment policy provides that investment decisions will
be made based on the safety of the investment, liquidity requirements, potential
returns, cash flow targets, collateral for pledging purposes and desired risk
parameters. In pursuing these objectives, consideration is given to the ability
of an investment to provide earnings consistent with factors of quality,
maturity, marketability and risk diversification.
The Company limits securities investments to U.S. Government and agency
securities, municipal bonds, corporate debt obligations and corporate equity
securities. In addition, the policy permits investments in mortgage-backed
securities, including collateralized mortgage obligations (CMO's) issued and
guaranteed by FNMA, FHLMC, Government National Mortgage Association ("GNMA") or
privately-issued and backed by "whole loans." Also permitted are investments in
asset-backed securities ("ABS"), supported by auto loans, credit card
receivables, home equity loans, student loans, and home improvement loans. The
investment strategy generally utilizes a risk management approach of diversified
investing to optimize overall investment yields while managing the global
interest rate risk position of the Company. To accomplish these objectives, the
Company's focus is on investments in mortgage-related securities, including
CMO's, while U.S. Government and Agency and other non-amortizing securities are
utilized for call protection and liquidity purposes. The Company attempts to
maintain a high degree of liquidity in its investment securities and generally
does not invest in debt securities with expected average lives in excess of 5
years. At December 31, 2004, no investments in securities of a single non-U.S.
Government or government agency issuer exceeded 10% of stockholders' equity.
SOURCES OF FUNDS
General. Deposits and borrowed funds, primarily FHLB advances and repurchase
agreements, are the primary sources of the Company's funds for use in lending,
investing and for other general purposes. In addition, repayments on and
proceeds from sales of loans and securities, and cash flows from operations
provide additional sources of funds. The Company has available lines of credit
with the FHLB, Federal Reserve Bank ("FRB") and a commercial bank, which can
provide liquidity if the above funding sources are not sufficient to meet the
Company's short-term liquidity needs.
11
Deposits. The Company offers a variety of deposit products with a range of
interest rates and terms. Consumer deposit accounts consist of savings accounts,
negotiable order of withdrawal ("NOW") accounts, checking accounts, money market
accounts, and certificates of deposit. The Company also offers Individual
Retirement Accounts ("IRAs") and other qualified plan accounts. Commercial
account offerings include business savings and checking accounts, money market
accounts, cash management services and a totally free checking product. The
Company also has the ability to accept municipal deposits through the Commercial
Bank.
Borrowed Funds. Borrowings are utilized to lock-in lower cost funding, improve
the maturity and match between certain assets and liabilities and leverage
capital for the purpose of improving return on equity. Such borrowings primarily
consist of advances and repurchase agreements entered into with the FHLB,
nationally recognized securities brokerage firms and with commercial customers.
FINANCIAL SERVICES
General. To complement its traditional core banking business, the Company offers
a wide-range of insurance and investment products and services to help customers
achieve their financial goals. These products and services are delivered through
the Company's Risk Management and Wealth Management businesses. The goal of
these financial services businesses is to help customers identify and achieve
long- and short-range business and financial goals.
Risk Management. The Company's Risk Management services consists of the sale of
personal and commercial insurance on an agency basis to consumers, as well as to
small and medium sized companies located in its market areas. The Company offers
life, auto, home, long-term care, disability, key-person life, property
insurance, and general liability business insurance, which includes product
professional and umbrella policies. In addition to its insurance products sold,
the Company provides claims investigation and adjusting services, third party
administration of self insured workers' compensation plans and alternative risk
management and self-insurance consulting services.
The revenue attributable to the Company's Risk Management services consists
primarily of fees paid by clients and commissions, fees and contingent
profit-sharing paid by insurance companies. These revenues may be affected by
premium rate levels in the insurance markets and available insurance capacity
since compensation is frequently related to the premiums paid by insureds.
Revenue is also affected by insured values, the development of new products,
markets and services, new and lost business and the underlying economic activity
of existing clients. Contingent profit-sharing payments are primarily based upon
the profitability or loss to the insurer on the policies placed. Risk management
revenues vary from quarter to quarter as a result of policy renewals and the net
effect of new and lost business, whereas expenses tend to be more uniform
throughout the year. Commission rates vary in amount depending upon the type of
insurance coverage provided, the particular insurer, the capacity in which the
agent acts and negotiations with clients. For 2004 the Company serviced
approximately $125 million of annual insurance premium volume. The acquisition
of HRBT and its wholly-owned insurance agency subsidiary will add approximately
$30 million to this total.
Wealth Management. The Company's Wealth Management business consists of the sale
of stocks, bonds, mutual funds, annuities and other investment products
including IRAs, education savings plans and retirement plans to both consumer
and commercial clients. Additionally, the Company offers investment advisory,
trust, pension and custody services.
Revenue from the sale of mutual funds and annuities consists primarily of
commissions paid by clients, investment managers and third-party product
providers. Revenue is affected by the development of new products, markets and
services, new and lost business, the relative attractiveness of investment
products offered under prevailing market conditions, changes in the investment
patterns of clients, the flow of monies to and from accounts and the valuation
of accounts. Mutual funds and annuities as well as other investment products are
sold through First Niagara's branch network, by financial consultants and
appropriately licensed employees.
Investment management services are performed pursuant to advisory contracts,
which provide for fees payable to the Company. The amount of fees varies
depending on the individual account and is usually based upon a sliding scale in
relation to the level of assets under management. Assets under management and
revenue levels are particularly affected by fluctuations in stock and bond
market prices, the composition of assets under management and by the level of
investments and withdrawals for current and new clients. A decline in general
market levels will reduce future revenue. Items affecting revenue also include,
but are not limited to, actual and relative investment performance, service to
clients, the relative attractiveness of the investment style under prevailing
market conditions, changes in the investment patterns of clients and the ability
to maintain investment management fees at appropriate levels. The Company also
provides personal trust, employee benefit trust, and custodial services to
clients in its market areas. Similar to investment management services, trust
revenue is derived primarily from investment management fees, which depend
largely on the total value and composition of assets under management. Assets
under management and administration aggregated approximately $505.2 million as
of December 31, 2004. The acquisition of HRBT will add approximately $98.1
million of managed assets.
12
SEGMENT INFORMATION
Information about the Company's business segments is included in note 17 of
"Notes to Consolidated Financial Statements" filed herewith in Part II, Item 8,
"Financial Statements and Supplementary Data." The Company has identified two
business segments, banking and financial services. Financial services activities
consist of the results of the Company's wealth and risk management operations.
All other activities are considered banking.
SUPERVISION AND REGULATION
General. FNFG is a savings and loan holding company examined and supervised by
the OTS, while First Niagara is examined and supervised by the OTS and the
Federal Deposit Insurance Corporation ("FDIC"). This regulation and supervision
establishes a comprehensive framework of activities in which an institution may
engage and is intended primarily for the protection of the FDIC's deposit
insurance funds and depositors. Under this system of federal regulation,
financial institutions are periodically examined to ensure that they satisfy
applicable standards with respect to their capital adequacy, assets, management,
earnings, liquidity and sensitivity to market interest rates. Following
completion of its examination, the federal agency critiques the institution's
operations and assigns its rating (known as an institution's CAMELS rating).
Under federal law, an institution may not disclose its CAMELS rating to the
public. First Niagara also is a member of and owns stock in the FHLB of New
York, which is one of the twelve regional banks in the FHLB System. First
Niagara also is regulated to a lesser extent by the Board of Governors of the
Federal Reserve System, governing reserves to be maintained against deposits and
other matters. The OTS examines First Niagara and prepares reports for the
consideration of its Board of Directors on any operating deficiencies. First
Niagara's relationship with its depositors and borrowers also is regulated to a
great extent by both federal and state laws, especially in matters concerning
privacy, the ownership of deposit accounts and the form and content of loan
documents. Any change in these laws or regulations, whether by the FDIC, OTS or
Congress, could have a material adverse impact on the Company and its
operations.
Federal Banking Regulation
Business Activities. A federal savings bank derives its lending and investment
powers from the Home Owners' Loan Act, as amended, and the regulations of the
OTS. Under these laws and regulations, First Niagara may invest in mortgage
loans secured by residential and commercial real estate, commercial business and
consumer loans, certain types of debt securities and certain other assets. First
Niagara also may establish subsidiaries that may engage in activities not
otherwise permissible, including real estate investment and securities and
insurance brokerage.
Capital Requirements. OTS regulations require savings banks to meet three
minimum capital standards: A 1.5% tangible capital ratio, a 4% leverage ratio
and an 8% risk-based capital ratio. The prompt corrective action standards
discussed below, in effect, establish a minimum 2% tangible capital standard.
The risk-based capital standard for savings banks requires the maintenance of
Tier 1 (core) and total capital (which is defined as core capital and
supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 200%, assigned by the OTS capital regulation based on the risks
believed inherent in the type of asset. Core capital is defined as common
stockholders' equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus and minority interests in equity
accounts of consolidated subsidiaries, less intangibles other than certain
mortgage servicing rights and credit card relationships. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock, the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net
unrealized gains on available-for-sale equity securities with readily
determinable fair market values. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
At December 31, 2004, First Niagara exceeded all minimum regulatory capital
requirements. The current requirements and the actual levels for First Niagara
are detailed in note 11 of "Notes to Consolidated Financial Statements" filed
herewith in Part II, Item 8, "Financial Statements and Supplementary Data."
Liquidity. A federal savings bank is required to maintain a sufficient amount of
liquid assets to ensure its safe and sound operation.
13
Loans-to-One-Borrower. A federal savings bank generally may not make a loan or
extend credit to a sole obligor in excess of 15% of unimpaired capital and
surplus on an unsecured basis. An additional amount may be loaned, equal to 10%
of unimpaired capital and surplus, if the loan is secured by readily marketable
collateral, but generally does not include real estate. First Niagara is in
compliance with the loans-to-one-borrower limitations. As a result of the shares
issued in connection with the recently completed acquisition of HRB, the
Company's regulatory loans-to-one-borrower limit has increased from $92.1
million (15% of unimpaired capital and surplus) as of December 31, 2004 to
$103.9 million as of January 31, 2005. However, given the Company's conservative
underwriting standards and risk management philosophy, management and the Board
of Directors has established an internal loans-to-one-borrower limit of
approximately $69.3 million (10% of unimpaired capital and surplus) as of
January 31, 2005 unless approved by the Board of Directors.
Qualified Thrift Lender Test. As a federal savings bank, First Niagara is
subject to a qualified thrift lender ("QTL") test. Under the QTL test, First
Niagara must maintain at least 65% of its "portfolio assets" in "qualified
thrift investments" in at least nine months of the most recent 12-month period.
"Portfolio assets" generally means total assets of a savings institution, less
the sum of specified liquid assets up to 20% of total assets, goodwill and other
intangible assets, and the value of property used in the conduct of the savings
bank's business.
"Qualified thrift investments" includes various types of loans made for
residential and housing purposes, investments related to such purposes,
including certain mortgage-backed and related securities, and loans for
personal, family, household and certain other purposes up to a limit of 20% of
portfolio assets. "Qualified thrift investments" also include 100% of an
institution's credit card loans, education loans and small business loans. First
Niagara also may satisfy the QTL test by qualifying as a "domestic building and
loan association" as defined by the Internal Revenue Code of 1986, as amended.
Giving effect to the acquisition of HRB, as of January 31, 2005, First Niagara
had 76% of its portfolio assets in qualified thrift investments.
Capital Distributions. OTS regulations govern capital distributions by a federal
savings bank, which include cash dividends, stock repurchases and other
transactions charged to the capital account. A savings bank must file an
application for approval of a capital distribution if the total capital
distributions for the applicable calendar year exceed the sum of the savings
bank's net income for that year to date plus the savings bank's retained net
income for the preceding two years; the bank would not be at least adequately
capitalized following the distribution; the distribution would violate any
applicable statute, regulation, agreement or OTS-imposed condition; or the
savings bank is not eligible for expedited treatment of its filings.
Even if an application is not otherwise required, every savings bank that is a
subsidiary of a holding company must file a notice with the OTS at least 30 days
before the Board of Directors declares a dividend or approves a capital
distribution. The OTS may disapprove a notice or application if: The savings
bank would be undercapitalized following the distribution; the proposed capital
distribution raises safety and soundness concerns; or the capital distribution
would violate a prohibition contained in any statute, regulation or agreement.
In addition, the Federal Deposit Insurance Act provides that an insured
depository institution shall not make any capital distribution, if after making
such distribution, the institution would be undercapitalized.
Community Reinvestment Act and Fair Lending Laws. All savings banks have a
responsibility under the Community Reinvestment Act ("CRA") and related
regulations of the OTS to help meet the credit needs of their communities,
including low- and moderate-income neighborhoods. In connection with its
examination of a federal savings bank, the OTS is required to assess the savings
bank's record of compliance with the CRA. In addition, the Equal Credit
Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in
their lending practices on the basis of characteristics specified in those
statutes. A bank's failure to comply with the provisions of the CRA could, at a
minimum, result in regulatory restrictions on its activities. The failure to
comply with the Equal Credit Opportunity Act and the Fair Housing Act could
result in enforcement actions by the OTS, as well as other federal regulatory
agencies and the Department of Justice. First Niagara received a "Satisfactory"
CRA rating on its most recent federal examination.
Transactions with Related Parties. A federal savings bank's authority to engage
in transactions with its "affiliates" is limited by OTS regulations and by
Sections 23A and 23B of the Federal Reserve Act (the "FRA"). The term
"affiliates" for these purposes generally means any company that controls or is
under common control with an institution. FNFG is an affiliate of First Niagara.
In general, transactions with affiliates must be on terms that are as favorable
to the savings bank as comparable transactions with non-affiliates. In addition,
certain types of these transactions are restricted to an aggregate percentage of
the savings bank's capital. Collateral in specified amounts must usually be
provided by affiliates in order to receive loans from the savings bank. In
addition, OTS regulations prohibit a savings bank from lending to any of its
affiliates that are engaged in activities that are not permissible for bank
holding companies and from purchasing the securities of any affiliate, other
than a subsidiary.
14
Regulation W, issued by the Federal Reserve, comprehensively implements Sections
23A and 23B. The regulation unifies and updates staff interpretations issued
over the years, incorporates several new interpretative proposals (such as to
clarify when transactions with an unrelated third party will be attributed to an
affiliate) and addresses new issues arising as a result of the expanded scope of
non-banking activities engaged in by banks and bank holding companies in recent
years and authorized for financial holding companies under the
Gramm-Leach-Bliley ("GLB") Act.
First Niagara's authority to extend credit to its directors, executive officers
and 10% stockholders, as well as to entities controlled by such persons, is
currently governed by the requirements of Sections 22(g) and 22(h) of the FRA
and Regulation O of the FRB. Among other things, these provisions require that
extensions of credit to insiders (i) be made on terms that are substantially the
same as, and follow credit underwriting procedures that are not less stringent
than, those prevailing for comparable transactions with unaffiliated persons and
that do not involve more than the normal risk of repayment or present other
unfavorable features, and (ii) do not exceed certain limitations on the amount
of credit extended to such persons, individually and in the aggregate, which
limits are based, in part, on the amount of First Niagara's capital. In
addition, extensions of credit in excess of certain limits must be approved by
First Niagara's Board of Directors.
Enforcement. The OTS has primary enforcement responsibility over federal savings
institutions and has the authority to bring enforcement action against all
"institution-affiliated parties," including stockholders, and attorneys,
appraisers and accountants who knowingly or recklessly participate in wrongful
action likely to have an adverse effect on an insured institution. Formal
enforcement action may range from the issuance of a capital directive or a cease
and desist order for the removal of officers and/or directors of the
institution, receivership, conservatorship or the termination of deposit
insurance. Civil penalties cover a wide range of violations and actions, and
range up to $25 thousand per day, unless a finding of reckless disregard is
made, in which case penalties may be as high as $1.1 million per day. The FDIC
also has the authority to recommend to the Director of the OTS that enforcement
action be taken with respect to a particular savings institution. If action is
not taken by the OTS Director, the FDIC has authority to take action under
specified circumstances.
Standards for Safety and Soundness. Federal law requires each federal banking
agency to prescribe certain standards for all insured depository institutions.
These standards relate to, among other things, internal controls, information
and audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, compensation, and other operational and managerial
standards as the agency deems appropriate. The federal banking agencies adopted
Interagency Guidelines Prescribing Standards for Safety and Soundness to
implement the safety and soundness standards required under federal law. The
guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. If the appropriate federal banking agency
determines that an institution fails to meet any standard prescribed by the
guidelines, the agency may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard. If an institution fails
to meet these standards, the appropriate federal banking agency may require the
institution to submit a compliance plan.
Prompt Corrective Action Regulations. Under the prompt corrective action
regulations, the OTS is required and authorized to take supervisory actions
against undercapitalized savings banks. For this purpose, a savings bank is
placed in one of the following five categories based on the bank's capital:
well-capitalized (at least 5% leverage capital, 6% tier 1 risk-based capital and
10% total risk-based capital); adequately capitalized (at least 3% leverage
capital, 4% tier 1 risk-based capital and 8% total risk-based capital);
undercapitalized (less than 8% total risk-based capital, 4% tier 1 risk-based
capital or 3% leverage capital); significantly undercapitalized (less than 6%
total risk-based capital, 3% tier 1 risk-based capital or 3% leverage capital);
and critically undercapitalized (less than 2% tangible capital).
Generally, the banking regulator is required to appoint a receiver or
conservator for a bank that is "critically undercapitalized." The regulation
also provides that a capital restoration plan must be filed with the OTS within
45 days of the date a bank receives notice that it is "undercapitalized,"
"significantly undercapitalized," or "critically undercapitalized." A capital
restoration plan must disclose, among other things, the steps an insured
institution will take to become adequately capitalized without appreciably
increasing the risk to which the institution is exposed. In addition, each
company that controls the institution must guarantee that the institution will
comply with the plan until the institution has been adequately capitalized on
average during each of four consecutive calendar quarters. Such guarantee could
have a material adverse affect on the financial condition of such guarantor. In
addition, numerous mandatory supervisory actions become immediately applicable
to the bank, including, but not limited to, restrictions on growth, investment
activities, capital distributions and affiliate transactions. The OTS may also
take any one of a number of discretionary supervisory actions against
undercapitalized banks, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
15
At December 31, 2004, First Niagara met the criteria for being considered
"well-capitalized." The current requirements and the actual levels for First
Niagara are detailed in note 11 of "Notes to Consolidated Financial Statements"
filed herewith in Part II, Item 8, "Financial Statements and Supplementary
Data."
Insurance of Deposit Accounts. Deposit accounts in First Niagara are insured by
the FDIC, primarily through the Bank Insurance Fund, generally up to a maximum
of $100 thousand per separately insured depositor. Deposits therefore are
subject to FDIC deposit insurance assessments. The FDIC has adopted a risk-based
system for determining deposit insurance assessments. The FDIC is authorized to
raise the assessment rates as necessary to maintain the required ratio of
reserves to insured deposits at 1.25%. In addition, all FDIC-insured
institutions must pay assessments to the FDIC based upon the amount of insured
deposits to fund interest payments on bonds maturing in 2017 issued by a federal
agency to recapitalize the predecessor to the Savings Association Insurance
Fund.
Prohibitions Against Tying Arrangements. Federal savings banks are prohibited,
subject to some exceptions, from extending credit to or offering any other
service, or fixing or varying the consideration for such extension of credit or
service, on the condition that the customer obtain some additional service from
the institution or its affiliates or not obtain services of a competitor of the
institution.
Federal Home Loan Bank System. First Niagara is a member of the FHLB System,
which consists of 12 regional Federal Home Loan Banks. The FHLB System provides
a central credit facility primarily for member institutions. As a member of the
FHLB of New York, First Niagara is required to acquire and hold shares of
capital stock in the FHLB in an amount at least equal to 1% of the aggregate
principal amount of its unpaid residential mortgage loans and similar
obligations at the beginning of each year, or 1/20 of its borrowings from the
FHLB, whichever is greater. First Niagara is in compliance with this
requirement.
Federal Reserve System. The Federal Reserve Board regulations require savings
banks to maintain non-interest-earning reserves against their transaction
accounts, such as NOW and regular checking accounts. First Niagara is in
compliance with these reserve requirements. The balances maintained to meet the
reserve requirements imposed by the Federal Reserve Board may be used to satisfy
liquidity requirements imposed by the OTS.
Holding Company Regulation
FNFG is a savings and loan holding company, subject to regulation and
supervision by the OTS, which has enforcement authority over FNFG. Among other
things, this authority permits the OTS to restrict or prohibit activities that
are determined to be a risk to First Niagara.
Under prior law, a unitary savings and loan holding company generally had no
regulatory restrictions on the types of business activities in which it may
engage, provided that its subsidiary savings bank was a qualified thrift lender.
The GLB Act of 1999, however, restricts unitary savings and loan holding
companies not existing or applied for before May 4, 1999 to those activities
permissible for financial holding companies or for multiple savings and loan
holding companies. FNFG is not a grandfathered unitary savings and loan holding
company and, therefore, is limited to the activities permissible for financial
holding companies or for multiple savings and loan holding companies. A
financial holding company may engage in activities that are financial in nature,
including underwriting equity securities and insurance, incidental to financial
activities or complementary to a financial activity. A multiple savings and loan
holding company is generally limited to activities permissible for bank holding
companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the
prior approval of the OTS, and certain additional activities authorized by OTS
regulations.
Federal law prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring control of
another savings institution or holding company thereof, without prior written
approval of the OTS. It also prohibits the acquisition or retention of, with
specified exceptions, more than 5% of the equity securities of a company engaged
in activities that are not closely related to banking or financial in nature or
acquiring or retaining control of an institution that is not federally insured.
In evaluating applications by holding companies to acquire savings institutions,
the OTS must consider the financial and managerial resources, future prospects
of the savings institution involved, the effect of the acquisition on the risk
to the insurance fund, the convenience and needs of the community and
competitive factors.
16
Commercial Bank Regulation
The Commercial Bank is subject to extensive regulation by the New York State
Banking Department ("NYSBD") as its chartering agency and by the FDIC as its
deposit insurer. The Commercial Bank must file reports with the NYSBD and the
FDIC concerning its activities and financial condition, and it must obtain
regulatory approval prior to entering into certain transactions, such as mergers
with, or acquisitions of, other depository institutions and opening or acquiring
branch offices. The NYSBD and the FDIC conduct periodic examinations to assess
the Commercial Bank's compliance with various regulatory requirements. This
regulation and supervision is intended primarily for the protection of the
deposit insurance funds and depositors. The regulatory authorities have
extensive discretion in connection with the exercise of their supervisory and
enforcement activities, including the setting of policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. This enforcement authority also includes, among other
things, the ability to assess civil money penalties, to issue cease and desist
orders and to remove directors and officers. In general, these enforcement
actions may be initiated in response to violations of laws and regulations and
to unsafe or unsound practices.
The Commercial Bank derives its powers primarily from the applicable provisions
of the New York Banking Law and the regulations adopted thereunder. State banks
are limited in their investments and the activities they may engage in as
principal to those permissible under applicable state law and those permissible
for national banks and their subsidiaries, unless such investments and
activities are specifically permitted by the Federal Deposit Insurance Act or
the FDIC determines that such activity or investment would pose no significant
risk to the deposit insurance funds. The Commercial Bank limits its activities
to accepting municipal deposits and acquiring municipal and other securities.
Under New York Banking Law, the Commercial Bank is not permitted to declare,
credit or pay any dividends if its capital stock is impaired or would be
impaired as a result of the dividend. In addition, the New York Banking Law
provides that the Commercial Bank can not declare nor pay dividends in any
calendar year in excess of its "net profits" for such year combined with its
"retained net profits" of the two preceding years, less any required transfer to
surplus or a fund for the retirement of preferred stock, without prior
regulatory approval.
The Commercial Bank is subject to minimum capital requirements imposed by the
FDIC that are substantially similar to the capital requirements imposed on First
Niagara. The FDIC regulations require that each bank maintain a minimum ratio of
qualifying total capital to risk-weighted assets of 8.0%, and a minimum ratio of
tier 1 capital to risk-weighted assets of 4.0%. In addition, under the minimum
leverage-based capital requirement adopted by the FDIC, the Commercial Bank must
maintain a ratio of tier 1 capital to average total assets (leverage ratio) of
at least 3% to 5%, depending on the Bank's CAMELS composite examination rating.
Capital requirements higher than the generally applicable minimum requirements
may be established for a particular bank if the FDIC determines that a bank's
capital is, or may become, inadequate in view of the bank's particular
circumstances. Failure to meet capital guidelines could subject a bank to a
variety of enforcement actions, including actions under the FDIC's prompt
corrective action regulations.
At December 31, 2004, the Commercial Bank exceeded all minimum regulatory
capital requirements. The current requirements and the actual levels for the
Commercial Bank are detailed in note 11 of "Notes to Consolidated Financial
Statements" filed herewith in Part II, Item 8, "Financial Statements and
Supplementary Data."
Other Legislation
USA Patriot Act of 2001. The USA Patriot Act of 2001 (the "Patriot Act") was
enacted in response to the terrorist attacks, which occurred on September 11,
2001. The Patriot Act is intended to strengthen U.S. law enforcement's and the
intelligence communities' abilities to work cohesively to combat terrorism on a
variety of fronts. The potential impact of the Patriot Act on financial
institutions of all kinds is significant and wide ranging. The Patriot Act
contains sweeping anti-money laundering and financial transparency laws and
requires various regulations, including standards for verifying customer
identification at account opening, and rules to promote cooperation among
financial institutions, regulators and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering.
Financial Services Modernization Legislation. The GLB Act of 1999 repealed
provisions of the Glass-Steagall Act which restricted the affiliation of Federal
Reserve member banks with firms "engaged principally" in specified securities
activities, and which restricted officer, director, or employee interlocks
between a member bank and any company or person "primarily engaged" in specified
securities activities.
17
In addition, the GLB Act contains provisions that expressly preempt any state
law restricting the establishment of financial affiliations, primarily related
to insurance. The general effect of the law is to establish a comprehensive
framework to permit affiliations among commercial banks, insurance companies,
securities firms, and other financial service providers by revising and
expanding the Bank Holding Company Act framework to permit a holding company to
engage in a full range of financial activities through a new entity known as a
"financial holding company." "Financial activities" is broadly defined to
include not only banking, insurance and securities activities, but also merchant
banking and additional activities that the Federal Reserve Board, in
consultation with the Secretary of the Treasury, determines to be financial in
nature, incidental to such financial activities, or complementary activities
that do not pose a substantial risk to the safety and soundness of depository
institutions or the financial system.
The GLB Act provides that no company may acquire control of an insured savings
association unless that company engages, and continues to engage, only in the
financial activities permissible for a financial holding company, unless the
company is grandfathered as a unitary savings and loan holding company on May 4,
1999 or became a unitary savings and loan holding company pursuant to an
application pending on that date.
The GLB Act also permits national banks to engage in expanded activities through
the formation of financial subsidiaries. A national bank may have a subsidiary
engaged in any activity authorized for national banks directly or any financial
activity, except for insurance underwriting, insurance investments, real estate
investment or development, or merchant banking, which may only be conducted
through a subsidiary of a financial holding company. Financial activities
include all activities permitted under new sections of the Bank Holding Company
Act or permitted by regulation.
The Fair and Accurate Credit Transactions ("FACT") Act of 2003. The FACT Act
includes many provisions concerning national credit reporting standards, and
permits consumers, including the customers of the Company, to opt out of
information sharing among affiliated companies for marketing purposes. The FACT
Act also requires financial institutions, including banks, to notify their
customers if they report negative information about them to credit bureaus or if
the credit that is granted to them is on less favorable terms than are generally
available. Banks also must comply with guidelines to be established by their
federal banking regulators to help detect identity theft.
Sarbanes-Oxley Act. The stated goals of the Sarbanes-Oxley Act of 2002 ("SOX")
are to increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties at publicly traded companies and to
protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities laws.
The SOX includes very specific additional disclosure requirements and new
corporate governance rules, requires the SEC and securities exchanges to adopt
extensive additional disclosure, corporate governance and other related rules
and mandates further studies of certain issues by the SEC and the Comptroller
General. The SOX represents significant federal involvement in matters
traditionally left to state regulatory systems, such as the regulation of the
accounting profession, and to state corporate law, such as the relationship
between a board of directors and management and between a board of directors and
its committees.
The SOX addresses, among other matters, audit committees; certification of
financial statements and internal controls by the Chief Executive Officer and
Chief Financial Officer; the forfeiture of bonuses or other incentive-based
compensation and profits from the sale of an issuer's securities by directors
and senior officers in the twelve month period following initial publication of
any financial statements that later require restatement; a prohibition on
insider trading during pension plan black out periods; disclosure of off-balance
sheet transactions; a prohibition on certain loans to directors and officers;
expedited filing requirements for Forms 4; disclosure of a code of ethics and
filing a Form 8-K for a change or waiver of such code; "real time" filing of
periodic reports; the formation of a public accounting oversight board; auditor
independence; and various increased criminal penalties for violations of
securities laws. The SEC has enacted rules to implement various provisions of
SOX. The federal banking regulators have adopted generally similar requirements
concerning the certification of financial statements.
TAXATION
General. FNFG and First Niagara are subject to federal income taxation in the
same general manner as other corporations, with some exceptions discussed below.
The following discussion of federal taxation is intended only to summarize
certain pertinent federal and state income tax matters and is not a
comprehensive description of the tax rules applicable to FNFG and First Niagara.
Method of Accounting. For federal income tax purposes, FNFG and First Niagara
report their income and expenses on the accrual method of accounting and use a
tax year ending December 31 for filing its consolidated federal income tax
returns.
18
Net Operating Loss Carryovers. A financial institution may carry back net
operating losses to the preceding two taxable years and forward to the
succeeding 20 taxable years, subject to certain limitations. At December 31,
2004, First Niagara had $28.7 million net operating loss carryforwards for
federal income tax purposes and $28.6 million for New York State income tax
purposes obtained through the acquisition of TFC. The usage of these losses is
subject to an annual limitation.
Corporate Dividends. FNFG may exclude from its income 100% of dividends received
from First Niagara as a member of the same affiliated group of corporations.
Taxable Distributions and Recapture. Prior to the Small Business Protection Act
of 1996, bad debt reserves created prior to January 1, 1988 were subject to
recapture into taxable income should First Niagara fail to meet certain thrift
asset and definitional tests. New federal legislation eliminated these thrift
related recapture rules. However, under current law, pre-1988 reserves remain
subject to recapture should First Niagara make certain nondividend distributions
or cease to maintain a bank charter. At December 31, 2004, First Niagara's
federal pre-1988 reserve, which no federal income tax provision has been made,
was approximately $24.3 million.
State of New York. FNFG reports income on a consolidated calendar year basis to
New York State. New York State franchise tax on corporations is imposed in an
amount equal to the greater of (a) 7.5% of "entire net income" allocable to New
York State, (b) 3% of "alternative entire net income" allocable to New York
State, (c) 0.01% of the average value of assets allocable to New York State, or
(d) nominal minimum tax. Entire net income is based on Federal taxable income,
subject to certain modifications. Alternative entire net income is based on
entire net income with certain modifications.
Status of Audits by Taxing Authorities. FNFG and First Niagara are subject to
routine audits of their tax returns by the Internal Revenue Service and New York
State Department of Taxation. There are no indications of any material
adjustments noted for any examination currently being conducted by these taxing
authorities.
Proposed REIT Legislation. The Governor of New York State has proposed
legislation in his 2005 budget that would eliminate the tax benefit of REITs.
FNF, a wholly owned subsidiary of First Niagara, qualifies as a REIT under the
Internal Revenue Code. Currently, under New York State tax law, 60% of the
dividends FNF pays to First Niagara are excluded from New York State taxable
income. If this legislation were passed, First Niagara would lose this benefit
effective January 1, 2005. Without this exclusion, the Company's 2004 effective
tax rate would have been approximately 36.2%.
ITEM 2. PROPERTIES
- --------------------------------------------------------------------------------
Both FNFG and First Niagara maintain their executive offices at an
administrative center located at 6950 South Transit Road, Lockport, New York.
The administrative center, built in 1997, has 76 thousand square feet of space
and is owned by First Niagara. As of December 31, 2004, First Niagara conducted
its business through 71 full-service branches, a loan production office, 96 ATMs
and several financial services subsidiaries. Of the 71 branches, 15 are located
in Erie County, 6 each in Albany and Monroe Counties, 5 each in Cayuga, Greene,
Niagara and Oneida Counties, 4 in Rensselaer County, 3 each in Cortland, Ontario
and Tompkins Counties, 2 in Orleans and Warren Counties and 1 each in Genesee,
Onondaga, Saratoga, Schenectady, Schoharie, Seneca and Washington Counties.
Additionally, 35 of the branches are owned and 36 are leased. The loan
production office is leased and located in Monroe County. Taking into
consideration the acquisition of HRB, including the consolidation of 6 branches
into First Niagara's existing branches, First Niagara now conducts its business
through 115 branches, 3 loan production offices and 155 ATMs. The additional
branches are located in Albany (10), Columbia (7), Dutchess (1), Fulton (2),
Montgomery (5), Rensselaer (6), Saratoga (7) and Schenectady (6), of which 20
are owned and 24 are leased.
In addition to its branch network, First Niagara leases 9 offices and owns 10
buildings that it utilizes for its financial services subsidiaries, back office
operations, training, tenant rental and storage. The total square footage for
these facilities is approximately 237 thousand square feet, which are located in
Cayuga, Cortland, Erie, Monroe, Niagara, Onondaga, Ontario, Rensselaer and
Seneca Counties. At December 31, 2004, the Company's premises and equipment had
a net book value of $61.8 million. See note 5 of the "Notes to Consolidated
Financial Statements" filed herewith in Part II, Item 8, "Financial Statements
and Supplementary Data" for further detail on the Company's premises and
equipment. All of these properties are generally in good condition and are
appropriate for their intended use.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------------------------------------------------------------
The Company is not involved in any legal proceedings other than proceedings
occurring in the ordinary course of business.
19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- --------------------------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 2004.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
- --------------------------------------------------------------------------------
The common stock of FNFG is traded under the symbol of FNFG on the Nasdaq
National Market. At March 9, 2005, FNFG had 117,240,621 shares of common stock
outstanding and had approximately 17,891 shareholders of record. During 2004,
the high and low sales price of the common stock was $15.78 and $11.49,
respectively. FNFG paid dividends of $0.30 per common share during the year
ended December 31, 2004. See additional information regarding the market price
and dividends paid filed herewith in Part II, Item 6, "Selected Financial Data."
The Company does not have any equity compensation plan that was not approved by
stockholders, other than its employee stock ownership plan. Set forth below is
certain information as of December 31, 2004 regarding equity compensation to
directors and employees of the Company that has been approved by stockholders.
Number of securities to be Number of securities
Equity compensation plans approved by issued upon exercise of Weighted average remaining available for
stockholders outstanding options and rights exercise price issuance under the plan
- --------------------------------------- ------------------------------ ---------------- -----------------------
First Niagara Financial Group, Inc.
1999 Stock Option Plan............... 2,091,631 $4.64 1,425
First Niagara Financial Group, Inc.
1999 Recognition and Retention Plan.. 345,410(1) Not Applicable 177,756
First Niagara Financial Group, Inc.
2002 Long-term Incentive Stock
Benefit Plan......................... 1,557,323 $13.17 551,172
----------- ----------
Total........................... 3,994,364 730,353
=========== ==========
(1) Represents shares that have been granted but have not yet vested.
FNFG's ability to pay dividends to its stockholders is substantially dependent
upon the ability of First Niagara to pay dividends to FNFG. The payment of
dividends by First Niagara is subject to continued compliance with minimum
regulatory capital requirements. As a result of the $100 million dividend in
connection with the HRB acquisition, OTS approval is now required prior to First
Niagara declaring any dividends. The OTS may disapprove a notice if: First
Niagara would be undercapitalized following the distribution; the proposed
capital distribution raises safety and soundness concerns; or the capital
distribution would violate a prohibition contained in any statute, regulation or
agreement. Management does not believe this regulatory requirement will affect
First Niagara's ability to pay dividends in the future given its well
capitalized position.
The following table discloses information regarding the purchases of FNFG stock
made by the Company during the fourth quarter of 2004:
Cumulative number of
shares purchased as Maximum number
part of publicly of shares yet
Number of shares Average price per announced repurchase to be purchased
Date purchased share paid plans (1) under the plans
- ------------------ --------------------- -------------------- ----------------------- -----------------
October 300,000 $13.84 1,565,000 4,742,161
November 495,000 $14.23 1,865,000 4,442,161
December 318,300 $14.30 2,360,000 3,947,161
----------
Fourth quarter 2004 1,113,300 $14.15 2,678,300 3,628,861
========== ====== ========== ==========
(1) In July 2003 the Company announced a program to repurchase up to 2,107,161
shares of its outstanding common stock in order to fund the Company's
vested stock options at that time. This program was completed in the
fourth quarter of 2004 at an average cost of $13.44. On August 31, 2004,
the Company announced that its Board of Directors had approved an
additional 4,200,000 share stock repurchase program to supplement that
authorization. As of December 31, 2004, the average cost of the 571,139
shares repurchased under the current program was $14.33 per share. The
extent to which shares are repurchased will depend on a number of factors
including market trends and prices, economic conditions, and alternative
uses for capital.
In addition to the above purchases, during the fourth quarter of 2004, the
Company repurchased 9,024 shares from executives of the Company at an
average cost of $13.87 per share to satisfy tax withholding requirements
on vested restricted shares as allowed under the Company's restricted
stock plans. The price of these repurchases is based upon the closing
market price of the Company's stock on the date of vesting.
20
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------------------------------------------------------
At or for the year ended December 31,
------------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(Dollar and share amounts in thousands, except per share amounts)
Selected financial condition data:
Total assets .......................... $5,078,374 $3,589,507 $2,934,795 $2,857,946 $2,624,686
Loans and leases, net ................. 3,215,255 2,269,203 1,974,560 1,853,141 1,823,174
Securities available for sale:
Mortgage-backed .................... 618,156 499,611 340,319 339,881 302,334
Other .............................. 551,973 346,272 292,045 354,016 199,500
Deposits .............................. 3,337,682 2,355,216 2,205,421 1,990,830 1,906,351
Borrowings ............................ 750,686 457,966 397,135 559,040 429,567
Stockholders' equity .................. $ 928,162 $ 728,174 $ 283,696 $ 260,617 $ 244,540
Common shares outstanding(1) .......... 78,277 66,326 64,681 64,158 63,808
Selected operations data:
Interest income ....................... $ 224,578 $ 169,959 $ 167,637 $ 178,368 $ 137,040
Interest expense ...................... 68,476 62,544 76,107 99,352 76,862
---------- ---------- ---------- ---------- ----------
Net interest income ................ 156,102 107,415 91,530 79,016 60,178
Provision for credit losses ........... 8,442 7,929 6,824 4,160 2,258
---------- ---------- ---------- ---------- ----------
Net interest income after provision
for credit losses ............... 147,660 99,486 84,706 74,856 57,920
Noninterest income .................... 51,866 43,379 41,787 34,625 26,835
Noninterest expense ................... 120,850 88,277 77,331 75,889 54,670
---------- ---------- ---------- ---------- ----------
Income from continuing operations
before income taxes ........... 78,676 54,588 49,162 33,592 30,085
Income taxes from continuing operations 26,859 18,646 18,752 12,427 10,668
---------- ---------- ---------- ---------- ----------
Income from continuing operations .. 51,817 35,942 30,410 21,165 19,417
Income from discontinued
operations, net of tax(2) ........ -- 164 385 55 102
---------- ---------- ---------- ---------- ----------
Net income ........................ $ 51,817 $ 36,106 $ 30,795 $ 21,220 $ 19,519
========== ========== ========== ========== ==========
Adjusted net income(3) ............ $ 51,817 $ 36,106 $ 30,795 $ 25,962 $ 21,633
========== ========== ========== ========== ==========
Stock and related per share data(1):
Earnings per common share:
Basic .............................. $ 0.66 $ 0.55 $ 0.48 $ 0.33 $ 0.30
Diluted ............................ 0.65 0.53 0.47 0.33 0.30
Adjusted earnings per common share(3):
Basic .............................. 0.66 0.55 0.48 0.41 0.34
Diluted ............................ 0.65 0.53 0.47 0.40 0.34
Cash dividends ....................... 0.30 0.22 0.17 0.14 0.11
Book value ........................... 11.86 10.98 4.39 4.06 3.83
Market Price (NASDAQ: FNFG):
High ............................... 15.78 16.55 12.41 6.92 4.28
Low ................................ 11.49 10.11 6.07 4.16 3.19
Close .............................. $ 13.95 $ 14.97 $ 10.10 $ 6.51 $ 4.18
21
At or for the year ended December 31,
------------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Selected financial ratios and other data:
Performance ratios(4):
Return on average assets .................................. 1.05% 1.02% 1.08% 0.79% 0.98%
Adjusted return on average assets(3) ...................... 1.05 1.02 1.08 0.97 1.09
Return on average equity .................................. 5.59 5.19 11.22 8.30 8.38
Adjusted return on average equity(3) ...................... 5.59 5.19 11.22 10.16 9.29
Return on average tangible equity(5) ...................... 8.75 6.15 15.90 12.34 10.12
Adjusted return on average tangible equity(3)(5) .......... 8.75 6.15 15.90 15.09 11.22
Net interest rate spread .................................. 3.32 2.89 3.30 2.99 2.82
Net interest margin ....................................... 3.60 3.33 3.52 3.25 3.26
As a percentage of average assets:
Noninterest income ..................................... 1.05 1.23 1.46 1.29 1.35
Noninterest expense(3) ................................. 2.44 2.50 2.71 2.66 2.65
---------- ---------- ---------- ---------- ----------
Net overhead ......................................... 1.39 1.27 1.25 1.37 1.30
Efficiency ratio(3) ....................................... 58.11 58.54 58.01 62.74 60.57
Dividend payout ratio ..................................... 45.45% 40.00% 35.42% 41.86% 35.44%
Capital Ratios(6):
Total risk-based capital .................................. 17.65% 19.04% 11.34% 11.36% 11.13%
Tier 1 risk-based capital ................................. 16.40 17.94 10.27 10.27 9.96
Tier 1 (core) capital ..................................... 11.40 11.92 6.54 6.71 6.78
Tangible capital .......................................... 11.40 11.87 6.54 N/A N/A
Ratio of stockholders' equity to total assets ............. 18.28% 20.29% 9.67% 9.12% 9.32%
Asset quality ratios:
Total non-accruing loans .................................. $ 12,028 $ 12,305 $ 7,478 $ 11,480 $ 6,483
Other non-performing assets ............................... 740 543 1,423 665 757
Allowance for credit losses ............................... 41,422 25,420 20,873 18,727 17,746
Net loan charge-offs ...................................... $ 7,090 $ 5,383 $ 4,678 $ 3,179 $ 735
Total non-accruing loans to total loans ................... 0.37% 0.54% 0.37% 0.61% 0.35%
Total non-performing assets as a percentage of total assets 0.25 0.36 0.30 0.42 0.28
Allowance for credit losses to non-accruing loans ......... 344.38 206.58 279.13 163.13 273.73
Allowance for credit losses to total loans ................ 1.27 1.11 1.05 1.00 0.96
Net charge-offs to average loans .......................... 0.23% 0.24% 0.24% 0.17% 0.06%
Other data:
Number of branches ........................................ 71 47 38 37 36
Full time equivalent employees ............................ 1,200 944 945 919 930
22
2004 2003
----------------------------------------- ------------------------------------------
Fourth Third Second First Fourth Third Second First
quarter quarter quarter quarter quarter quarter quarter quarter
-------- -------- -------- -------- -------- -------- -------- --------
Selected Quarterly Data: (In thousands except per share amounts)
Interest income .................... $ 58,954 $ 56,818 $ 55,750 $ 53,056 $ 42,450 $ 41,984 $ 42,602 $ 42,923
Interest expense ................... 18,028 17,180 16,815 16,453 14,197 14,836 15,976 17,535
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income ........... 40,926 39,638 38,935 36,603 28,253 27,148 26,626 25,388
Provision for credit losses ........ 1,846 1,742 3,104 1,750 2,007 1,757 2,208 1,957
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income after
provision for credit losses 39,080 37,896 35,831 34,853 26,246 25,391 24,418 23,431
Noninterest income ................. 13,521 13,107 13,387 11,851 11,153 11,375 10,804 10,047
Noninterest expense................. 30,826 29,196 28,685 27,538 22,360 22,022 20,782 21,729
Amortization of intangibles ........ 1,218 1,182 1,164 1,041 378 398 290 318
-------- -------- -------- -------- -------- -------- -------- --------
Income from continuing
operations before income taxes 20,557 20,625 19,369 18,125 14,661 14,346 14,150 11,431
Income taxes from continuing
operations ..................... 6,998 7,295 6,356 6,210 4,551 5,042 5,073 3,980
-------- -------- -------- -------- -------- -------- -------- --------
Income from continuing operations .. 13,559 13,330 13,013 11,915 10,110 9,304 9,077 7,451
Income (loss) from discontinued
operations, net of tax(2) ...... -- -- -- -- (22) -- 23 163
-------- -------- -------- -------- -------- -------- -------- --------
Net income ................ $ 13,559 $ 13,330 $ 13,013 $ 11,915 $ 10,088 $ 9,304 $ 9,100 $ 7,614
======== ======== ======== ======== ======== ======== ======== ========
Earnings per share:
Basic ......................... $ 0.17 $ 0.17 $ 0.16 $ 0.15 $ 0.15 $ 0.14 $ 0.14 $ 0.12
Diluted ....................... 0.17 0.17 0.16 0.15 0.15 0.14 0.13 0.11
Market price (NASDAQ:FNFG):
High .......................... 14.85 14.00 14.13 15.78 15.64 16.55 14.20 11.92
Low ........................... 13.18 11.84 11.49 13.32 13.85 13.70 11.40 10.11
Close ......................... 13.95 13.38 12.00 13.64 14.97 15.09 13.92 11.75
Cash Dividends ..................... $ 0.08 $ 0.08 $ 0.07 $ 0.07 $ 0.06 $ 0.06 $ 0.05 $ 0.05
- ----------
(1) All per share data and references to the number of shares outstanding for
purposes of calculating per share amounts prior to January 17, 2003 are
adjusted to give recognition to the 2.58681 exchange ratio applied in the
Conversion.
(2) Effective February 18, 2003, First Niagara sold NOVA Healthcare
Administrators, Inc. its wholly- owned third-party benefit plan
administrator subsidiary. For the periods presented, the Company has
reported the results of operations from NOVA as "Discontinued Operations."
First quarter 2003 amounts include the net gain realized on the sale of
$208 thousand.
(3) With the adoption of SFAS No. 142 "Goodwill and Other Intangibles" on
January 1, 2002, the Company is no longer required to amortize goodwill.
Goodwill amortization of $4.7 million and $2.1 million has been excluded
from 2001 and 2000 adjusted net income, respectively, for consistency
purposes. The 2001 and 2000 efficiency ratio and noninterest expense as a
percentage of average assets ratio, excludes $4.6 million and $2.0 million
of goodwill amortization from continuing operations, respectively. Without
excluding these amounts the 2001 and 2000 efficiency ratio and noninterest
expense as a percentage of average assets ratio would have been 66.78% and
62.83%, respectively, and 2.83% and 2.74%, respectively.
(4) Computed using daily averages.
(5) Excludes average goodwill and other intangibles of $335.8 million, $109.2
million, $80.9 million, $83.6 million and $40.1 million for 2004, 2003,
2002, 2001 and 2000, respectively.
(6) Effective November 8, 2002, First Niagara converted to a federal charter
subject to OTS capital requirements. These capital requirements apply only
to First Niagara and do not consider additional capital retained by FNFG.
Prior to converting to federal charters, FNFG and First Niagara were
required to maintain minimum capital ratios calculated in a similar manner
to, but not entirely the same as, the framework of the OTS. Amounts prior
to 2002 have not been recomputed to reflect OTS requirements.
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
GENERAL
The following is an analysis of the financial condition and results of
operations of the Company. This item should be read in conjunction with the
consolidated financial statements and related notes filed herewith in Part II,
Item 8, "Financial Statements and Supplementary Data" and the description of the
Company's business filed here within Part I, Item I, "Business."
OVERVIEW
First Niagara Financial Group, Inc. ("FNFG") holds all of the capital stock of
First Niagara Bank ("First Niagara"), a federally chartered savings bank. FNFG
and First Niagara are hereinafter referred to collectively as "the Company." The
Company is positioned as one of the leading community banks in Upstate New York,
providing its customers with consumer and commercial banking services including
residential and commercial real estate loans, commercial business loans and
leases, consumer loans, and consumer and commercial deposit products.
Additionally, the Company offers risk management and wealth management services.
With the acquisition of Hudson River Bancorp, Inc. ("HRB"), effective January
14, 2005, the Company now has nearly $8.0 billion of assets and $5.1 billion of
deposits and provides customer services through 115 branches across Upstate New
York.
FNFG was organized in April 1998 in connection with the conversion of First
Niagara from a New York State chartered mutual savings bank to a New York State
chartered stock savings bank and the reorganization to a two-tiered mutual
holding company. As part of that reorganization, FNFG issued a majority of its
shares of common stock to First Niagara Financial Group, Inc. MHC (the "MHC")
which raised $132.4 million of net offering proceeds from the sale of common
stock to eligible depositors. In November 2002, FNFG converted First Niagara and
the MHC to a federal charter subject to Office of Thrift Supervision ("OTS")
regulation. On January 17, 2003, the MHC converted to stock form (the
"Conversion"), with the shares of FNFG common stock owned by the MHC being sold
to depositors and other investors (the "Offering"). The Conversion and Offering
resulted in the issuance of 67.4 million shares of common stock and raised an
additional $390.9 million of net proceeds. Since 1998, the Company has deployed
the proceeds from these stock offerings through its "Buy and Build" strategy,
which has resulted in a combination of strategic acquisitions and de novo
expansion in target market areas. This strategy coupled with the Company's
organic growth initiatives, which include an emphasis on expanding commercial
operations and financial services businesses, have resulted in a successful
transition from a Western New York traditional thrift to an Upstate New York
community banking financial services company.
Simultaneously with the Conversion and Offering, the Company acquired Finger
Lakes Bancorp, Inc. ("FLBC") the holding company of the Savings Bank of the
Finger Lakes, headquartered in Geneva, New York. FLBC operated seven branch
locations and added $411.0 million of assets and $259.5 million of deposits.
This acquisition increased the Company's presence in Cayuga and Tompkins
Counties and bridged the Company's Western and Central New York markets. The
acquisition resulted in the issuance of 3.4 million shares of FNFG stock and
cash payments totaling $33.8 million. The transaction was accounted for under
the purchase method of accounting and resulted in the recording of $28.7 million
of goodwill and $2.6 million of core deposit intangibles.
On January 16, 2004, FNFG acquired Troy Financial Corporation ("TFC"), the
holding company of The Troy Savings Bank and The Troy Commercial Bank. TFC
operated twenty-one branch locations in the Capital Region of New York State and
added $1.4 billion of assets and $923.7 million of deposits. The acquisition
resulted in the issuance of 13.3 million shares of FNFG stock and cash payments
totaling $155.3 million. The transaction was accounted for under the purchase
method of accounting and resulted in the recording of $217.4 million of goodwill
and $17.2 million of core deposit intangibles. This acquisition expanded the
Company's market reach into the higher growth Capital Region in Eastern New York
State and furthered its strategic initiatives of increasing commercial
relationships and core deposits.
On January 14, 2005, FNFG acquired HRB, the holding company of Hudson River Bank
& Trust Company, with total assets of approximately $2.5 billion and fifty
branch locations. Following completion of the acquisition, HRB locations were
merged into First Niagara's branch network. The acquisition resulted in the
issuance of 35.7 million shares of FNFG stock and cash payments totaling $126.8
million. The results of operations of HRB will be included in the 2005
consolidated statement of income from the date of acquisition. As a result, the
Company now has a leading market share in the Capital region of New York State.
24
Financial Overview
Total assets increased to $5.1 billion at December 31, 2004 from $3.6 billion at
December 31, 2003, while deposits increased to $3.3 billion from $2.4 billion
during the same period. The acquisition of TFC added $760.0 million of loans,
64% of which were commercial real estate and business loans, and $923.7 million
of deposits, 75% of which were core accounts. While the impact of the TFC
acquisition was significant, balance sheet growth also includes a $253.2
million, or 18%, organic increase in commercial real estate and business loans.
In addition, core deposits increased 11% during the year. Total deposits
increased modestly from December 31, 2003 as the core growth was offset by the
maturities of higher rate certificates of deposit. During the year, the Company
also continued its branch expansion strategy, which contributed to the increase
in core deposits and expanded the Company's presence in the target market areas
of Buffalo and Rochester.
Net income for the year ended December 31, 2004 increased 44% to $51.8 million,
or $0.65 per diluted share from $36.1 million, or $0.53 per diluted share for
2003. These results reflect the benefits of the acquisition of TFC, as well as
increased commercial real estate and business lending activity and core deposit
growth and contributed to a $48.7 million or 45% increase in net interest income
and a 27 basis point improvement in the net interest margin. In addition to the
acquisition of TFC, increases in both noninterest income and expense reflect the
impact of continued expansion of existing operations and financial services
businesses, including the addition of three new branches, the development and
initial implementation of the Company's strategic plan, the acquisition of a
leasing company in September 2004 and the full year benefit from the acquisition
of two insurance agencies in July 2003. The updated strategic plan focuses the
Company, more than ever, on becoming a trusted financial advisor to its
customers by deepening relationships and providing superior customer service and
is expected to drive improved performance and profitability in the future.
Net income for the year ended December 31, 2003 increased 17% from $30.8
million, or $0.47 per diluted share in 2002. During 2003, the Company benefited
from the investment of funds raised in the Offering, the acquisition of FLBC in
January and two insurance agencies in July, as well as increased commercial real
estate and business lending activity. These benefits were partially mitigated by
the impact of the low interest rate environment on investment and loan portfolio
yields, including $8.2 million of mortgage-backed security ("MBS") purchased
premium amortization. In addition, costs incurred in connection with the
acquisition of FLBC and TFC and the unexpected passing of the Company's CEO
impacted earnings during 2003.
CRITICAL ACCOUNTING ESTIMATES
Management of the Company evaluates those accounting estimates that are judged
to be critical - those most important to the portrayal of the Company's
financial condition and results of operations, and that require management's
most difficult, subjective and complex judgements. Accordingly, the accounting
estimates relating to the adequacy of the allowance for credit losses and the
analysis of the carrying value of goodwill for impairment are deemed to be
critical, as the judgments made regarding the allowance and goodwill impairment
could have a material effect on the results of operations of the Company.
A detailed description of the Company's methodology for calculating the
allowance for credit losses and assumptions made is included within the "Lending
Activities" section filed herewith in Part I, Item 1, "Business."
Although goodwill is not subject to amortization, the carrying value must be
tested for impairment at least annually, or more frequently if events or changes
in circumstances indicate that the asset might be impaired. Impairment testing
requires that the fair value of each reporting unit be compared to the carrying
amount of its net assets, including goodwill. Reporting units were identified
based upon an analysis of each of the Company's individual operating segments. A
reporting unit is defined as any distinct, separately identifiable component of
an operating segment for which complete, discrete financial information is
available that management regularly reviews. Goodwill was allocated to each
reporting unit based on its relative fair value at the time of the related
acquisition. Determining the fair value of a reporting unit requires a high
degree of subjective management judgment. Discounted cash flow valuation models
are utilized that incorporate such variables as revenue growth rates, expense
trends, interest rates and terminal values. Based upon an evaluation of key data
and market factors, management selects from a range the specific variables to be
incorporated into the valuation model. Future changes in the economic
environment or operations of reporting units could cause changes to these
variables, which could result in impairment being identified.
The Company has established November 1st as the date for conducting its annual
goodwill impairment assessment. The variables are selected as of that date and
the valuation models are run to determine the fair value of each reporting unit.
At November 1, 2004, the Company did not identify any individual reporting unit
where fair value was less than carrying value, including goodwill.
25
ANALYSIS OF FINANCIAL CONDITION
Lending Activities
Loan Portfolio Composition. Set forth below is selected information concerning
the composition of the Company's loan portfolio in dollar amounts and in
percentages as of the dates indicated:
At December 31,
---------------------------------------------------------------------------
2004 2003 2002
--------------------- --------------------- ----------------------
Amount Percent Amount Percent Amount Percent
----------- ------- ----------- ------- ----------- -------
(Dollars in thousands)
Commercial:
Real estate ................ $ 1,081,709 33.31% $ 653,976 28.60% $ 473,493 23.80%
Construction ............... 187,149 5.76 86,154 3.77 101,633 5.11
Business ................... 424,878 13.08 215,000 9.41 178,555 8.98
----------- ------ ----------- ------ ----------- ------
Total commercial loans ... 1,693,736 52.15 955,130 41.78 753,681 37.89
----------- ------ ----------- ------ ----------- ------
Residential real estate ....... 1,132,471 34.87 948,877 41.51 929,524 46.72
----------- ------ ----------- ------ ----------- ------
Consumer:
Home equity ................ 247,190 7.61 179,282 7.85 136,986 6.89
Other ...................... 174,309 5.37 202,630 8.86 169,155 8.50
----------- ------ ----------- ------ ----------- ------
Total consumer ......... 421,499 12.98 381,912 16.71 306,141 15.39
----------- ------ ----------- ------ ----------- ------
Total loans ................ 3,247,706 100.00% 2,285,919 100.00% 1,989,346 100.00%
----------- ====== ----------- ====== ----------- ======
Net deferred costs and unearned
discounts .................. 8,971 8,704 6,087
Allowance for credit losses ... (41,422) (25,420) (20,873)
----------- ----------- -----------
Total loans, net ........... $ 3,215,255 $ 2,269,203 $ 1,974,560
=========== =========== ===========
At December 31,
----------------------------------------------
2001 2000
--------------------- ---------------------
Amount Percent Amount Percent
----------- ------- ----------- -------
(Dollars in thousands)
Commercial:
Real estate ................ $ 392,896 21.06% $ 329,427 17.96%
Construction ............... 56,394 3.02 29,195 1.59
Business ................... 135,621 7.27 93,730 5.11
----------- ------ ----------- ------
Total commercial loans ... 584,911 31.35 452,352 24.66
----------- ------ ----------- ------
Residential real estate ....... 983,947 52.75 1,089,773 59.40
----------- ------ ----------- ------
Consumer:
Home equity ................ 114,443 6.14 104,254 5.68
Other ...................... 182,126 9.76 188,129 10.26
----------- ------ ----------- ------
Total consumer ......... 296,569 15.90 292,383 15.94
----------- ------ ----------- ------
Total loans ................ 1,865,427 100.00% 1,834,508 100.00%
----------- ====== ----------- ======
Net deferred costs and unearned
discounts .................. 6,441 6,412
Allowance for credit losses ... (18,727) (17,746)
----------- -----------
Total loans, net ........... $ 1,853,141 $ 1,823,174
=========== ===========
Total loans outstanding increased $961.8 million from December 31, 2003 to
December 31, 2004, including $760.0 million attributable to the acquisition of
TFC. The TFC portfolio included $306.8 million of commercial mortgages, $178.6
million of commercial business loans, $226.1 million of residential mortgages,
$40.2 million of home equity loans and $8.3 million of other consumer loans. In
2004, the Company continued to strategically shift its portfolio emphasis from
residential mortgage loans to commercial real estate and business loans by
continuing to focus on expanding commercial relationships, hiring additional
seasoned commercial loan officers, and limiting the amount of long-term
fixed-rate residential real estate loans held in portfolio. Excluding the loans
acquired with TFC, commercial real estate loans increased $221.9 million, or
21%, in 2004, while commercial business loans increased $31.3 million, or 8%,
during the same period. Combined, these portfolios grew at a rate of 18% during
the year, which exceeded the Company's 15% target. At December 31, 2004,
commercial loans comprised 52% of the loan portfolio versus 42% as of December
31, 2003.
Another 2004 highlight was the 13% organic growth in the home equity portfolio,
which was a direct result of the Company's increased emphasis on this
relationship building product. The residential mortgage portfolio declined 4%
due to refinance related prepayments. As a result of the de-emphasis on indirect
lending, including the Company's strategic decision to exit the third-party
indirect auto business as these products were not consistent with the Company's
focus on building relationships, other consumer loan balances declined 14%
during the year.
Allowance for Credit Losses. The allowance for credit losses increased to $41.4
million at December 31, 2004 from $25.4 million at December 31, 2003 which
primarily relates to the $14.7 million of allowance obtained from TFC. The $6.0
million increase in the unallocated portion of the allowance for credit losses
during 2004 also reflects the acquisition of TFC, as well as the continuing weak
economy in Upstate New York and the significant growth in larger balance, higher
risk commercial real estate and business loans over the last several years,
including growth in new markets, which are still relatively unseasoned. The
allowance for credit losses represented 1.27% of total loans and 344% of
non-accruing loans at December 31, 2004, compared to 1.11% and 207% at December
31, 2003, respectively.
While management uses available information to recognize losses on loans, future
credit loss provisions may be necessary based on numerous factors, including
changes in economic conditions. Various regulatory agencies, as an integral part
of their examination process, periodically review the allowance for credit
losses and may require the Company to recognize additional provisions based on
their judgment of information available to them at the time of their
examination. To the best of management's knowledge, the allowance for credit
losses includes all losses at each reporting date that are both probable and
reasonable to estimate. However, there can be no assurance that the allowance
for credit losses will be adequate to cover all losses that may in fact be
realized in the future or that additional provisions for credit losses will not
be required.
26
The following table sets forth the allocation of the allowance for credit losses
by loan category as of the dates indicated:
At December 31,
----------------------------------------------------------------------------------------
2004 2003 2002
------------------------ ------------------------ ------------------------
Percent Percent Percent
of loans of loans of loans
Amount of in each Amount of in each Amount of in each
allowance category allowance category allowance category
for credit to total for credit to total for credit to total
losses loans losses loans losses loans
---------- --------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Commercial real estate.............. $ 12,117 39 % $ 7,137 32 % $ 4,917 29 %
Commercial business................. 12,619 13 7,665 9 7,329 9
Residential real estate............. 2,196 35 1,763 42 1,828 47
Home equity......................... 703 8 509 8 524 7
Other consumer...................... 3,254 5 3,781 9 3,811 8
Unallocated......................... 10,533 -- 4,565 -- 2,464 --
--------- --------- --------- ---------- --------- ----------
Total............................ $ 41,422 100 % $ 25,420 100 % $ 20,873 100 %
========= ========= ========= ========== ========= ==========
At December 31,
---------------------------------------------------------
2001 2000
------------------------ ------------------------
Percent Percent
of loans of loans
Amount of in each Amount of in each
allowance category allowance category
for credit to total for credit to total
losses loans losses loans
---------- --------- ---------- ----------
(Dollars in thousands)
Commercial real estate.............. $ 4,824 24 % $ 4,027 20 %
Commercial business................. 4,883 7 4,307 5
Residential real estate............. 1,996 53 3,248 59
Home equity......................... 614 6 885 6
Other consumer...................... 3,379 10 3,014 10
Unallocated......................... 3,031 -- 2,265 --
--------- --------- --------- ----------
Total............................ $ 18,727 100 % $ 17,746 100 %
========= ========= ========= ==========
Non-Accruing Loans and Non-Performing Assets. The following table sets forth
information regarding non-accruing loans and other non-performing assets as of
the dates indicated:
At December 31,
-------------------------------------------------------
2004 2003 2002 2001 2000
------- ------- ------- ------- -------
(Dollars in thousands)
Non-accruing loans (1):
Commercial:
Real estate ................... $ 3,416 $ 3,878 $ 1,225 $ 2,402 $ 926
Business ...................... 3,016 3,583 1,198 3,244 858
Residential real estate .......... 4,276 3,905 4,071 4,833 3,543
Consumer:
Home equity ................... 519 401 332 491 641
Other ......................... 801 538 652 510 515
------- ------- ------- ------- -------
Total non-accruing loans ...... 12,028 12,305 7,478 11,480 6,483
Real estate owned ................... 740 543 1,423 665 757
------- ------- ------- ------- -------
Total non-performing assets (2) $12,768 $12,848 $ 8,901 $12,145 $ 7,240
======= ======= ======= ======= =======
Total non-performing assets as a
percentage of total assets ....... 0.25% 0.36% 0.30% 0.42% 0.28%
======= ======= ======= ======= =======
Total non-accruing loans as a
percentage of total loans ........ 0.37% 0.54% 0.37% 0.61% 0.35%
======= ======= ======= ======= =======
(1) Loans generally are placed on non-accrual status when they become 90 days
past due or if they have been identified by the Company as presenting
uncertainty with respect to the collectibility of interest or principal.
Non-accruing loans does not include loans that were 90 days or more past
due but still accruing interest of $510 thousand and $221 thousand at
December 31, 2001 and 2000, respectively. There were no such loans at
December 31, 2004, 2003 or 2002.
(2) Non-performing assets does not include $2.7 million and $259 thousand of
performing renegotiated loans that are accruing interest at December 31,
2004 and 2003 respectively. There were no such loans at December 31, 2002,
2001 or 2000.
27
Non-performing assets represented 0.25% of total assets at December 31, 2004
compared to 0.36% at December 31, 2003. This improvement reflects the Company's
continuing emphasis on credit quality while growing its loan portfolio, as well
as its ongoing efforts to actively work with customers with substandard credits.
These efforts led to a $1.0 million decline in non-accruing commercial real
estate and business loans during 2004.
Investing Activities
Securities Portfolio. At December 31, 2004, all of the Company's investment
securities were classified as available for sale. The following table sets forth
certain information with respect to the amortized cost and fair values of the
Company's portfolio as of the dates indicated:
At December 31,
-------------------------------------------------------------------------------------
2004 2003 2002
------------------------- ------------------------- -------------------------
Amortized Fair Amortized Fair Amortized Fair
cost value cost value cost value
---------- ---------- ---------- ---------- ---------- ----------
Investment securities: (Dollars in thousands)
Debt securities:
States and political subdivisions .. $ 277,599 $ 277,573 $ 36,766 $ 38,189 $ 32,957 $ 34,566
U.S. Government Agencies ........... 249,045 246,483 287,604 287,058 229,582 230,583
Corporate .......................... 21,424 21,420 13,708 13,610 14,665 14,563
---------- ---------- ---------- ---------- ---------- ----------
Total debt securities .......... 548,068 545,476 338,078 338,857 277,204 279,712
Other ................................... 6,358 6,497 7,372 7,415 12,406 12,333
---------- ---------- ---------- ---------- ---------- ----------
Total investment securities $ 554,426 $ 551,973 $ 345,450 $ 346,272 $ 289,610 $ 292,045
========== ========== ========== ========== ========== ==========
Average remaining life of investment
securities(1)......................... 1.54 years 2.53 years 2.31 years
========== ========== ==========
Mortgage-backed securities:
FNMA ............................... $ 190,406 $ 188,224 $ 207,480 $ 206,798 $ 12,619 $ 13,790
FHLMC .............................. 135,971 134,093 121,639 121,219 51,024 52,960
GNMA ............................... 5,951 6,187 9,959 10,304 9,910 10,569
CMO's .............................. 291,871 289,652 161,922 161,290 262,161 263,000
---------- ---------- ---------- ---------- ---------- ----------
Total mortgage-backed securities $ 624,199 $ 618,156 $ 501,000 $ 499,611 $ 335,714 $ 340,319
========== ========== ========== ========== ========== ==========
Average remaining life of mortgage-
backed securities(1).................. 3.59 years 3.65 years 1.64 years
========== ========== ==========
Total securities available for sale ..... $1,178,625 $1,170,129 $ 846,450 $ 845,883 $ 625,324 $ 632,364
========== ========== ========== ========== ========== ==========
Average remaining life of investment
securities available for sale(1)...... 2.63 years 3.20 years 1.94 years
========== ========== ==========
(1) Average remaining life does not include other investment securities and is
computed utilizing estimated maturities and prepayment assumptions.
The $324.2 million increase in the investment securities portfolio in 2004
included $251.0 million of securities acquired with TFC, including $210.8
million of tax advantaged municipal debt securities. Securities available for
sale otherwise increased $73.2 million, as the remaining proceeds from the
Company's second-step stock offering were further deployed from short-term
investments to higher yielding MBS's and agency bonds with a weighted average
life of 2 to 4 years. The Company has positioned its investment portfolio to
optimize earnings while limiting earnings volatility due to interest rate
fluctuations and providing cash flow to fund loan growth and on-going
operations.
Funding Activities
Deposits. The $982.5 million increase in deposits from December 31, 2003
resulted primarily from the acquisition of TFC, which added $923.7 million of
accounts, including $273.6 million of savings, $331.0 million of interest
bearing checking, $232.3 million of certificates and $86.8 million of
noninterest bearing accounts. However, in 2004 the Company further focused its
marketing and sales efforts on increasing core deposits through the continued
development of customer relationships, as well as the on-going execution of its
branch expansion strategy. As a result, core deposits organically increased
$233.6 million, or 11%, in 2004. Also contributing to total deposit growth
during the year was the opening of two de novo branches, which added $25.5
million of deposits and the purchase of a Monroe County branch which added $11.2
million of deposits. The impact of this growth on total deposits is not evident
given that certificates of deposits from core operations decreased $186.0
million as the Company opted to fund higher-rate account run-off with lower cost
wholesale borrowings. The Company continues to prioritize deposit gathering and
retention given the low growth and competitiveness of its markets and the
importance of low cost funds to the continued net interest margin expansion.
28
Set forth below is selected information concerning the composition of the
Company's deposits:
At December 31,
-------------------------------------------------------------------------------------------------
2004 2003 2002
------------------------------- ------------------------------- -------------------------------
Weighted Weighted Weighted
average average average
Amount Percent rate Amount Percent rate Amount Percent rate
---------- ------- -------- ---------- ------- -------- ---------- ------- --------
(Dollars in thousands)
Core deposits:
Savings ................... $1,086,769 32.56% 1.02% $ 654,320 27.78% 0.78% $ 708,846 32.14% 1.48%
Interest-bearing checking . 912,598 27.34 1.06 538,967 22.88 0.80 483,169 21.91 1.21
Noninterest-bearing ....... 291,491 8.74 -- 170,384 7.24 -- 134,160 6.08 --
---------- ------ ---------- ------ ---------- ------
Total core deposits ... 2,290,858 68.64 0.91 1,363,671 57.90 0.69 1,326,175 60.13 1.23
Certificates ................. 1,046,824 31.36 2.37 991,545 42.10 2.58 879,246 39.87 3.71
---------- ------ ---------- ------ ---------- ------
Total deposits ......... $3,337,682 100.00% 1.37% $2,355,216 100.00% 1.49% $2,205,421 100.00% 2.04%
========== ====== ========== ====== ========== ======
Borrowings. The following table sets forth certain information as to the
Company's borrowings for the years indicated:
At or for the year ended December 31,
-------------------------------------
2004 2003 2002
-------- -------- --------
(Dollars in thousands)
Period end balance:
FHLB advances ............................ $336,671 $214,501 $236,003
Repurchase agreements .................... 400,930 243,465 155,132
Other borrowings ......................... 13,085 -- 6,000
-------- -------- --------
Total borrowings .................... $750,686 $457,966 $397,135
======== ======== ========
Maximum balance:
FHLB advances ............................ $367,300 $256,820 $315,416
Repurchase agreements .................... 400,930 243,465 235,124
Other borrowings ......................... 13,453 6,000 8,500
Average balance:
FHLB advances ............................ $321,398 $231,729 $249,974
Repurchase agreements .................... 343,813 199,248 157,890
Other borrowings ......................... 12,573 322 6,201
Period end weighted average interest rate:
FHLB advances ............................ 4.31% 5.37% 5.52%
Repurchase agreements .................... 3.83 4.58 5.09
Other borrowings ......................... 5.34 -- 2.19
Excluding the $124.7 million of funds assumed in the TFC acquisition, the
additional $168.0 million of borrowings in 2004 was primarily short-term
instruments that were used to support commercial lending growth and replace
maturities of higher-rate certificates of deposit.
Equity Activities
Stockholders' equity increased to $928.2 million at December 31, 2004 compared
to $728.2 million at December 31, 2003. The TFC acquisition included the
issuance of 13.3 million shares of common stock with an aggregate value of
$201.3 million. During 2004, common stock dividends declared of $0.30 per share
totaled $23.9 million, which represents a 36% increase over the prior year $0.22
per share and equated to a 45% payout ratio.
In 2004, the Company completed its 2.1 million share repurchase program
announced in the third quarter of 2003 and made additional buybacks under a 4.2
million share repurchase program announced in August 2004. In total, the Company
repurchased 2.6 million of its shares during 2004 at an average cost of $13.59
per share. The extent to which shares are repurchased in the future will depend
on a number of factors including market trends and prices, economic conditions,
and alternative uses for capital.
29
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2004 AND DECEMBER 31,
2003
Net Interest Income
Average Balance Sheet. The following table sets forth certain information
relating to the consolidated statements of condition and reflects the average
yields earned on interest-earning assets, as well as the average rates paid on
interest-bearing liabilities for the years indicated. All average balances are
average daily balances:
For the year ended December 31,
---------------------------------------------------------------------------------------
2004 2003
------------------------------------------ ------------------------------------------
Average Average
outstanding Interest earned/ outstanding Interest earned/
balance paid Yield/rate balance paid Yield/rate
----------- ---------------- ---------- ----------- ---------------- ----------
(Dollars in thousands)
Interest-earning assets:
Mortgage-backed securities(1) ........... $ 613,888 $ 22,598 3.68% $ 425,253 $ 10,397 2.44%
Other investment securities(1) .......... 563,315 11,023 1.96 312,450 6,939 2.22
Loans(2) ................................ 3,094,203 190,100 6.14 2,245,055 148,995 6.64
Money market and other investments ...... 61,259 857 1.39 243,450 3,628 1.49
----------- ----------- -------- ----------- ----------- --------
Total interest-earning assets ......... 4,332,665 $ 224,578 5.18% 3,226,208 $ 169,959 5.27%
----------- ----------- -------- ----------- ----------- --------
Allowance for credit losses ............... (40,228) (24,328)
Noninterest-earning assets(3)(4) .......... 657,280 329,817
----------- -----------
Total assets .......................... $ 4,949,717 $ 3,531,697
=========== ===========
Interest-bearing liabilities:
Savings deposits ........................ $ 1,033,983 $ 9,768 0.94% $ 670,785 $ 6,809 1.01%
Interest-bearing checking accounts ...... 889,372 8,258 0.93 525,346 4,767 0.91
Certificates of deposit ................. 1,081,034 23,924 2.21 998,428 29,232 2.93
Borrowed funds .......................... 677,784 26,526 3.91 431,299 21,736 5.04
----------- ----------- -------- ----------- ----------- --------
Total interest-bearing liabilities .... 3,682,173 $ 68,476 1.86% 2,625,858 $ 62,544 2.38%
----------- ----------- -------- ----------- ----------- --------
Noninterest-bearing deposits .............. 275,227 155,546
Other noninterest-bearing liabilities ..... 64,560 54,379
----------- -----------
Total liabilities ..................... 4,021,960 2,835,783
Stockholders' equity(3) ................... 927,757 695,914
----------- -----------
Total liabilities and
stockholders' equity ............... $ 4,949,717 $ 3,531,697
=========== ===========
Net interest income ....................... $ 156,102 $ 107,415
=========== ===========
Net interest rate spread .................. 3.32% 2.89%
======== ========
Net earning assets ........................ $ 650,492 $ 600,350
=========== ===========
Net interest margin ....................... 3.60% 3.33%
=========== ===========
Ratio of average interest-earning assets
to average interest-bearing liabilities 117.67% 122.86%
=========== ===========
For the year ended December 31,
------------------------------------------
2002
------------------------------------------
Average
outstanding Interest earned/
balance paid Yield/rate
----------- ---------------- ----------
(Dollars in thousands)
Interest-earning assets:
Mortgage-backed securities(1) ........... $ 320,569 $ 16,100 5.02%
Other investment securities(1) .......... 192,992 7,496 3.88
Loans(2) ................................ 1,920,101 140,459 7.32
Money market and other investments ...... 163,480 3,582 2.19
----------- ----------- --------
Total interest-earning assets ......... 2,597,142 $ 167,637 6.45%
----------- ----------- --------
Allowance for credit losses ............... (19,815)
Noninterest-earning assets(3)(4) .......... 275,472
-----------
Total assets .......................... $ 2,852,799
===========
Interest-bearing liabilities:
Savings deposits ........................ $ 590,965 $ 12,750 2.16%
Interest-bearing checking accounts ...... 524,884 8,087 1.55
Certificates of deposit ................. 883,867 32,774 3.71
Borrowed funds .......................... 414,065 22,496 5.43
----------- ----------- --------
Total interest-bearing liabilities .... 2,413,781 $ 76,107 3.15%
----------- ----------- --------
Noninterest-bearing deposits .............. 115,977
Other noninterest-bearing liabilities ..... 48,508
-----------
Total liabilities ..................... 2,578,266
Stockholders' equity(3) ................... 274,533
-----------
Total liabilities and
stockholders' equity ............... $ 2,852,799
===========
Net interest income ....................... $ 91,530
===========
Net interest rate spread .................. 3.30%
========
Net earning assets ........................ $ 183,361
===========
Net interest margin ....................... 3.52%
===========
Ratio of average interest-earning assets
to average interest-bearing liabilities 107.60%
===========
(1) Amounts shown are at amortized cost. Interest earned amounts have not been
adjusted for tax benefits on municipal investment securities.
(2) Net of deferred costs, unearned discounts and non-accruing loans.
(3) Includes unrealized gains/losses on securities available for sale.
(4) Includes non-accruing loans and the cash surrender value of bank-owned
life insurance, earnings from which are reflected in other noninterest
income.
Net interest income increased to $156.1 million and the net interest margin
improved to 3.60% from 3.33% when comparing 2004 to 2003. Contributing to these
increases was a 43 basis point improvement in the net interest rate spread due
to the Company's active asset and liability management initiatives and lower MBS
premium amortization. Additionally, net interest income benefited from a $50.1
million increase in average net earning assets from 2003 to 2004 primarily due
to a $32.9 million organic increase in average noninterest-bearing deposits and
the acquisition of TFC.
The 32% increase in interest income in 2004 compared to 2003 reflects the impact
of a $1.1 billion increase in average interest earning assets due primarily to
the acquisition of TFC, and increased commercial real estate and business loans.
The benefits of those increases were partially offset by a 9 basis point
decrease in the yield on those assets when compared to 2003, which was
attributable to the generally lower interest rate environment. This was
partially mitigated by the shift in the Company's loan portfolio mix to higher
yielding commercial real estate and business loans, as well as the rise in
short-term rates during the second half of the year which caused the yield on
the Company's variable-rate assets and short-term investment securities
portfolio to increase. Additionally, the Company's yield on interest earning
assets benefited from lower MBS premium amortization, which amounted to $1.8
million for 2004 compared to $8.2 million for 2003.
30
The increase in interest expense during 2004 resulted from a $1.1 billion
increase in average interest bearing liabilities, due to the deposits and
borrowings assumed in the TFC acquisition and core deposit growth. However, a 72
basis point reduction in the rate paid on certificates of deposits resulted from
the Company's strategy to replace higher-rate time accounts with lower cost core
deposits and borrowings. Additionally, the Company benefited from the run-off of
higher rate borrowings, which contributed to the rate paid on borrowed funds
declining from 5.04% in 2003 to 3.91% in 2004.
Rate/Volume Analysis. The following table presents the extent to which changes
in interest rates and changes in the volume of interest-earning assets and
interest-bearing liabilities have affected the Company's net interest income
during the years indicated. Information is provided in each category with
respect to: (i) changes attributable to changes in volume (changes in volume
multiplied by prior rate); (ii) changes attributable to changes in rate (changes
in rate multiplied by prior volume); and (iii) the net change. The changes
attributable to the combined impact of volume and rate have been allocated
proportionately to the changes due to volume and the changes due to rate:
For the year ended December 31,
-----------------------------------------------------------------------------------
2004 vs. 2003 2003 vs. 2002
--------------------------------------- --------------------------------------
Increase/(decrease) Increase/(decrease)
due to Total due to Total
----------------------- increase ---------------------- increase
Volume Rate (decrease) Volume Rate (decrease)
-------- -------- ---------- -------- -------- ----------
(In thousands)
Interest-earning assets:
Mortgage-backed securities ........... $ 5,702 $ 6,499 $ 12,201 $ 4,208 $ (9,911) $ (5,703)
Other investment securities .......... 4,995 (911) 4,084 3,466 (4,023) (557)
Loans ................................ 52,854 (11,749) 41,105 22,347 (13,811) 8,536
Money market and other investments ... (1,923) (848) (2,771) 1,048 (1,002) 46
-------- -------- -------- -------- -------- --------
Total interest-earning assets .... $ 61,628 $ (7,009) $ 54,619 $ 31,069 $(28,747) $ 2,322
======== ======== ======== ======== ======== ========
Interest-bearing liabilities:
Savings deposits ..................... $ 3,461 $ (502) $ 2,959 $ 1,496 $ (7,437) $ (5,941)
Interest-bearing checking accounts ... 3,378 113 3,491 257 (3,577) (3,320)
Certificates of deposit .............. 2,269 (7,577) (5,308) 3,907 (7,449) (3,542)
Borrowed funds ....................... 10,427 (5,637) 4,790 912 (1,672) (760)
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities $ 19,535 $(13,603) $ 5,932 $ 6,572 $(20,135) $(13,563)
======== ======== ======== ======== ======== ========
Net interest income .............. $ 48,687 $ 15,885
======== ========
Provision for Credit Losses
As a percentage of average loans outstanding, net charge-offs for 2004 were
comparable to the 2003 level. During 2004, the Company continued to experience a
low level of charge-offs in its residential, home equity and commercial real
estate loan portfolios. Commercial business loan charge-offs decreased to 0.71%
of average loans outstanding from 1.28% in 2003. The increase in consumer loan
net charge-offs was entirely the result of $1.4 million of charge-offs incurred
during the second quarter of 2004 related to an indirect auto relationship. In
consideration of the higher amount of charge-offs, as well as an increase in
higher-risk commercial real estate and business loans outstanding, the Company
raised its provision for credit losses to $8.4 million in 2004 from $7.9 million
in 2003.
31
The following table sets forth the analysis of the allowance for credit losses,
including charge-off and recovery data, for the years indicated:
For the year ended December 31,
---------------------------------------------------------------
2004 2003 2002 2001 2000
------- ------- ------- ------- -------
(Dollars in thousands)
Balance at beginning of year .......... $25,420 $20,873 $18,727 $17,746 $ 9,862
Charge-offs:
Commercial:
Real estate ..................... 669 416 390 901 131
Business ........................ 3,236 3,279 2,472 1,059 204
Residential real estate ............ 49 518 370 382 175
Consumer:
Home equity ..................... -- -- -- 158 28
Other ........................... 4,272 2,547 2,572 1,571 534
------- ------- ------- ------- -------
Total ........................ 8,226 6,760 5,804 4,071 1,072
------- ------- ------- ------- -------
Recoveries:
Commercial:
Real estate ..................... 86 154 270 268 31
Business ........................ 329 528 213 169 47
Residential real estate ............ 83 74 107 30 22
Consumer:
Home equity ..................... -- -- -- -- 13
Other ........................... 638 621 536 425 224
------- ------- ------- ------- -------
Total ........................ 1,136 1,377 1,126 892 337
------- ------- ------- ------- -------
Net charge-offs ....................... 7,090 5,383 4,678 3,179 735
Provision for credit losses ........... 8,442 7,929 6,824 4,160 2,258
Allowance obtained through acquisitions 14,650 2,001 -- -- 6,361
------- ------- ------- ------- -------
Balance at end of year ................ $41,422 $25,420 $20,873 $18,727 $17,746
======= ======= ======= ======= =======
Ratio of net charge-offs to average
loans outstanding during the year . 0.23% 0.24% 0.24% 0.17% 0.06%
======= ======= ======= ======= =======
Ratio of allowance for credit losses
to total loans at year-end ........ 1.27% 1.11% 1.05% 1.00% 0.96%
======= ======= ======= ======= =======
Ratio of allowance for credit losses
to non-accruing loans at year-end . 344.38% 206.58% 279.13% 163.13% 273.73%
======= ======= ======= ======= =======
Noninterest Income
Noninterest income continues to be a strong diversified source of revenue for
the Company and amounted to 25% of net revenue for 2004. The Company earned
$51.9 million of noninterest income in 2004, compared to $43.4 million for 2003.
This reflects the impact of the acquisition of TFC, which added approximately
$6.9 million of noninterest income, as well as the Company's efforts to further
implement its financial services business model across it market areas, which
resulted in core growth in bank services, lending and leasing and mutual fund
and annuity revenue. Additionally, leasing revenue benefited from the
acquisition of a leasing company in September 2004. Also contributing to the
increase was the full year benefit of two insurance agencies acquired in July
2003, which added $1.7 million to fee income. Core risk management revenue for
2004 was higher than 2003 as increased plan administration and agency
commissions more than offset the impact of lower contingent profit sharing
commissions received. Contingent commission income amounted to $1.3 million for
2004. Partially offsetting these increases was the impact of lower gains from
the sale of mortgage loans from 2003 record levels.
32
Noninterest Expenses
Noninterest expenses from continuing operations for 2004 increased $32.6 million
over 2003. This was mainly the result of operating costs associated with the 21
TFC branches and lending operations acquired, as well as costs related to the
insurance agencies and leasing company. Additionally, 2004 results include $2.2
million of non-recurring marketing, training and other expenses associated with
the TFC and HRB acquisitions. Professional services include fees incurred in
connection with the Company's strategic planning initiative and implementation
of section 404 of the Sarbanes-Oxley Act of 2002. The remainder of the increase
in noninterest expense is attributable to the addition of three branches, growth
in commercial operations, which included the hiring of seasoned commercial loan
officers, as well as other costs and investments in the Company's systems to
support future growth. Given the revenue growth during the year, even with these
increases, the Company's efficiency ratio of 58% for 2004 improved from the 59%
for 2003.
Income Taxes
The effective tax rate from continuing operations of 34.1% for 2004 remained
consistent with the 2003 effective rate of 34.2%.
The Governor of New York State has proposed legislation in his 2005 budget that
would eliminate the tax benefit of Real Estate Investment Trusts ("REIT"). First
Niagara Funding, Inc. ("FNF"), a wholly owned subsidiary of First Niagara,
qualifies as a REIT under the Internal Revenue Code. Currently, under New York
State tax law, 60% of the dividends FNF pays to First Niagara are excluded from
New York State taxable income. If this legislation were passed, First Niagara
would lose this benefit effective January 1, 2005. Without this exclusion, the
Company's 2004 effective tax rate would have been approximately 36.2%.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003 AND DECEMBER 31,
2002
Net Interest Income
Net interest income increased 17% when comparing 2003 to 2002. The major factors
contributing to this improvement were the investment of the proceeds from the
Offering, and the acquisition of FLBC, which increased average net earning
assets by a total of $417.0 million during 2003. Offsetting the benefits of the
additional net earning assets was a 41 basis point decline in net interest rate
spread due to the low interest rate environment throughout the year.
The impact of a $629.1 million increase in average interest earning assets from
2002 to 2003, due primarily to the proceeds from the Offering, the acquisition
of FLBC and increased commercial real estate and business loans, was
substantially offset by a 118 basis point decrease in the rate earned on those
assets. The declining interest rate environment caused the Company's
variable-rate interest-earning assets to reprice to lower rates and fixed-rate
interest earning assets, mainly residential mortgages and MBS's, to
significantly prepay. The higher level of principal prepayments on MBS's
significantly impacted the effective yield earned on those assets as the Company
was required to amortize approximately $8.2 million of purchase premiums in 2003
compared to $2.8 million in 2002. That additional amortization reduced the yield
earned on those securities by 128 basis points.
The decrease in interest expense from 2002 to 2003 resulted from a 77 basis
point reduction in the rate paid on interest-bearing liabilities. This was
largely due to the low interest rate environment, which caused the Company's
variable rate interest-bearing liabilities to reprice to lower rates throughout
the year. Additionally, the rate paid on interest-bearing liabilities benefited
from the Company's decision near the end of the year to replace higher-rate
liabilities, such as time deposits and long-term borrowings, with lower-cost
wholesale funding.
Provision for Credit Losses
As a percentage of average loans outstanding, net charge-offs for 2003 remained
consistent with the 2002 level. During 2003, the Company continued to experience
a low level of charge-offs in its commercial and residential real estate loan
portfolios. However, the amount of net charge-offs for the year increased
primarily as a result of the continuing growth in higher risk commercial
business loans and leases and the weaker economic conditions in 2003. That trend
led the Company to increase its provision for credit losses to $7.9 million in
2003 from $6.8 million in 2002.
33
Noninterest Income
In 2003, the Company earned $43.4 million of noninterest income from continuing
operations, compared to $41.8 million for 2002. Banking services revenue
increased $2.2 million, due to fees earned on accounts acquired from FLBC, and
higher transaction account activity. Additionally, during 2003 risk management
services income increased $2.2 million, or 17%, as a result of the acquisition
of two insurance agencies and higher contingent profit sharing commissions.
Bank-owned life insurance acquired with FLBC and death benefit proceeds received
during the year resulted in bank-owned life insurance income increasing $796
thousand from 2002. These increases were partially offset by higher mortgage
servicing rights amortization, due to continuing prepayments during this low
interest rate environment, which is recorded as an offset to lending and leasing
income. Also affecting the year-over-year comparison were $1.0 million of losses
on the sale of investment securities and a $2.4 million gain recognized on the
sale of a branch in 2002.
Noninterest Expenses
Noninterest expenses from continuing operations for 2003 increased $10.9 million
over 2002. The banking and insurance agency acquisitions during the year
accounted for approximately $7.5 million of this increase. Additionally,
compensation expense was higher by $1.0 million due to the ESOP shares purchased
in the Offering and the rise in the Company's stock price. The remainder of the
increase is primarily attributable to the addition of three new branches, higher
professional and regulatory fees, $387 thousand of expense related to the TFC
acquisition and approximately $750 thousand attributable to the unexpected
passing of the Company's CEO and related transition.
Income Taxes
The effective tax rate from continuing operations decreased to 34.2% for 2003
compared to 38.1% for 2002. However, excluding the $1.8 million New York State
bad debt tax expense recapture charge recorded in 2002, which caused the 2002
effective tax rate to increase 363 basis points, the effective tax rate for 2003
is consistent with 2002.
LIQUIDITY AND CAPITAL RESOURCES
In addition to cash flow from operations, funding is provided by deposits and
borrowings, principal and interest payments received on loans and investment
securities, proceeds from the maturities and sale of investment securities, as
well as proceeds from the sale of fixed rate mortgage loans in the secondary
market. While maturities and scheduled amortization of loans and securities are
predictable sources of funds, deposit balances and mortgage prepayments are
greatly influenced by the general level of interest rates, the economic
environment and local competitive conditions.
The Company's primary investing activities are the origination of loans and the
purchase of mortgage-backed and other investment securities. During 2004, loan
originations totaled $1.1 billion compared to $973.7 million for 2003, while
purchases of investment securities totaled $553.4 million during 2004 compared
to $928.7 million for 2003. The higher amount of investment security purchases
in 2003 primarily relates to the investment of the Company's second-step
proceeds, as well as the reinvestment of funds from higher MBS prepayments.
During 2004, cash flows provided by the sale, repayment and maturity of
securities available for sale amounted to $466.5 million compared to $840.0
million for 2003. This decrease was primarily due to a lower level of interest
rate driven prepayments received on MBS's. Deposit growth and borrowings,
excluding those acquired from TFC, provided $218.0 million of additional funding
for 2004. The Company has a total of $495.9 million available under existing
lines of credit with the Federal Home Loan Bank ("FHLB"), Federal Reserve Bank
("FRB") and a commercial bank that provide funding for lending, liquidity and
asset and liability management.
34
Contractual Obligations and Other Commitments. The following table indicates
certain funding obligations of the Company by time remaining until maturity as
follows:
At December 31, 2004
--------------------------------------------------------------------------
Less than 1 Over 1 to 3 Over 3 to 5 Over 5
year years years years Total
---------- ---------- ---------- ---------- ----------
(In thousands)
Certificates of deposit (1) .......... $ 768,608 $ 247,109 $ 29,133 $ 1,974 $1,046,824
Borrowings ........................... 209,236 320,362 129,776 91,312 750,686
Commitments to extend credit (2) ..... 506,961 -- -- -- 506,961
Standby letters of credit (2) ........ 31,070 -- -- -- 31,070
Hudson River Bancorp, Inc. acquisition 126,807 -- -- -- 126,807
Operating leases ..................... 2,790 4,676 3,864 9,072 20,402
Purchase obligations ................. 5,105 6,613 6,092 5,854 23,664
Investment partnership commitments ... 1,544 1,051 -- -- 2,595
---------- ---------- ---------- ---------- ----------
Total contractual obligations $1,652,121 $ 579,811 $ 168,865 $ 108,212 $2,509,009
========== ========== ========== ========== ==========
(1) Includes the maturity of certificates of deposit greater than $100
thousand as follows: $96.5 million in three months or less; $27.6 million
between three months and six months; $57.4 million between six months and
one year; and $53.1 million over one year.
(2) The Company does not expect all of the commitments to extend credit and
standby letters of credit to be funded. Thus, the total commitment amounts
do not necessarily represent future cash requirements. Commitments to
extend credit includes $367.7 million available under lines of credit,
which generally expire unfunded one year from the date of origination.
Included in the borrowing amounts in the preceding table are advances and
reverse repurchase agreements that have call provisions that could accelerate
their maturity if interest rates were to rise significantly from current levels
as follows: $118.0 million in 2005; and $27.1 million in 2006.
Loan Commitments. In the ordinary course of business the Company extends
commitments to originate commercial and residential loans and other consumer
loans. 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 payment of a fee. Since the Company does not expect all of the
commitments to be funded, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. Collateral may be obtained based upon
management's assessment of the customers' creditworthiness. Commitments to
extend credit may be written on a fixed rate basis exposing the Company to
interest rate risk given the possibility that market rates may change between
the commitment date and the actual extension of credit. The Company had
outstanding commitments to originate loans of approximately $139.3 million and
$115.9 million at December 31, 2004 and 2003, respectively.
To assist with asset and liability management and to provide cash flow to
support loan growth, the Company generally sells newly originated conventional,
conforming 20 to 30 year monthly fixed, and 25 to 30 year bi-weekly loans in the
secondary market to government sponsored enterprises such as the Federal
National Mortgage Association and the Federal Home Loan Mortgage Corporation. In
line with its customer relationship focus, the Company generally retains the
servicing rights on residential mortgage loans sold, which results in monthly
service fee income. Commitments to sell residential mortgages amounted to $7.6
million and $3.8 million at December 31, 2004 and 2003, respectively.
The Company extends credit to consumer and commercial customers, up to a
specified amount, through lines of credit. The borrower is able to draw on these
lines as needed, thus the funding is generally unpredictable. Unused lines of
credit amounted to $367.7 million at December 31, 2004 and generally have an
expiration period of less than one year. In addition to the above, the Company
issues standby letters of credit to third parties which guarantees payments on
behalf of commercial customers in the event that the customer fails to perform
under the terms of the contract between the customer and the third-party.
Standby letters of credit amounted to $31.1 million at December 31, 2004 and
generally have an expiration period greater than one year. Since the majority of
unused lines of credit and outstanding standby letters of credit expire without
being funded, the Company's obligation under the above commitment amounts is
substantially less than the amounts reported. It is anticipated that there will
be sufficient funds available to meet the current loan commitments and other
obligations through the sources described above. The credit risk involved in
issuing these commitments is essentially the same as that involved in extending
loans to customers and is limited to the contractual notional amount of those
instruments.
35
Security Yields, Maturities and Repricing Schedule. The following table sets
forth certain information regarding the carrying value, weighted average yields
and contractual maturities of the Company's available for sale securities
portfolio as of December 31, 2004. Adjustable-rate securities are included in
the period in which interest rates are next scheduled to adjust and fixed-rate
securities are included in the period in which the final contractual repayment
is due. No adjustments have been made for prepayment of principal. Actual
maturities are expected to be significantly shorter as a result of loan
repayments underlying MBS's. The tax benefits of the Company's investment
securities have not been factored into the yield calculations in this table.
Amounts are shown at fair value:
At December 31, 2004
-------------------------------------------------------------------------------
More than one More than five
One year or less year to five years years to ten years
--------------------- ----------------------- -----------------------
Weighted Weighted Weighted
carrying Average carrying Average carrying Average
value yield value yield value yield
---------- ------- ---------- ------- ---------- -------
(Dollars in thousands)
Debt securities:
States and political
subdivisions ............ $ 176,457 1.60% $ 97,511 2.48% $ 3,605 4.27%
U.S. Government agencies .. 128,261 1.90 118,222 2.34 -- --
Corporate ................. 1,499 2.64 19,447 4.22 -- --
---------- ---------- ----------
Total debt securities ..... 306,217 1.73 235,180 2.55 3,605 4.27
---------- ---------- ----------
Mortgage-backed securities:
CMO's ..................... -- -- 223 6.15 14 6.93
FNMA ...................... -- -- 1,764 5.71 153,910 3.70
FHLMC ..................... 5 5.58 80,604 3.17 39,158 4.18
GNMA ...................... -- -- 181 7.95 -- --
---------- ---------- ----------
Total mortgage-backed
securities .............. 5 5.58 82,772 3.24 193,082 3.80
---------- ---------- ----------
Other (1) ................. -- -- -- -- -- --
---------- ---------- ----------
Total securities
available for sale ...... $ 306,222 1.73% $ 317,952 2.73% $ 196,687 3.81%
========== ========== ==========
At December 31, 2004
--------------------------------------------------
After ten years Total
---------------------- -----------------------
Weighted Weighted
carrying Average carrying Average
value yield value yield
-------- ------- ---------- -------
(Dollars in thousands)
Debt securities:
States and political
subdivisions ............ $ -- --% $ 277,573 1.94%
U.S. Government agencies .. -- -- 246,483 2.11
Corporate ................. 474 3.59 21,420 4.10
---------- ----------
Total debt securities ..... 474 3.59 545,476 2.10
---------- ----------
Mortgage-backed securities:
CMO's ..................... 289,415 4.03 289,652 4.03
FNMA ...................... 32,550 4.87 188,224 3.92
FHLMC ..................... 14,326 4.50 134,093 3.61
GNMA ...................... 6,006 6.26 6,187 6.31
---------- ----------
Total mortgage-backed
securities .............. 342,297 4.17 618,156 3.93
---------- ----------
Other (1) ................. -- -- 6,497 2.88
---------- ----------
Total securities
available for sale ...... $ 342,771 4.17% $1,170,129 3.07%
========== ==========
(1) Estimated maturities do not include other securities available for sale.
Loan Maturity and Repricing Schedule. The following table sets forth certain
information as of December 31, 2004, regarding the amount of loans maturing or
repricing in the Company's portfolio. Demand loans having no stated schedule of
repayment and no stated maturity and overdrafts are reported as due in one year
or less. Adjustable-rate loans are included in the period in which interest
rates are next scheduled to adjust rather than the period in which they
contractually mature, and fixed-rate loans (including bi-weekly loans) are
included in the period in which contractual payments are due. No adjustments
have been made for prepayment of principal:
One
Within through After
one five five
year years years Total
---------- ---------- ---------- ----------
(In thousands)
Commercial:
Real estate .............. $ 344,694 $ 498,738 $ 238,277 $1,081,709
Construction ............. 184,368 503 2,278 187,149
Business ................. 274,407 130,377 20,094 424,878
---------- ---------- ---------- ----------
Total commercial loans 803,469 629,618 260,649 1,693,736
---------- ---------- ---------- ----------
Residential real estate ....... 161,844 356,304 614,323 1,132,471
---------- ---------- ---------- ----------
Consumer:
Home equity .............. 157,765 35,049 54,376 247,190
Other .................... 70,387 69,579 34,343 174,309
---------- ---------- ---------- ----------
Total consumer loans . 228,152 104,628 88,719 421,499
---------- ---------- ---------- ----------
Total loans .......... $1,193,465 $1,090,550 $ 963,691 $3,247,706
========== ========== ========== ==========
36
For the loans reported in the preceding table, the following sets forth at
December 31, 2004, the dollar amount of all fixed-rate and adjustable-rate loans
due after December 31, 2005:
Due after December 31, 2005
------------------------------------------
Fixed Adjustable Total
---------- ---------- ----------
(In thousands)
Commercial:
Real estate ............... $ 449,107 $ 287,908 $ 737,015
Construction .............. 2,781 -- 2,781
Business .................. 150,471 -- 150,471
---------- ---------- ----------
Total commercial loans . 602,359 287,908 890,267
---------- ---------- ----------
Residential real estate ........ 871,481 99,146 970,627
---------- ---------- ----------
Consumer:
Home equity ............... 89,425 -- 89,425
Other ..................... 103,922 -- 103,922
---------- ---------- ----------
Total consumer loans ... 193,347 -- 193,347
---------- ---------- ----------
Total loans ........... $1,667,187 $ 387,054 $2,054,241
========== ========== ==========
The Company has lines of credit with the FHLB, FRB and a commercial bank that
provide a secondary funding source for lending, liquidity and asset and
liability management. At December 31, 2004, the FHLB line of credit totaled
$766.7 million with $336.7 million outstanding. The FRB and commercial bank
lines of credit totaled $15.9 million and $50.0 million, respectively, with no
borrowings outstanding on either line as of December 31, 2004.
FNFG's ability to pay dividends to its shareholders and make acquisitions are
primarily dependent upon the ability of First Niagara to pay dividends to FNFG.
As a result of the $100 million dividend from First Niagara to FNFG in
connection with the HRB acquisition, OTS approval is now required prior to First
Niagara declaring any dividends. The OTS may disapprove a notice if: First
Niagara would be undercapitalized following the distribution; the proposed
capital distribution raises safety and soundness concerns; or the capital
distribution would violate a prohibition contained in any statute, regulation or
agreement. Management does not believe this regulatory requirement will affect
First Niagara's ability to pay dividends in the future given its well
capitalized position.
Cash, interest-bearing demand accounts at correspondent banks, federal funds
sold, and other short-term investments are the Company's most liquid assets. The
level of these assets is monitored daily and are dependent on operating,
financing, lending and investing activities during any given period. Excess
short-term liquidity is usually invested in overnight federal funds sold. In the
event that funds beyond those generated internally are required due to higher
than expected loan commitment fundings, deposit outflows or the amount of debt
being called, additional sources of funds are available through the use of
repurchase agreements, the sale of loans or investments or the Company's various
lines of credit. As of December 31, 2004, the total of cash, interest-bearing
demand accounts, federal funds sold and other short-term investments was $67.6
million, or 1.3% of total assets. On January 14, 2005, FNFG deployed $126.8
million of cash in connection with the acquisition of HRB. This transaction was
funded through the use of repurchase agreements, with maturities of 18 to 24
months, and a temporary draw on the Company's commercial bank line of credit.
FOURTH QUARTER RESULTS
Net income for the quarter ended December 31, 2004 increased 34% to $13.6
million, or $0.17 per diluted share from $10.1 million, or $0.15 per diluted
share for the same period of 2003. In comparison to the third quarter of 2004,
net income increased from $13.3 million or $0.17 per diluted share.
Net interest income was $40.9 million for the fourth quarter of 2004, a $1.3
million increase from the third quarter of 2003. This improvement reflects an 8
basis point increase in the Company's net interest rate spread which was driven
by a combination of commercial mortgage and home equity loan growth and a higher
level of commercial real estate prepayment fees. As a result, the Company's net
interest margin improved 9 basis points to 3.69% for the quarter, compared to
3.60% in the third quarter of 2004. However, excluding the benefit of the
additional commercial mortgage prepayment fees earned in the fourth quarter, the
net interest margin was consistent with the third quarter.
37
A $1.8 million provision for credit losses was recognized during the quarter
ended December 31, 2004 as credit quality remained stable and loan loss
experience continued at low levels. Total non-performing assets were $12.8
million at December 31, 2004 compared to $15.6 million at September 30, 2004.
For the fourth quarter of 2004, the Company had $13.5 million of noninterest
income, which represents a 13% annualized increase over the third quarter level
of $13.1 million. During the quarter, increases in core banking fees were
supplemented by additional income from the leasing company acquired in September
2004.
Noninterest expense for the three months ended December 31, 2004 was $32.0
million compared to $30.4 million for the three months ended September 30, 2004.
Fourth quarter expenses include costs associated with the on-going development
and implementation of the Company's strategic plan, growth in lending and
leasing businesses, expansion of the Company's branch network, as well as
approximately $800 thousand incurred in preparation for the Hudson River
integration.
Total loans were $3.25 billion at December 31, 2004 compared to $3.21 billion at
September 30, 2004. This increase was driven by a 14% annualized increase in
commercial real estate and business loans, and an 18% annualized increase in
home equity loans during the quarter. Total deposits were $3.34 billion at
December 31, 2004 compared to $3.32 billion at September 30, 2004. This increase
was across various product types and reflects the Company's focus on increasing
its core deposit base, which included the introduction of new relationship based
products during the quarter.
IMPACT OF NEW ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 123R "Share Based Payment" which
revised SFAS No. 123 and superseded Accounting Principles Board Opinion No. 25.
More specifically, this Statement requires companies to recognize in the income
statement over the required vesting period the grant-date fair value of stock
options and other equity-based compensation issued to employees and directors
estimated using option pricing models. This Statement is effective for interim
and annual periods beginning after June 15, 2005 and the Company has chosen to
apply the modified prospective approach. Accordingly, awards that are granted,
modified or settled after July 1, 2005 will be accounted for in accordance with
SFAS No. 123R and any unvested equity awards granted prior to July 1, 2005 will
be recognized in the income statement as service is rendered based on their
grant-date fair value calculated in accordance with SFAS No. 123. See note 1(i)
filed herewith in Part II, Item 8, "Financial Statements" for further
information regarding equity based compensation.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
The principal objective of the Company's interest rate risk management is to
evaluate the interest rate risk inherent in certain assets and liabilities,
determine the appropriate level of risk given the Company's business strategy,
operating environment, capital and liquidity requirements and performance
objectives, and manage the risk consistent with the Board's approved guidelines
to reduce the vulnerability of operations to changes in interest rates. The
Asset and Liability Committee ("ALCO") is comprised of senior management who are
responsible for reviewing the Company's activities and strategies, the effect of
those strategies on the net interest margin, the fair value of the portfolio and
the effect that changes in interest rates will have on the portfolio and
exposure limits.
The Company utilizes the following strategies to manage interest rate risk: (1)
emphasizing the origination and retention of residential and commercial
adjustable-rate loans, home equity loans, and residential fixed-rate mortgage
loans having terms to maturity of less than twenty years; (2) selling
substantially all newly originated 20-30-year fixed-rate, residential mortgage
loans into the secondary market without recourse; (3) investing in shorter term
securities which generally bear lower yields as compared to longer term
investments, but which better position the Company for increases in market
interest rates; (4) growing core deposits; and (5) utilizing wholesale
borrowings to support cash flow needs and help match asset repricing.
Additionally, the Company intends to continue to analyze the future utilization
of derivative instruments such as interest rate swaps, caps and collars as part
of its overall asset and liability management process as permitted by the
Company's ALCO Policy.
38
Gap Analysis. The matching of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities are "interest rate
sensitive" and by monitoring a Company's interest rate sensitivity "gap." An
asset or liability is said to be interest rate sensitive within a specific time
period if it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
same time period. At December 31, 2004, the Company's one-year gap position as a
percentage of interest-earning assets was a positive 9.78%. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities. A gap is considered negative when the
amount of interest rate sensitive liabilities exceeds the amount of interest
rate sensitive assets. Accordingly, during a period of rising interest rates, an
institution with a negative gap position is likely to experience a decline in
net interest income as the cost of its interest-bearing liabilities increase at
a rate faster than its yield on interest-earning assets. In comparison, an
institution with a positive gap is likely to realize an increase in net interest
income in a rising interest rate environment. Management believes that the
Company's net interest income simulation modeling analysis is a better indicator
of the Company's interest rate risk exposure than gap analysis, and believes
that the Company is generally interest rate "neutral" at December 31, 2004.
The following table sets forth the amount of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 2004, which are
anticipated by the Company, based upon certain assumptions, to reprice or mature
in each of the future time periods shown. Except as stated below, the amount of
assets and liabilities shown which reprice or mature during a particular period
were determined in accordance with the earlier of the repricing date or the
contractual maturity of the asset or liability. The table sets forth an
approximation of the projected repricing of assets and liabilities at December
31, 2004, on the basis of contractual maturities, anticipated prepayments, and
scheduled rate adjustments within the selected time intervals. Residential and
commercial real estate loans were projected to repay at rates between 4% and 8%
annually, while mortgage-backed securities were projected to prepay at rates
between 20% and 30% annually. Savings, interest bearing checking and noninterest
bearing accounts were assumed to decay, or run-off, between 8% and 17% annually.
While the Company believes such assumptions to be reasonable, there can be no
assurance that assumed prepayment rates and decay rates will approximate actual
future loan prepayment and deposit withdrawal activity:
Amounts maturing or repricing at December 31, 2004
----------------------------------------------------------------------------
Less than 3-6 6 months
3 months months to 1 year 1-3 years 3-5 years
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Interest-earning assets:
Mortgage-backed securities (1) ................ $ 47,676 $ 30,590 $ 58,095 $ 183,934 $ 144,050
Other investment securities (1) ............... 107,614 60,337 158,166 184,185 25,475
Loans (2) ..................................... 886,976 134,987 295,158 749,959 614,718
Money market and other investments ............ 3,300 -- -- -- --
---------- ---------- ---------- ---------- ----------
Total interest-earning assets ........... 1,045,566 225,914 511,419 1,118,078 784,243
---------- ---------- ---------- ---------- ----------
Interest-bearing liabilities:
Savings deposits .............................. 40,708 40,708 81,162 322,617 133,683
Interest-bearing checking accounts ............ 136,805 23,628 47,256 189,025 189,024
Certificates of deposit ....................... 246,913 157,524 364,171 247,109 29,133
Borrowed funds ................................ 102,021 19,788 87,427 320,362 129,776
---------- ---------- ---------- ---------- ----------
Total interest-bearing liabilities ...... 526,447 241,648 580,016 1,079,113 481,616
---------- ---------- ---------- ---------- ----------
Interest rate sensitivity gap .................... $ 519,119 ($ 15,734) ($ 68,597) $ 38,965 $ 302,627
========== ========== ========== ========== ==========
Cumulative interest rate sensitivity gap ......... $ 519,119 $ 503,385 $ 434,788 $ 473,753 $ 776,380
========== ========== ========== ========== ==========
Ratio of interest-earning assets to
interest-bearing liabilities .................. 198.61% 93.49% 88.17% 103.61% 162.84%
Ratio of cumulative gap to interest-earning assets 11.68% 11.32% 9.78% 10.66% 17.46%
Amounts maturing or repricing at December 31, 2004
--------------------------------------------------
Over 10
5-10 years years Total
---------- ---------- ----------
(Dollars in thousands)
Interest-earning assets:
Mortgage-backed securities (1) ................ $ 149,004 $ 10,850 $ 624,199
Other investment securities (1) ............... 13,437 5,212 554,426
Loans (2) ..................................... 517,448 32,526 3,231,772
Money market and other investments ............ -- 32,027 35,327
---------- ---------- ----------
Total interest-earning assets ........... 679,889 80,615 4,445,724
---------- ---------- ----------
Interest-bearing liabilities:
Savings deposits .............................. 334,208 133,683 1,086,769
Interest-bearing checking accounts ............ 275,036 51,824 912,598
Certificates of deposit ....................... 1,758 216 1,046,824
Borrowed funds ................................ 80,310 11,002 750,686
---------- ---------- ----------
Total interest-bearing liabilities ...... 691,312 196,725 3,796,877
---------- ---------- ----------
Interest rate sensitivity gap .................... ($ 11,423) ($ 116,110) $ 648,847
========== ========== ==========
Cumulative interest rate sensitivity gap ......... $ 764,957 $ 648,847
========== ==========
Ratio of interest-earning assets to
interest-bearing liabilities .................. 98.35% 40.98% 117.09%
Ratio of cumulative gap to interest-earning assets 17.21% 14.59%
(1) Amounts shown are at amortized cost.
(2) Amounts shown include principal balance net of deferred costs, unearned
discounts and non-accruing loans.
Net Interest Income Analysis. Certain shortcomings are inherent in the method of
analysis presented in the gap table. For example, although certain assets and
liabilities may have similar maturities or periods to repricing, they may react
in different degrees to changes in market interest rates. Also, the interest
rates on certain types of assets and liabilities may fluctuate in advance of
changes in market interest rates, while interest rates on other types may lag
behind changes in market rates. Additionally, certain assets, such as
adjustable-rate loans, have features, which restrict changes in interest rates,
both on a short-term basis and over the life of the asset. Further, in the event
of changes in interest rates, prepayment and early withdrawal levels would
likely deviate significantly from those assumed in calculating the table.
Finally, the ability of many borrowers to service their adjustable-rate loans
may decrease in the event of an interest rate increase.
39
As a result of these shortcomings, the Company focuses more attention on
simulation modeling, such as the net interest income analysis discussed below,
rather than gap analysis. The net interest income simulation modeling is
considered by Management to be more informative in forecasting future income.
The accompanying table sets forth as of December 31, 2004 and 2003 the estimated
impact on the Company's net interest income resulting from changes in interest
rates during the next twelve months. These estimates require making certain
assumptions including loan and mortgage-related investment prepayment speeds,
reinvestment rates, and deposit maturities and decay rates similar to the gap
analysis. These assumptions are inherently uncertain and, as a result, the
Company cannot precisely predict the impact of changes in interest rates on net
interest income. Actual results may differ significantly due to timing,
magnitude and frequency of interest rate changes and changes in market
conditions:
Calculated increase (decrease) at December 31,
-----------------------------------------------------------------------------------
2004 2003
------------------------------------- ----------------------------------
Changes in Net interest Net interest
interest rates income % Change income % Change
-------------- ------------ -------- ------------ --------
(Dollars in thousands)
+200 basis points $ 1,811 1.09 % $ 959 0.82 %
+100 basis points 1,049 0.63 627 0.54
- -100 basis points (1,674) (1.01) (966) (0.83)
As is the case with the gap table, certain shortcomings are inherent in the
methodology used in the above interest rate risk measurements. Modeling changes
in net interest income requires the making of certain assumptions that may or
may not reflect the manner in which actual yields respond to changes in market
interest rates. In this regard, the net interest income table presented assumes
that the change in interest rates is reflected uniformly across the yield curve
regardless of the duration to maturity or repricing of specific assets and
liabilities. Accordingly, although the net interest income table provides an
indication of the Company's interest rate risk exposure at a particular point in
time, such measurements are not intended to and do not provide a precise
forecast of the effect of changes in market interest rates on the Company's net
interest income and will differ from actual results.
40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- --------------------------------------------------------------------------------
Management's Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f). Management conducted an evaluation of the effectiveness of the
Company's internal control over financial reporting as of December 31, 2004
based on the framework in "Internal Control - Integrated Framework" issued by
the Committee of Sponsoring Organizations of the Treadway Commission. Based on
that evaluation, Management concluded that the Company's internal control over
financial reporting is effective.
KPMG LLP, an independent registered public accounting firm, has audited the
consolidated financial statements included in this Annual Report and has issued
an attestation report on management's assessment of the Company's internal
control over financial reporting. Their reports follow this statement.
/s/ Paul J. Kolkmeyer /s/ John R. Koelmel
Paul J. Kolkmeyer John R. Koelmel
President and Chief Executive Officer Executive Vice President, Chief
Financial Officer
41
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
First Niagara Financial Group, Inc.:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that First
Niagara Financial Group, Inc. and subsidiary (the Company) maintained effective
internal control over financial reporting as of December 31, 2004, based on
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). The
Company's management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's a
ssets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
42
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2004, is fairly
stated, in all material respects, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Also, in our opinion, the
Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2004, based on criteria established in
Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated statements of
condition of First Niagara Financial Group, Inc. and subsidiary as of December
31, 2004 and 2003, and the related consolidated statements of income,
comprehensive income, changes in stockholders' equity, and cash flows for each
of the years in the three-year period ended December 31, 2004, and our report
dated March 14, 2005 expressed an unqualified opinion on those consolidated
financial statements.
/s/ KPMG LLP
Buffalo, New York
March 14, 2005
43
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
First Niagara Financial Group, Inc.:
We have audited the accompanying consolidated statements of condition of First
Niagara Financial Group, Inc. and subsidiary (the Company) as of December 31,
2004 and 2003, and the related consolidated statements of income, comprehensive
income, changes in stockholders' equity, and cash flows for each of the years in
the three-year period ended December 31, 2004. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Niagara
Financial Group, Inc. and subsidiary as of December 31, 2004 and 2003, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2004, in conformity with U.S. generally
accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004, based on
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our
report dated March 14, 2005 expressed an unqualified opinion on management's
assessment of, and the effective operation of, internal control over financial
reporting.
/s/ KPMG LLP
Buffalo, New York
March 14, 2005
44
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Consolidated Statements of Condition
December 31, 2004 and 2003
(In thousands, except share and per share amounts)
2004 2003
----------- -----------
Assets
Cash and due from banks $ 64,342 49,997
Money market investments 3,300 124,255
Securities available for sale 1,170,129 845,883
Loans and leases, net 3,215,255 2,269,203
Bank-owned life insurance 86,464 70,767
Premises and equipment, net 61,760 43,694
Goodwill 323,782 105,981
Core deposit and other intangibles 21,878 8,717
Other assets 131,464 71,010
----------- -----------
Total assets $ 5,078,374 3,589,507
=========== ===========
Liabilities and Stockholders' Equity
Liabilities:
Deposits $ 3,337,682 2,355,216
Short-term borrowings 209,236 87,148
Long-term borrowings 541,450 370,818
Other liabilities 61,844 48,151
----------- -----------
Total liabilities 4,150,212 2,861,333
----------- -----------
Commitments and contingent liabilities (note 10) -- --
Stockholders' equity:
Preferred stock, $0.01 par value, 50,000,000 shares authorized;
none issued -- --
Common stock, $0.01 par value, 250,000,000 shares authorized;
84,298,473 shares issued in 2004 and 70,813,651 shares issued
in 2003 843 708
Additional paid-in capital 751,175 544,618
Retained earnings 238,048 217,538
Accumulated other comprehensive loss (5,437) (740)
Common stock held by ESOP, 3,895,159 shares in 2004 and
4,049,658 shares in 2003 (29,275) (30,399)
Unearned compensation - recognition and retention plan,
345,410 shares in 2004 and 358,095 shares in 2003 (3,173) (2,376)
Treasury stock, at cost, 1,781,029 shares in 2004 and
79,422 shares in 2003 (24,019) (1,175)
----------- -----------
Total stockholders' equity 928,162 728,174
----------- -----------
Total liabilities and stockholders' equity $ 5,078,374 3,589,507
=========== ===========
See accompanying notes to consolidated financial statements.
45
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Consolidated Statements of Income
Years ended December 31, 2004, 2003 and 2002
(In thousands, except per share amounts)
2004 2003 2002
-------- -------- --------
Interest income:
Loans and leases, including fees $190,100 148,995 140,459
Securities available for sale 33,621 17,336 23,596
Money market and other investments 857 3,628 3,582
-------- -------- --------
Total interest income 224,578 169,959 167,637
Interest expense:
Deposits 41,950 40,808 53,611
Borrowings 26,526 21,736 22,496
-------- -------- --------
Total interest expense 68,476 62,544 76,107
-------- -------- --------
Net interest income 156,102 107,415 91,530
Provision for credit losses 8,442 7,929 6,824
-------- -------- --------
Net interest income after provision
for credit losses 147,660 99,486 84,706
-------- -------- --------
Noninterest income:
Banking services 19,818 16,445 14,226
Risk management services 17,391 14,765 12,610
Wealth management services 4,764 3,525 3,697
Lending and leasing 3,918 3,617 5,523
Bank-owned life insurance 3,761 3,502 2,706
Net realized gains (losses) on securities available for sale 60 9 (1,044)
Other 2,154 1,516 4,069
-------- -------- --------
Total noninterest income 51,866 43,379 41,787
-------- -------- --------
Noninterest expense:
Salaries and employee benefits 65,264 50,377 45,180
Occupancy and equipment 12,513 9,315 7,526
Technology and communications 11,230 9,647 8,599
Professional services 5,117 2,219 1,675
Marketing and advertising 4,738 3,205 2,612
Amortization of core deposit and other intangibles 4,605 1,384 677
Other 17,383 12,130 11,062
-------- -------- --------
Total noninterest expense 120,850 88,277 77,331
-------- -------- --------
Income from continuing operations before income taxes 78,676 54,588 49,162
Income taxes from continuing operations 26,859 18,646 18,752
-------- -------- --------
Income from continuing operations 51,817 35,942 30,410
Discontinued operations:
Income, including gain on sale in 2003, before income taxes -- 2,032 787
Income taxes -- 1,868 402
-------- -------- --------
Income from discontinued operations -- 164 385
-------- -------- --------
Net income $ 51,817 36,106 30,795
======== ======== ========
Earnings per common share:
Basic $ 0.66 0.55 0.48
Diluted 0.65 0.53 0.47
Weighted average common shares outstanding:
Basic 78,750 66,111 64,445
Diluted 79,970 67,754 65,883
See accompanying notes to consolidated financial statements.
46
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Consolidated Statements of Comprehensive Income
Years ended December 31, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
-------- -------- --------
Net income $ 51,817 36,106 30,795
-------- -------- --------
Other comprehensive income (loss), net of income taxes:
Securities available for sale:
Net unrealized gains (losses) arising during the year (4,729) (4,566) 836
Reclassification adjustment for realized (gains)
losses included in net income (36) (5) 627
-------- -------- --------
(4,765) (4,571) 1,463
-------- -------- --------
Cash flow hedges:
Net unrealized losses arising during the year -- -- (105)
Reclassification adjustment for realized losses
included in net income -- -- 311
-------- -------- --------
-- -- 206
-------- -------- --------
Minimum pension liability adjustment 68 1,757 (2,156)
-------- -------- --------
Total other comprehensive loss (4,697) (2,814) (487)
-------- -------- --------
Total comprehensive income $ 47,120 33,292 30,308
======== ======== ========
See accompanying notes to consolidated financial statements.
47
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
Years ended December 31, 2004, 2003 and 2002
(In thousands, except per share amounts)
Accumulated Common
Additional other stock
Common paid-in Retained comprehensive held by
stock capital earnings income (loss) ESOP
-------- -------- -------- ------------- --------
Balances at January 1, 2002 $ 298 135,917 176,073 2,561 (11,630)
Net income -- -- 30,795 -- --
Total other comprehensive loss, net -- -- -- (487) --
Exercise of stock options -- 533 -- -- --
ESOP shares released -- 547 -- -- 606
Recognition and retention plan -- 627 -- -- --
Common stock dividends of $0.43 per
share (equivalent to $0.17 per share
after the reorganization in 2003) -- -- (10,794) -- --
-------- -------- -------- -------- --------
Balances at December 31, 2002 $ 298 137,624 196,074 2,074 (11,024)
Net income -- -- 36,106 -- --
Total other comprehensive loss, net -- -- -- (2,814) --
Corporate reorganization:
Merger of First Niagara Financial
Group, MHC (158) 19,607 -- -- --
Treasury stock retired (37) (38,860) -- -- --
Exchange of common stock 161 (197) -- -- --
Proceeds from stock offering, net of
related expenses 410 390,535 -- -- --
Purchase of shares by ESOP -- -- -- -- (20,500)
Common stock issued for the acquisition
of Finger Lakes Bancorp, Inc. 34 33,527 -- -- --
Purchase of treasury shares -- -- -- -- --
Exercise of stock options -- 165 -- -- --
ESOP shares released -- 966 -- -- 1,125
Recognition and retention plan -- 1,251 -- -- --
Common stock dividends of $0.22 per
share -- -- (14,642) -- --
-------- -------- -------- -------- --------
Balances at December 31, 2003 $ 708 544,618 217,538 (740) (30,399)
Net income -- -- 51,817 -- --
Total other comprehensive loss, net -- -- -- (4,697) --
Common stock issued for the acquisition
of Troy Financial Corporation 133 201,147 -- -- --
Purchase of treasury shares -- -- -- -- --
Exercise of stock options 2 3,847 (7,387) -- --
ESOP shares released -- 952 -- -- 1,124
Recognition and retention plan -- 611 -- -- --
Common stock dividends of $0.30 per
share -- -- (23,920) -- --
-------- -------- -------- -------- --------
Balances at December 31, 2004 $ 843 751,175 238,048 (5,437) (29,275)
======== ======== ======== ======== ========
Unearned
compensation -
recognition and Treasury
retention plan stock Total
--------------- -------- --------
Balances at January 1, 2002 (2,153) (40,449) 260,617
Net income -- -- 30,795
Total other comprehensive loss, net -- -- (487)
Exercise of stock options -- 886 1,419
ESOP shares released -- -- 1,153
Recognition and retention plan (300) 666 993
Common stock dividends of $0.43 per
share (equivalent to $0.17 per share
after the reorganization in 2003) -- -- (10,794)
-------- -------- --------
Balances at December 31, 2002 (2,453) (38,897) 283,696
Net income -- -- 36,106
Total other comprehensive loss, net -- -- (2,814)
Corporate reorganization:
Merger of First Niagara Financial
Group, MHC -- -- 19,449
Treasury stock retired -- 38,897 --
Exchange of common stock -- -- (36)
Proceeds from stock offering, net of
related expenses -- -- 390,945
Purchase of shares by ESOP -- -- (20,500)
Common stock issued for the acquisition
of Finger Lakes Bancorp, Inc. -- -- 33,561
Purchase of treasury shares -- (1,604) (1,604)
Exercise of stock options -- 570 735
ESOP shares released -- -- 2,091
Recognition and retention plan 77 (141) 1,187
Common stock dividends of $0.22 per
share -- -- (14,642)
-------- -------- --------
Balances at December 31, 2003 (2,376) (1,175) 728,174
Net income -- -- 51,817
Total other comprehensive loss, net -- -- (4,697)
Common stock issued for the acquisition
of Troy Financial Corporation -- -- 201,280
Purchase of treasury shares -- (34,961) (34,961)
Exercise of stock options -- 10,612 7,074
ESOP shares released -- -- 2,076
Recognition and retention plan (797) 1,505 1,319
Common stock dividends of $0.30 per
share -- -- (23,920)
-------- -------- --------
Balances at December 31, 2004 (3,173) (24,019) 928,162
======== ======== ========
See accompanying notes to consolidated financial statements.
48
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 51,817 36,106 30,795
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of fees and discounts, net 9,738 14,082 3,853
Provision for credit losses 8,442 7,929 6,824
Depreciation of premises and equipment 8,206 6,187 5,286
Amortization of core deposit and other intangibles 4,605 1,417 873
ESOP and stock based compensation expense 3,175 3,592 2,080
Deferred income tax expense 7,340 2,857 1,100
Net increase in other assets (3,660) (3,812) (5,225)
Net increase (decrease) in other liabilities 4,099 (5,951) (253)
----------- ----------- -----------
Net cash provided by operating activities 93,762 62,407 45,333
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sales of securities available for sale 66,837 64,734 449,110
Proceeds from maturities of securities available for sale 244,050 381,559 196,961
Principal payments received on securities available for sale 155,624 393,707 170,181
Purchases of securities available for sale (553,427) (928,709) (756,685)
Net increase in loans (211,539) (100,900) (128,740)
Acquisitions, net of cash acquired (51,724) (32,542) (605)
Net cash distributed for sale of banking center -- -- (21,566)
Other, net (13,332) (7,356) (7,246)
----------- ----------- -----------
Net cash used in investing activities (363,511) (229,507) (98,590)
----------- ----------- -----------
Cash flows from financing activities:
Net increase (decrease) in deposits 47,609 (33,773) 165,038
Net proceeds from Conversion and Offering -- 313,906 75,952
Repayments of short-term borrowings, net (22,024) (36,458) (175,492)
Proceeds from long-term borrowings 211,500 39,890 30,000
Repayments of long-term borrowings (19,114) (16,951) (16,518)
Proceeds from exercise of stock options 4,049 459 942
Purchase of treasury stock (34,961) (1,604) --
Dividends paid on common stock (23,920) (14,642) (10,794)
----------- ----------- -----------
Net cash provided by financing activities 163,139 250,827 69,128
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents (106,610) 83,727 15,871
Cash and cash equivalents at beginning of year 174,252 90,525 74,654
----------- ----------- -----------
Cash and cash equivalents at end of year $ 67,642 174,252 90,525
=========== =========== ===========
Cash paid during the year for:
Income taxes $ 19,231 14,782 16,970
Interest expense 67,591 62,552 76,684
Acquisition of banks and financial services companies:
Assets acquired (excluding cash acquired) $ 1,330,282 377,204 --
Liabilities assumed 1,077,177 344,201 --
See accompanying notes to consolidated financial statements.
49
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
(1) Summary of Significant Accounting Policies
First Niagara Financial Group, Inc. ("FNFG"), a Delaware corporation, and
its subsidiary bank (the "Company") provide financial services to
individuals and businesses in Upstate New York. The Company's services
include consumer banking, residential and commercial lending, as well as
risk and wealth management services.
FNFG owns all of the capital stock of First Niagara Bank ("First
Niagara"), a federally chartered savings bank. First Niagara Commercial
Bank (the "Commercial Bank"), a wholly-owned subsidiary of First Niagara,
is a New York State chartered commercial bank whose primary purpose is to
generate municipal deposits, which under New York State law cannot be
accepted by a federally chartered savings banks.
The accounting and reporting policies of the Company conform to general
practices within the banking industry and to U.S. generally accepted
accounting principles ("GAAP"). Certain reclassification adjustments were
made to the 2003 and 2002 financial statements to conform them to the 2004
presentation. The following is a description of the Company's significant
accounting policies:
(a) Principles of Consolidation
The consolidated financial statements include the accounts of FNFG
and First Niagara and its subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
(b) Cash and Cash Equivalents
For purposes of the consolidated statement of cash flows, cash and
cash equivalents include cash and due from banks, federal funds
sold, and other money market investments which have a term of less
than three months at the time of purchase.
(c) Investment Securities
All investment securities are classified as available for sale and
are carried at fair value, with unrealized gains and losses, net of
the related deferred income tax effect, reported as a component of
stockholders' equity (accumulated other comprehensive income
(loss)). Realized gains and losses are included in the consolidated
statements of income using the specific identification method. A
decline in the fair value of any available for sale security below
cost that is deemed other than temporary is charged to operations,
resulting in the establishment of a new cost basis. Premiums and
discounts on investment securities are amortized/accreted to
interest income utilizing the interest method.
(d) Loans and Leases
Loans are stated at the principal amount outstanding, adjusted for
unamortized deferred fees and costs as well as discounts and
premiums, all of which are amortized to income using the interest
method. Accrual of interest income on loans is discontinued after
payments become more than ninety days delinquent, unless the status
of a particular loan clearly indicates earlier discontinuance is
more appropriate. Delinquency status is based upon the contractual
terms of the loans. All uncollected interest income previously
recognized on non-accrual loans is reversed and subsequently
recognized only to the extent payments are received. When there is
doubt as to the collectibility of loan principal, interest payments
are applied to principal. Loans are generally returned to accrual
status when principal and interest payments are current, full
collectibility of principal and interest is reasonably assured and a
consistent repayment record, generally six months, has been
demonstrated. Loans are charged off against the allowance for credit
losses when it becomes evident that such balances are not fully
collectible.
50
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect
all amounts of principal and interest under the original terms of
the agreement. Such loans are measured based on the present value of
expected future cash flows discounted at the loan's effective
interest rate or, as a practical expedient, the loan's observable
market price or the fair value of the underlying collateral if the
loan is collateral dependent.
The Company enters into direct financing equipment lease
transactions with certain commercial customers. At lease inception,
the present value of future rentals and the estimated lease residual
value are recorded as commercial business loans. Unearned interest
income and sales commissions and other direct costs incurred are
capitalized and are amortized to interest income over the lease term
utilizing the interest method.
(e) Allowance for Credit Losses
The allowance for credit losses is established through charges to
the provision for credit losses. Management's evaluation of the
allowance is based on a continuing review of the loan portfolio.
Larger balance nonaccruing, impaired and delinquent loans are
reviewed individually and the value of any underlying collateral is
considered in determining estimates of losses associated with those
loans. Losses in smaller balance, homogeneous loans are estimated
based on historical experience, industry trends and current trends
in the real estate market and the current economic environment in
the Company's market areas. The adequacy of the allowance for credit
losses is based on management's evaluation of various conditions
including the following: changes in the composition of and growth in
the loan portfolio; industry and regional conditions; the strength
and duration of the current business cycle; existing general
economic and business conditions in lending areas; credit quality
trends, including trends in nonaccruing loans; historical loan
charge-off experience; and the results of bank regulatory
examinations.
(f) Premises and Equipment
Premises and equipment are carried at cost, net of accumulated
depreciation and amortization. Depreciation is computed on the
straight-line method over the estimated useful lives of the assets.
Leasehold improvements are amortized on the straight-line method
over the lesser of the life of the improvements or the lease term.
The Company generally amortizes buildings over a period of 20 to 39
years, furniture and equipment over a period of 3 to 10 years, and
capital leases over the respective lease term.
(g) Goodwill and Intangible Assets
The excess of the cost of acquired entities over the fair value of
identifiable tangible and intangible assets acquired, less
liabilities assumed, is recorded as goodwill. Acquired intangible
assets with definite useful economic lives are generally amortized
over their useful economic life utilizing the double-declining
balance method. Goodwill and any acquired intangible assets with an
indefinite useful economic life are not amortized, but are reviewed
for impairment annually at the reporting unit level. A reporting
unit is defined as any distinct, separately identifiable component
of an operating segment for which complete, discrete financial
information is available that segment management regularly reviews.
Discounted cash flow valuation models that incorporate such
variables as revenue growth rates, expense trends, discount rates
and terminal values are utilized to determine the fair value of the
Company's reporting units.
(h) Employee Benefits
The Company maintains several defined contribution plans and accrues
contributions due under those plans as earned by employees.
51
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
The Company also maintains several non-contributory, qualified,
defined benefit pension plans (the "Pension Plans") that cover
substantially all employees who meet certain age and service
requirements. Effective February 1, 2002, the Company froze all
benefit accruals and participation in First Niagara's Pension Plan.
Pension plans acquired in connection with the Company's previous
whole-bank acquisitions are frozen prior to the completion of the
respective transaction. The actuarially determined pension benefit
in the form of a life annuity is based on the employee's combined
years of service, age and compensation. The Company's policy is to
fund the minimum amount required by government regulations. The cost
of the pension plans is based on actuarial computations of current
and future benefits for employees, and is charged to current
operating expenses.
The Company provides post-retirement benefits, principally health
care and group life insurance ("the Post-retirement Plan"), to
employees who met certain age and service requirements by December
31, 2001. The expected costs of providing these post-retirement
benefits are accrued during an employee's active years of service.
(i) Stock-Based Compensation
The Company maintains various long-term incentive stock benefit
plans under which fixed award stock options and restricted stock may
be granted to certain directors and key employees. The Company has
continued to apply the intrinsic value-based method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," and has only adopted the
disclosure requirements of Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - An Amendment
of FASB Statement No. 123." As such, compensation expense is
recorded on the date the options are granted only if the current
market price of the underlying stock exceeded the exercise price.
Compensation expense related to restricted stock awards is based
upon the market value of FNFG's stock on the grant date and is
accrued ratably over the required service period.
Had the Company determined compensation cost based on the fair value
method under SFAS No. 123, net income would have been reduced to the
pro forma amounts indicated below. These amounts may not be
representative of the effects on reported net income for future
years due to changes in market conditions and the number of options
outstanding:
2004 2003 2002
---------- ---------- ----------
(In thousands, except per share amounts)
Net Income:
As reported $ 51,817 36,106 30,795
Add: Stock-based employee compensation
expense included in net income, net of
related income tax effects 659 900 556
Deduct: Stock-based employee compensation
expense determined under the fair-value
based method, net of related income tax effects (1,788) (1,997) (1,172)
---------- ---------- ----------
Pro forma $ 50,688 35,009 30,179
========== ========== ==========
Basic earnings per share:
As reported $ 0.66 0.55 0.48
Pro forma 0.64 0.53 0.47
Diluted earnings per share:
As reported $ 0.65 0.53 0.47
Pro forma 0.63 0.52 0.46
52
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
The per share weighted-average fair value of stock options granted
for 2004, 2003 and 2002 were $4.12, $4.46 and $3.95 on the date of
grant, respectively, using the Black Scholes option-pricing model.
The following weighted-average assumptions were utilized to compute
the fair value of options granted for the respective years:
2004 2003 2002
------------ ----------- -----------
Expected dividend yield 2.11% 1.55% 1.51%
Risk-free interest rate 3.98% 3.02% 3.91%
Expected life 6.5 years 6.5 years 6.5 years
Expected volatility 32.13% 33.14% 33.71%
============ =========== ===========
The Company deducted 10% in each year to reflect an estimate of
forfeitures prior to vesting.
In December 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 123R "Share Based Payment" which revised SFAS No.
123 and superseded APB Opinion No. 25. More specifically, this
Statement requires companies to recognize in the income statement
over the required vesting period the grant-date fair value of stock
options and other equity-based compensation issued to employees and
directors estimated using option pricing models. This Statement is
effective for interim and annual periods beginning after June 15,
2005 and the Company has chosen to apply the modified prospective
approach. Accordingly, awards that are granted, modified or settled
after July 1, 2005 will be accounted for in accordance with SFAS No.
123R and any unvested equity awards granted prior to July 1, 2005
will be recognized in the income statement as service is rendered
based on their grant-date fair value calculated in accordance with
SFAS No. 123.
(j) Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the periods in which the
deferred tax assets or liabilities are expected to be realized or
settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through income tax expense.
(k) Earnings per Share
Basic earnings per share ("EPS") is computed by dividing net income
available to common stockholders by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts
to issue common stock were exercised or converted into common stock
or resulted in the issuance of common stock that then shared in the
earnings of the Company. All per share data and references to the
number of shares outstanding for purposes of calculating per share
amounts prior to January 17, 2003 have been restated to give
recognition to the 2.58681 exchange ratio applied in the Conversion
(See note 11).
(l) Investment and Fiduciary Services
Assets held in fiduciary or agency capacity for customers are not
included in the accompanying consolidated statements of condition,
since such assets are not assets of the Company. Fee income is
recognized on the accrual method based on the fair value of assets
administered.
(m) Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and
disclosure of contingent assets and liabilities to prepare these
financial statements in conformity with U.S. generally accepted
accounting principles. Actual results could differ from those
estimates.
53
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
(2) Acquisitions
Troy Financial Corporation
On January 16, 2004, FNFG acquired all of the outstanding common shares of
Troy Financial Corporation ("TFC"), the holding company of The Troy
Savings Bank ("TSB") and The Troy Commercial Bank, in exchange for a
combination of cash and stock valued at $35.50 per share. The aggregate
purchase price of $356.5 million included the issuance of 13.3 million
shares of FNFG stock (valued at $15.15 per share), cash payments totaling
$151.9 million and capitalized costs related to the acquisition, primarily
investment banking and professional fees, of $3.4 million. The acquisition
was accounted for under the purchase method of accounting. Accordingly,
the results of operations of TFC were included in the 2004 consolidated
statement of income from the date of acquisition.
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition (in
thousands):
January 16,
2004
-----------
Cash and cash equivalents $ 94,090
Securities available for sale 250,969
Loans, net 745,399
Goodwill 217,389
Core deposit intangible 17,247
Other assets 97,440
----------
Total assets acquired 1,422,534
----------
Deposits 923,665
Borrowings 124,723
Other liabilities 17,597
----------
Total liabilities assumed 1,065,985
----------
Net assets acquired $ 356,549
==========
The core deposit intangible asset acquired is being amortized over 11
years.
Unaudited pro forma information as if the acquisition of TFC had been
consummated as of January 1, 2003 follows. Pro forma information for 2004
is not presented since such pro forma results were not materially
different from actual results. This unaudited pro forma information gives
effect to certain adjustments, including purchase accounting fair value
adjustments, amortization of core deposit intangibles and related income
tax effects. The unaudited pro forma information does not necessarily
reflect the results of operations that would have occurred had the Company
acquired TFC on January 1, 2003. In particular, cost savings and $1.3
million of indirect merger and integration costs are not reflected in the
pro unaudited forma amounts (in thousands, except per share amounts):
Pro forma
2003
---------
Net interest income $146,960
Noninterest income 52,599
Noninterest expense 123,131
Net income $ 45,098
Basic earnings per share $ 0.57
Diluted earnings per share $ 0.56
========
54
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
Subsequent Event - Acquisition of Hudson River Bancorp, Inc.
On January 14, 2005, FNFG acquired 100% of the outstanding common shares
of Hudson River Bancorp, Inc. ("HRB"), the holding company of Hudson River
Bank & Trust Company, with total assets of approximately $2.5 billion and
fifty branch locations. Following completion of the acquisition, HRB
locations were merged into First Niagara's branch network.
The aggregate purchase price was approximately $615 million and included
the issuance of 35.7 million shares of FNFG stock (valued at $13.55 per
share), cash payments totaling approximately $126.8 million and
capitalized costs related to the acquisition, primarily investment banking
and professional fees, of approximately $4 million. This acquisition was
accounted for under the purchase method of accounting. The results of
operations of HRB will be included in the 2005 consolidated statement of
income from the date of acquisition. The estimated fair values of the
assets acquired and liabilities assumed from HRB as of January 14, 2005
were $2.8 billion and $2.2 billion, respectively.
(3) Investment Securities
The amortized cost, gross unrealized gains and losses and approximate fair
value of securities available for sale at December 31, 2004 and 2003 are
summarized as follows (in thousands):
Amortized Unrealized Unrealized Fair
At December 31, 2004: cost gains losses value
---------- ---------- ---------- ----------
Debt securities:
States and political subdivisions $ 277,599 1,031 (1,057) 277,573
U.S. Government agencies 249,045 12 (2,574) 246,483
Corporate 21,424 100 (104) 21,420
---------- ---------- ---------- ----------
Total debt securities 548,068 1,143 (3,735) 545,476
---------- ---------- ---------- ----------
Mortgage-backed securities:
Federal National Mortgage Association 190,406 307 (2,489) 188,224
Federal Home Loan Mortgage Corporation 135,971 544 (2,422) 134,093
Government National Mortgage Association 5,951 239 (3) 6,187
Collateralized mortgage obligations:
Federal Home Loan Mortgage Corporation 145,797 119 (1,116) 144,800
Federal National Mortgage Association 84,508 93 (752) 83,849
Privately issued 48,830 40 (446) 48,424
Government National Mortgage Association 12,736 -- (157) 12,579
---------- ---------- ---------- ----------
Total collateralized mortgage obligations 291,871 252 (2,471) 289,652
---------- ---------- ---------- ----------
Total mortgage-backed securities 624,199 1,342 (7,385) 618,156
---------- ---------- ---------- ----------
Other 6,358 183 (44) 6,497
---------- ---------- ---------- ----------
Total securities available for sale $1,178,625 2,668 (11,164) 1,170,129
========== ========== ========== ==========
55
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
Amortized Unrealized Unrealized Fair
At December 31, 2003: cost gains losses value
---------- ---------- ---------- ----------
Debt securities:
States and political subdivisions $ 36,766 1,433 (10) 38,189
U.S. Government agencies 287,604 563 (1,109) 287,058
Corporate 13,708 46 (144) 13,610
---------- ---------- ---------- ----------
Total debt securities 338,078 2,042 (1,263) 338,857
---------- ---------- ---------- ----------
Mortgage-backed securities:
Federal National Mortgage Association 207,480 934 (1,616) 206,798
Federal Home Loan Mortgage Corporation 121,639 786 (1,206) 121,219
Government National Mortgage Association 9,959 346 (1) 10,304
Collateralized mortgage obligations:
Federal Home Loan Mortgage Corporation 97,419 163 (453) 97,129
Federal National Mortgage Association 43,370 180 (214) 43,336
Privately issued 6,411 15 (3) 6,423
Government National Mortgage Association 14,722 -- (320) 14,402
---------- ---------- ---------- ----------
Total collateralized mortgage obligations 161,922 358 (990) 161,290
---------- ---------- ---------- ----------
Total mortgage-backed securities 501,000 2,424 (3,813) 499,611
---------- ---------- ---------- ----------
Other 7,372 55 (12) 7,415
---------- ---------- ---------- ----------
Total securities available for sale $ 846,450 4,521 (5,088) 845,883
========== ========== ========== ==========
The following tables sets forth certain information regarding the
Company's securities available for sale that were in an unrealized loss
position at December 31, 2004 and 2003 by the length of time those
securities were in a continuous loss position as follows (in thousands):
Less than 12 months 12 months or longer Total
---------------------- ---------------------- ----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
At December 31, 2004: value losses value losses value losses
-------- ---------- -------- ---------- -------- ----------
Debt securities:
States and political subdivisions $221,725 1,030 4,104 27 225,829 1,057
U.S. Government agencies 190,586 1,648 45,910 926 236,496 2,574
Corporate 8,794 93 474 11 9,268 104
-------- -------- -------- -------- -------- --------
Total debt securities 421,105 2,771 50,488 964 471,593 3,735
-------- -------- -------- -------- -------- --------
Mortgage-backed securities:
Federal National Mortgage Association 122,069 1,384 39,042 1,105 161,111 2,489
Federal Home Loan Mortgage Corporation 47,994 676 62,882 1,746 110,876 2,422
Government National Mortgage Association 765 3 -- -- 765 3
Collateralized mortgage obligations:
Federal Home Loan Mortgage Corporation 118,465 937 7,795 179 126,260 1,116
Federal National Mortgage Association 56,546 752 -- -- 56,546 752
Privately issued 35,627 446 -- -- 35,627 446
Government National Mortgage Association 12,579 157 -- -- 12,579 157
-------- -------- -------- -------- -------- --------
Total collateralized mortgage obligations 223,217 2,292 7,795 179 231,012 2,471
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities 394,045 4,355 109,719 3,030 503,764 7,385
-------- -------- -------- -------- -------- --------
Other 4,462 44 -- -- 4,462 44
-------- -------- -------- -------- -------- --------
Total securities available for sale $819,612 7,170 160,207 3,994 979,819 11,164
======== ======== ======== ======== ======== ========
56
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
Less than 12 months 12 months or longer Total
---------------------- ---------------------- ----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
At December 31, 2003: value losses value losses value losses
-------- ---------- -------- ---------- -------- ----------
Debt securities:
States and political subdivisions $ 4,856 10 -- -- 4,856 10
U.S. Government agencies 137,306 1,109 -- -- 137,306 1,109
Corporate 7,324 111 1,871 33 9,195 144
-------- -------- -------- -------- -------- --------
Total debt securities 149,486 1,230 1,871 33 151,357 1,263
-------- -------- -------- -------- -------- --------
Mortgage-backed securities:
Federal National Mortgage Association 114,061 1,616 -- -- 114,061 1,616
Federal Home Loan Mortgage Corporation 95,664 1,206 -- -- 95,664 1,206
Government National Mortgage Association 111 1 -- -- 111 1
Collateralized mortgage obligations:
Federal Home Loan Mortgage Corporation 59,822 453 -- -- 59,822 453
Federal National Mortgage Association 22,196 214 -- -- 22,196 214
Privately issued 2,636 2 25 1 2,661 3
Government National Mortgage Association 14,402 320 -- -- 14,402 320
-------- -------- -------- -------- -------- --------
Total collateralized mortgage obligations 99,056 989 25 1 99,081 990
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities 308,892 3,812 25 1 308,917 3,813
-------- -------- -------- -------- -------- --------
Other 2,466 12 -- -- 2,466 12
-------- -------- -------- -------- -------- --------
Total securities available for sale $460,844 5,054 1,896 34 462,740 5,088
======== ======== ======== ======== ======== ========
Management has assessed the securities available for sale that were in an
unrealized loss position at December 31, 2004 and 2003 and determined that
the decline in fair value was temporary. In making this determination
management considered the period of time the securities were in a loss
position, the percentage decline in comparison to the securities amortized
cost, the financial condition of the issuer (primarily government or
government agencies) and the Company's ability and intent to hold these
securities until their fair value recovers to their amortized cost.
Management believes the decline in fair value was caused by the increase
in interest rates and not the credit deterioration of the individual
issuer. More specifically, the $4.0 million of unrealized losses on the 34
investment securities that have been in a continuous loss position for
twelve months or longer at December 31, 2004 was determined to be
temporary as nearly all of the investment securities are guaranteed by
U.S. Government or government agencies which have minimal credit risk, if
any, and all of the investment securities are investment grade and have
investment ratings of AA or better except for one security which had a
BBB+ rating and a nominal unrealized loss at December 31, 2004.
Gross realized gains and losses on securities available for sale are
summarized as follows (in thousands):
2004 2003 2002
------ ------ ------
Gross realized gains $ 774 1,208 8,924
Gross realized losses (714) (1,199) (9,968)
------ ------ ------
Net realized gains (losses) $ 60 9 (1,044)
====== ====== ======
57
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
Scheduled contractual maturities of certain investment securities owned by
the Company at December 31, 2004 are as follows (in thousands):
Amortized Fair
cost value
---------- ----------
Debt securities:
Within one year $ 298,929 297,900
After one year through five years 210,265 208,493
After five years through ten years 13,550 13,777
After ten years 25,324 25,306
---------- ----------
Total debt securities 548,068 545,476
Mortgage-backed securities 624,199 618,156
---------- ----------
$1,172,267 1,163,632
========== ==========
While the contractual maturities of mortgage-backed securities ("MBS")
generally exceed ten years, the effective lives are expected to be
significantly shorter due to prepayments of the underlying loans and the
nature of the MBS structures owned.
At December 31, 2004 and 2003, $620.5 million and $276.0 million,
respectively, of investment securities were pledged to secure borrowings
and lines of credit from the Federal Home Loan Bank ("FHLB") and Federal
Reserve Bank ("FRB"), as well as repurchase agreements and certain
deposits. At December 31, 2004 and 2003, no investments in securities of a
single non-U.S. Government or government agency issuer exceeded 10% of
stockholders' equity.
Money market investments at December 31, 2003 include $75.0 million of
securities purchased under agreements to resell. The maximum and average
amount outstanding under these agreements during 2003 was $125.0 million
and $72.5 million, respectively. There were no such agreements outstanding
at any month-end during 2004. In connection with these agreements, the
Company accepted investment securities or loans as collateral, which were
maintained at a third-party custodian or with the counterparty and could
not be sold or repledged. The collateral was returned at the maturity of
the investment, which typically was 30 days or less. Money market
investments also include $2.6 million and $43.6 million of federal funds
sold at December 31, 2004 and 2003, respectively.
(4) Loans and Leases
Loans and leases receivable at December 31, 2004 and 2003 consist of the
following (in thousands):
2004 2003
----------- -----------
Commercial:
Real estate $ 1,081,709 653,976
Construction 187,149 86,154
Business 345,520 136,869
Leases 79,358 78,131
----------- -----------
Total commercial 1,693,736 955,130
Residential real estate 1,132,471 948,877
Consumer:
Home equity 247,190 179,282
Other 174,309 202,630
----------- -----------
Total consumer 421,499 381,912
----------- -----------
Total loans and leases 3,247,706 2,285,919
Net deferred costs and unearned discounts 8,971 8,704
Allowance for credit losses (41,422) (25,420)
----------- -----------
Total loans and leases, net $ 3,215,255 2,269,203
=========== ===========
58
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
Non-accrual loans amounted to $12.0 million, $12.3 million and $7.5
million at December 31, 2004, 2003 and 2002, respectively. Interest income
that would have been recorded if the loans had been performing in
accordance with their original terms amounted to $393 thousand, $295
thousand and $182 thousand in 2004, 2003 and 2002, respectively. There
were no loans past due 90 days or more that were still accruing interest
at December 31, 2004 and 2003. The balance of impaired loans at December
31, 2004 and 2003 amounted to $10.4 million. The allowance for credit
losses includes valuation allowances relating to those loans of $1.9
million and $1.7 million, respectively. The aggregate recorded investment
of loans whose terms have been modified through a troubled debt
restructuring amounted to $4.2 million at December 31, 2004 and $2.5
million at December 31, 2003.
Residential mortgage loans include loans held for sale of $3.9 million and
$2.7 million at December 31, 2004 and December 31, 2003, respectively.
Loans sold amounted to $48.6 million, $56.4 million and $55.5 million in
2004, 2003 and 2002, respectively. Gains on the sale of loans were $612
thousand, $1.3 million and $1.0 million in 2004, 2003 and 2002,
respectively. Mortgages serviced for others by the Company totaled $325.1
million, $246.1 million and $242.9 million at December 31, 2004, 2003 and
2002, respectively. The mortgage servicing assets recorded as a result of
those loans amounted $2.0 million, $1.7 million and $1.4 million at
December 31, 2004, 2003 and 2002, respectively.
The majority of the Company's loans are to customers across Upstate New
York. The ultimate collectibility of these loans is susceptible to changes
in market conditions in this market area.
Loans due from certain officers and directors of the Company and
affiliates amounted to $2.5 million and $1.9 million at December 31, 2004
and 2003, respectively.
Changes in the allowance for credit losses are summarized as follows (in
thousands):
2004 2003 2002
-------- -------- --------
Balance, beginning of year $ 25,420 20,873 18,727
Provision for credit losses 8,442 7,929 6,824
Obtained through acquisitions 14,650 2,001 --
Charge-offs (8,226) (6,760) (5,804)
Recoveries 1,136 1,377 1,126
-------- -------- --------
Balance, end of year $ 41,422 25,420 20,873
======== ======== ========
(5) Premises and Equipment
A summary of premises and equipment at December 31, 2004 and 2003 follows
(in thousands):
2004 2003
--------- ---------
Land $ 5,008 3,539
Buildings and improvements 55,978 40,821
Furniture and equipment 53,074 44,309
--------- ---------
114,060 88,669
Accumulated depreciation and amortization (52,300) (44,975)
--------- ---------
Premises and equipment, net $ 61,760 43,694
========= =========
Rent expense was $3.2 million, $2.1 million and $1.8 million for 2004,
2003 and 2002, respectively.
59
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
(6) Goodwill and Other Intangible Assets
The following table sets forth information regarding the Company's
goodwill for 2004 and 2003 (in thousands):
Financial Consolidated
Banking segment services segment total
--------------- ---------------- ------------
Balances at January 1, 2003 $ 66,875 7,226 74,101
Acquired 28,665 4,520 33,185
Sold -- (1,028) (1,028)
Contingent earn-out -- (277) (277)
-------- -------- --------
Balances at December 31, 2003 95,540 10,441 105,981
Acquired 217,735 -- 217,735
Contingent earn-out -- 66 66
-------- -------- --------
Balances at December 31, 2004 $313,275 10,507 323,782
======== ======== ========
The Company has performed the required annual goodwill impairment test as
of November 1, 2004 and 2003. Based upon the results of these tests, the
Company has determined that goodwill was not impaired as of those dates.
The following table sets forth information regarding the Company's
amortizing intangible assets at December 31, 2004 and 2003 (in thousands):
2004 2003
-------- --------
Customer lists:
Gross amount $ 10,458 10,271
Accumulated amortization (4,873) (3,693)
-------- --------
Net carrying amount 5,585 6,578
-------- --------
Core deposit intangible:
Gross amount 20,157 2,578
Accumulated amortization (3,864) (439)
-------- --------
Net carrying amount 16,293 2,139
-------- --------
Total amortizing intangible assets, net $ 21,878 8,717
======== ========
Estimated future amortization expense over the next five years for
intangible assets outstanding at December 31, 2004 is as follows (in
thousands):
2005 $ 4,197
2006 3,428
2007 2,901
2008 2,486
2009 2,123
60
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
(7) Other Assets
A summary of other assets at December 31, 2004 and 2003 follows (in
thousands):
2004 2003
-------- --------
FHLB stock $ 28,485 19,221
Accrued interest receivable 20,016 14,913
Other receivables and prepaid assets 18,801 12,061
Net deferred tax assets (see note 13) 26,836 11,296
Real estate and limited partnership investments 27,873 4,582
Other 9,453 8,937
-------- --------
$131,464 71,010
======== ========
Included in real estate and limited partnership investments at December
31, 2004 is a $17.3 million, 90% ownership, multi-tenant retail shopping
plaza located in the Company's market area, which was acquired from TFC.
The Company has reported the investment as a consolidated subsidiary in
its financial statements. Also included in real estate and limited
partnership investments are $10.6 million and $4.6 million of limited
partnership investments at December 31, 2004 and 2003, respectively, that
the Company has determined to be variable interest entities which the
Company is not the primary beneficiary. These investments were made
primarily to support the Company's community reinvestment initiatives and
are accounted for under the equity method. The Company's exposure related
to these entities is limited to its recorded investment. At December 31,
2004, the Company has committed to invest an additional $2.6 million to
these partnerships.
(8) Deposits
Deposits consist of the following at December 31, 2004 and 2003 (in
thousands):
2004 2003
-------------------------- --------------------------
Weighted Weighted
average average
Balance rate Balance rate
---------- -------- ---------- --------
Core deposits:
Savings $1,086,769 1.02% $ 654,320 0.78%
Interest-bearing checking 912,598 1.06 538,967 0.80
Noninterest-bearing 291,491 -- 170,384 --
---------- ----------
Total core deposits 2,290,858 0.91 1,363,671 0.69
Certificates maturing:
Within one year 768,608 2.15 777,160 2.34
After one year, through two years 207,467 2.90 140,717 3.09
After two years, through three years 39,642 3.35 48,686 4.37
After three years, through four years 23,022 3.18 17,808 3.83
After four years, through five years 6,111 3.26 4,919 3.08
After five years 1,974 3.97 2,255 4.32
---------- ----------
Total certificates 1,046,824 2.37 991,545 2.58
---------- ----------
Total deposits $3,337,682 1.37% $2,355,216 1.49%
========== ==========
61
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
Interest expense on deposits is summarized as follows (in thousands):
2004 2003 2002
------- ------- -------
Savings $ 9,768 6,809 12,750
Certificates 23,924 29,232 32,774
Interest-bearing checking 8,258 4,767 8,087
------- ------- -------
$41,950 40,808 53,611
======= ======= =======
Certificates of deposit issued in amounts over $100 thousand amounted to
$234.6 million, $198.0 million and $170.0 million at December 31, 2004,
2003 and 2002, respectively. Interest expense thereon totaled $5.3
million, $5.8 million and $6.3 million in 2004, 2003 and 2002,
respectively. Interest rates on all certificates range from 1.00% to 7.70%
at December 31, 2004.
(9) Other Borrowed Funds
Outstanding borrowings at December 31, 2004 and 2003 are summarized as
follows (in thousands):
2004 2003
-------- --------
Short-term borrowings:
FHLB advances $105,597 31,573
Repurchase agreements 103,639 55,575
-------- --------
$209,236 87,148
======== ========
Long-term borrowings:
FHLB advances $231,074 182,928
Repurchase agreements 297,291 187,890
Other 13,085 --
-------- --------
$541,450 370,818
======== ========
FHLB advances generally bear fixed interest rates ranging from 1.50% to
7.47% and had a weighted average rate of 4.31% at December 31, 2004.
Repurchase agreements generally bear fixed interest rates ranging from
0.80% to 6.75% and had a weighted average rate of 3.83% at December 31,
2004.
Interest expense on borrowings is summarized as follows (in thousands):
2004 2003 2002
------- ------- -------
FHLB advances $13,132 11,328 14,081
Repurchase agreements 12,767 10,408 8,256
Other 627 -- 159
------- ------- -------
$26,526 21,736 22,496
======= ======= =======
62
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
The Company has lines of credit with the FHLB, FRB and a commercial bank
that provide a secondary funding source for lending, liquidity and asset
and liability management. At December 31, 2004, the FHLB facility totaled
$766.7 million with $336.7 million outstanding that was secured by
approximately $370.3 million of residential mortgage and multifamily
loans. The FRB and commercial bank lines of credit totaled $15.9 million
and $50.0 million, respectively, with no borrowings outstanding on either
line as of December 31, 2004. Under the commercial bank line of credit
agreement, FNFG is required to pledge shares of First Niagara common stock
equal to two times the borrowings outstanding and maintain certain
standard financial covenants. The interest rate on outstanding borrowings
under this line of credit is equal to the LIBOR rate plus 150 basis points
that resets every 30, 60 or 90 days or the Prime Rate less 25 basis
points, at the election of FNFG.
As of December 31, 2004, the Company had entered into repurchase
agreements with the FHLB and various broker-dealers, whereby securities
available for sale with a carrying value of $400.9 million were pledged to
collateralize the borrowings. These are treated as financing transactions
and the obligations to repurchase are reflected as a liability in the
consolidated financial statements. The dollar amount of securities
underlying the agreements are included in securities available for sale in
the consolidated statements of condition. However, the securities are
delivered to the dealer with whom each transaction is executed. The
dealers may sell, loan or otherwise dispose of such securities to other
parties in the normal course of their business, but agree to resell to the
Company the same securities at the maturity of the agreements. The Company
also retains the right of substitution of collateral throughout the terms
of the agreements. At December 31, 2004, there were no amounts at risk
under reverse repurchase agreements with any individual counterparty or
group of related counterparties that exceeded 10% of stockholders' equity.
The amount at risk is equal to the excess of the carrying value (or market
value if greater) of the securities sold under agreements to repurchase
over the amount of the repurchase liability.
The aggregate maturities of long-term borrowings at December 31, 2004 are
as follows (in thousands):
2006 $ 211,868
2007 108,494
2008 120,635
2009 9,141
Thereafter 91,312
----------
$ 541,450
==========
(10) Commitments and Contingent Liabilities
Loan Commitments
In the ordinary course of business, the Company extends commitments to
originate residential mortgages, commercial loans and other consumer
loans. 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 payment of a fee. Since the Company
does not expect all of the commitments to be funded, the total commitment
amounts do not necessarily represent future cash requirements. The Company
evaluates each customer's creditworthiness on a case-by-case basis.
Collateral may be obtained based upon management's assessment of the
customers' creditworthiness. Commitments to extend credit may be written
on a fixed rate basis exposing the Company to interest rate risk given the
possibility that market rates may change between commitment and actual
extension of credit. The Company had outstanding commitments to originate
loans of approximately $139.3 million and $115.9 million at December 31,
2004 and 2003, respectively.
63
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
The Company extends credit to consumer and commercial customers, up to a
specified amount, through lines of credit. As the borrower is able to draw
on these lines as needed, the funding requirements are generally
unpredictable. Unused lines of credit amounted to $367.7 million and
$234.3 million at December 31, 2004 and 2003, respectively. The Company
also issues standby letters of credit to third parties, which guarantee
payments on behalf of commercial customers in the event the customer fails
to perform under the terms of the contract with the third-party. Standby
letters of credit amounted to $31.1 million and $20.4 million at December
31, 2004 and 2003, respectively. Since a significant portion of unused
commercial lines of credit and the majority of outstanding standby letters
of credit expire without being funded, the Company's expectation is that
its obligation to fund the above commitment amounts is substantially less
than the amounts reported. The credit risk involved in issuing these
commitments is essentially the same as that involved in extending loans to
customers and is limited to the contractual notional amount of those
instruments.
To assist with asset and liability management and to provide cash flow to
support loan growth, the Company generally sells newly originated
conventional, conforming 20 to 30 year monthly fixed, and 25 to 30 year
bi-weekly loans in the secondary market to government sponsored
enterprises such as the Federal National Mortgage Association and the
Federal Home Loan Mortgage Corporation. The Company generally retains the
servicing rights on residential mortgage loans sold, which results in
monthly service fee income. Commitments to sell residential mortgages
amounted to $7.6 million and $3.8 million at December 31, 2004 and 2003,
respectively.
Lease Obligations
Future minimum rental commitments for premises and equipment under
noncancellable operating leases at December 31, 2004 were $2.8 million in
2005; $2.5 million in 2006; $2.2 million in 2007; $2.0 million in 2008;
$1.9 million in 2009; and a total of $9.1 million thereafter through 2029.
Real estate taxes, insurance and maintenance expenses related to these
leases are obligations of the Company.
Contingent Liabilities
In the ordinary course of business there are various threatened and
pending legal proceedings against the Company. Based on consultation with
outside legal counsel, management believes that the aggregate liability,
if any, arising from such litigation would not have a material adverse
effect on the Company's consolidated financial statements at December 31,
2004.
(11) Capital
Office of Thrift Supervision ("OTS") regulations require savings
institutions such as First Niagara to maintain a minimum ratio of tangible
capital to total adjusted assets of 1.5%, a minimum ratio of Tier 1 (core)
capital to total adjusted assets of 4.0%, and a minimum ratio of total
(core and supplementary) capital to risk-weighted assets of 8.0%. The
Commercial Bank, as a New York State chartered commercial bank, is also
subject to minimum capital requirements imposed by the Federal Deposit
Insurance Corporation ("FDIC") that are substantially similar to the
capital requirements imposed on First Niagara. The FDIC regulations
require the Commercial Bank to maintain a minimum ratio of total capital
to risk-weighted assets of 8.0%, and a minimum ratio of Tier 1 capital to
risk-weighted assets of 4.0%. In addition, under the minimum
leverage-based capital requirement adopted by the FDIC, the Commercial
Bank must maintain a ratio of Tier 1 capital to average total assets
(leverage ratio) of at least 3% to 5%, depending on its CAMELS composite
examination rating.
64
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
Under prompt corrective action regulations, an institution's respective
regulatory authority is required to take certain supervisory actions (and
may take additional discretionary actions) with respect to an
undercapitalized institution. Such actions could have a direct material
effect on the institution's financial statements. The regulations
establish a framework for the classification of banks into five categories
-- well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized.
Generally, an institution is considered well capitalized if it has a Tier
1 (core) capital ratio of at least 5.0%, a Tier 1 risk-based capital ratio
of at least 6.0%, and a total risk-based capital ratio of at least 10.0%.
The actual capital amounts and ratios for First Niagara at December 31,
2004 and 2003 and the Commercial Bank at December 31, 2004 are presented
in the following table (in thousands):
To be well capitalized
Minimum under prompt corrective
Actual capital adequacy action provisions
----------------------- -------------------------- ---------------------------
Amount Ratio Amount Ratio Amount Ratio
----------- --------- ------------ ---------- ------------- ---------
First Niagara Bank:
December 31, 2004:
Tangible capital $ 537,161 11.40 % $ 70,699 1.50 % $ N/A N/A %
Tier 1 (core) capital 537,161 11.40 188,531 4.00 235,663 5.00
Tier 1 risk-based capital 537,161 16.40 N/A N/A 196,545 6.00
Total risk-based capital 578,108 17.65 262,060 8.00 327,575 10.00
December 31, 2003:
Tangible capital $ 411,562 11.87 % $ 52,017 1.50 % $ N/A N/A %
Tier 1 (core) capital 413,700 11.92 138,797 4.00 173,496 5.00
Tier 1 risk-based capital 413,700 17.94 N/A N/A 138,366 6.00
Total risk-based capital 439,120 19.04 184,488 8.00 230,610 10.00
First Niagara Commercial Bank:
December 31, 2004:
Leverage Ratio $ 11,968 6.74 % $ 5,330 3.00 % $ 8,883 5.00 %
Tier 1 risk-based capital 11,968 26.03 1,839 4.00 2,758 6.00
Total risk-based capital 11,968 26.03 3,678 8.00 4,597 10.00
The foregoing capital ratios are based in part on specific quantitative
measures of assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. Capital amounts and
classifications are also subject to qualitative judgments by the OTS and
FDIC about capital components, risk weightings and other factors. These
capital requirements apply only to First Niagara and the Commercial Bank,
and do not consider additional capital retained by FNFG.
Management believes that as of December 31, 2004, First Niagara and the
Commercial Bank met all capital adequacy requirements to which they were
subject. Further, the most recent FDIC notification categorized First
Niagara and the Commercial Bank as well-capitalized institutions under the
prompt corrective action regulations. Management is unaware of any
conditions or events since the latest notification from federal
regulators, including a $100 million dividend from First Niagara to FNFG
in January 2005 in connection with the acquisition of HRB, that have
changed the capital adequacy category of First Niagara or the Commercial
Bank.
65
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
FNFG's ability to pay dividends to its stockholders is substantially
dependent upon the ability of First Niagara to pay dividends to FNFG. The
payment of dividends by First Niagara is subject to continued compliance
with minimum regulatory capital requirements. As a result of the $100
million dividend in connection with the HRB acquisition, OTS approval is
now required prior to First Niagara declaring any dividends. The OTS may
disapprove a notice if: First Niagara would be undercapitalized following
the distribution; the proposed capital distribution raises safety and
soundness concerns; or the capital distribution would violate a
prohibition contained in any statute, regulation or agreement. Management
does not believe this regulatory requirement will affect First Niagara's
ability to pay dividends in the future given its well capitalized
position.
During 2004 the Company purchased 2.0 million shares of FNFG common stock,
completing its 2.1 million (3%) share repurchase program approved by its
Board of Directors and the OTS in July 2003. The average cost of the
shares repurchased under this program was $13.44. In August 2004 the Board
of Directors approved an additional program to repurchase up to 4.2
million (5%) of FNFG's outstanding common stock. As of December 31, 2004,
571 thousand shares have been repurchased under this program at an average
cost of $14.33 per share.
On January 17, 2003, FNFG converted from mutual to stock form (the
"Conversion"). In connection with the Conversion, the 61% of outstanding
shares of FNFG common stock owned by First Niagara Financial Group, MHC
(the "MHC") was sold to depositors of First Niagara and other public
investors (the "Offering"). Completion of the Conversion and Offering
resulted in the issuance of 67.4 million shares of common stock. A total
of 41.0 million shares were sold in subscription, community and syndicated
offerings, at $10.00 per share. An additional 26.4 million shares were
issued to the former public stockholders of FNFG based upon an exchange
ratio of 2.58681 new shares for each share of FNFG held as of the close of
business on January 17, 2003. In connection with the Conversion, the
amount of authorized but unissued preferred stock was increased from 5.0
million shares to 50.0 million shares. The Conversion was accounted for as
a reorganization in corporate form with no change in the historical basis
of the Company's assets, liabilities and equity. All per share data and
references to the number of shares outstanding for purposes of calculating
per share amounts prior to January 17, 2003, have been adjusted to give
recognition to the exchange ratio applied in the Conversion.
Costs related to the Offering, primarily marketing fees paid to the
Company's investment banking firm, professional fees, registration fees,
printing and mailing costs were $19.1 million and accordingly, net
offering proceeds were $390.9 million. As a result of the Conversion and
Offering, FNFG was succeeded by a new, fully public, Delaware corporation
with the same name and the MHC ceased to exist.
First Niagara established a liquidation account at the time Conversion.
The liquidation account was established in an amount equal to First
Niagara's net worth as of the date of the latest consolidated statement of
financial condition appearing in the final prospectus for the Conversion
(September 30, 2002). In the event of a complete liquidation of First
Niagara, each eligible account holder will be entitled, under New York
State Law, to receive a distribution from the liquidation accounts in an
amount equal to their current adjusted account balance for all such
depositors then holding qualifying deposits in First Niagara. Accordingly,
retained earnings of the Company are deemed to be restricted up to the
balances of the liquidation account at December 31, 2004 and 2003. The
liquidation account, which is reduced annually to the extent that eligible
account holders have reduced their qualifying deposits as of each
anniversary date, totaled $129.6 million at December 31, 2004 and $176.3
million at December 31, 2003.
66
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
(12) Stock Based Compensation
The Company has two stock based compensation plans pursuant to which
options may be granted to directors and key employees. The 1999 Stock
Option Plan authorizes grants of options to purchase up to 1,390,660
shares of common stock. In 2002, the Board of Directors and stockholders
of FNFG adopted a long-term incentive stock benefit plan. That plan
authorizes the issuance of up to 834,396 shares of common stock pursuant
to grants of stock options, stock appreciation rights, accelerated
ownership option rights or stock awards. During 2004 and 2003, only stock
options were granted under the 2002 plan. Under both plans, stock options
are granted with an exercise price equal to the stock's market value on
the date of grant. All options have a 10-year term and become fully vested
and exercisable over a period of 4 to 5 years from the grant date. At
December 31, 2004, there were a total of 552,597 shares available for
grant under both plans. The reduction of income taxes paid as a result of
the exercise of stock options was $3.0 million, $203 thousand and $477
thousand for 2004, 2003 and 2002, respectively. All stock options and
restricted stock awards outstanding and available for grant on January 17,
2003 were adjusted for the 2.58681 exchange ratio applied in the
Conversion. Share and per share amounts within this note prior to that
date have not been adjusted for this exchange ratio.
The following is a summary of stock option activity for 2004, 2003, and
2002:
Weighted
Number of average
shares exercise price
---------- --------------
Balance at January 1, 2002 1,252,225 $10.51
Granted 164,868 29.38
Exercised (90,350) 10.43
----------
Balance at December 31, 2002 1,326,743 12.86
January 17, 2003 Conversion 2,105,289 4.97
Granted 667,900 13.73
Exercised (104,823) 4.38
Forfeited (65,858) 7.13
----------
Balance at December 31, 2003 3,929,251 6.44
Granted 780,660 13.15
Exercised (981,738) 4.41
Forfeited (79,219) 12.98
----------
Balance at December 31, 2004 3,648,954 $ 8.28
==========
67
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
The following is a summary of stock options outstanding at December 31,
2004, 2003 and 2002:
Weighted Weighted Weighted
average average average
Options exercise remaining Options exercise
Exercise price outstanding price life (years) exercisable price
-------------------------- -------------- ----------- ------------ ------------- -----------
December 31, 2004:
$3.49 - $3.65 687,430 $ 3.51 5.46 540,562 $ 3.51
$4.16 916,280 4.16 4.38 916,280 4.16
$4.87 - $12.87 1,355,884 10.58 8.17 385,734 8.27
$13.28 - $16.21 689,360 14.00 8.59 156,175 13.78
------------- ------------
Total 3,648,954 8.28 6.79 1,998,751 5.53
============= ============
December 31, 2003:
$3.49 - $3.65 965,510 $ 3.51 6.44 668,152 $ 3.51
$4.16 - $5.93 1,859,766 4.30 5.74 1,454,209 4.24
$6.52 - $9.80 109,939 8.83 8.26 35,569 8.31
$11.25 - $16.21 994,036 13.03 9.21 151,854 12.06
------------- ------------
Total 3,929,251 6.44 6.86 2,309,784 4.60
============= ============
December 31, 2002:
$9.03 - $12.60 1,135,375 $10.41 6.99 544,495 $10.37
$13.80 - $16.86 26,500 15.48 8.73 5,125 15.67
$25.35 - $31.54 164,868 29.38 9.62 -- --
------------- ------------
Total 1,326,743 12.86 7.35 549,620 10.42
============= ============
During 1999, the Company allocated 556,264 shares for issuance under a
Restricted Stock Plan. The plan grants shares of FNFG's stock to executive
management, members of the Board of Directors and key employees. The
restricted stock generally vests over five years from the grant date.
Compensation expense equal to the market value of FNFG's stock on the
grant date is accrued ratably over the service period for shares granted.
At December 31, 2004, there were 345,410 unvested shares outstanding and
177,756 additional shares available for grant under the plan. Shares
granted under the Restricted Stock Plan during 2004, 2003 and 2002 totaled
140,100, 97,100 and 45,315, respectively, and had a weighted average
market value on the date of grant of $13.36, $13.49 and $26.99,
respectively. Compensation expense related to this plan amounted to $1.1
million, $1.4 million and $927 thousand for 2004, 2003 and 2002,
respectively.
(13) Income Taxes
Total income taxes were allocated as follows (in thousands):
2004 2003 2002
-------- -------- --------
Income from continuing operations $ 26,859 18,646 18,752
Income from discontinued operations -- 1,868 402
Stockholders' equity (6,751) (2,877) (1,345)
======== ======== ========
68
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
The components of income taxes attributable to income from continuing and
discontinued operations are as follows (in thousands):
2004 2003 2002
------- ------- -------
Continuing Operations:
Current:
Federal $17,760 14,888 16,182
State 1,759 901 1,470
------- ------- -------
19,519 15,789 17,652
------- ------- -------
Deferred:
Federal 6,680 2,447 (549)
State 660 410 1,649
------- ------- -------
7,340 2,857 1,100
------- ------- -------
Income taxes from continuing operations 26,859 18,646 18,752
Income taxes from discontinued operations -- 1,868 402
------- ------- -------
Total income taxes $26,859 20,514 19,154
======= ======= =======
The Company's effective tax rate for 2004, 2003 and 2002 was 34.1%, 36.2%
and 38.3%, respectively. Income tax expense attributable to income from
continuing operations differs from the expected tax expense (computed by
applying the Federal corporate tax rate of 35% to income before income
taxes) as follows (in thousands):
2004 2003 2002
-------- -------- --------
Expected tax expense from continuing operations $ 27,537 19,106 17,206
Increase (decrease) attributable to:
State income taxes, net of Federal
benefit and deferred state tax 1,876 757 820
Bank-owned life insurance income (1,287) (1,202) (930)
Municipal interest (1,677) (499) (430)
Nondeductible ESOP expense 416 450 209
Amortization of goodwill and intangibles 186 186 233
New York State bad debt tax expense
recapture, net of Federal benefit -- -- 1,784
Other (192) (152) (140)
-------- -------- --------
Income taxes from continuing operations $ 26,859 18,646 18,752
======== ======== ========
Prior to 2002, First Niagara was subject to special provisions in the New
York State tax law that allowed it to deduct on its tax return bad debt
expenses in excess of those actually incurred based on a specified formula
("excess reserve") as long as First Niagara was able to maintain the
required percentage of qualified assets to total assets. In 2002, First
Niagara was no longer able to maintain this required percentage of
qualified assets and therefore is required to repay this excess reserve.
Accordingly, the Company recorded a $1.8 million deferred tax liability
for the recapture of this excess reserve in 2002. It is anticipated that
the tax liability will be repaid over a period of 10 to 15 years. At
December 31, 2004, First Niagara's federal pre-1988 reserve, for which no
federal income tax provision has been made, was $24.3 million.
69
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 2004 and 2003 are presented below (in thousands):
2004 2003
-------- --------
Deferred tax assets:
Financial statement allowance for credit losses $ 16,527 10,143
Net purchase discount on acquired companies 157 663
Deferred compensation 3,459 2,749
Post-retirement benefit obligation 3,081 1,626
Unrealized loss on securities available for sale 3,390 226
Net operating loss carryforwards acquired 11,466 1,228
Other 853 653
-------- --------
Total gross deferred tax assets 38,933 17,288
Valuation allowance -- --
-------- --------
Net deferred tax assets 38,933 17,288
-------- --------
Deferred tax liabilities:
Tax return allowance for credit losses, in excess
of base year amount (1,575) (1,930)
Excess of tax return depreciation over financial
statement depreciation (1,237) (1,179)
Acquired intangibles (6,154) (797)
Pension obligation (2,300) (1,421)
Other (831) (665)
-------- --------
Total gross deferred tax liabilities (12,097) (5,992)
-------- --------
Net deferred tax asset $ 26,836 11,296
======== ========
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, availability of operating loss carrybacks, projected future
taxable income, and tax planning strategies in making this assessment.
Based upon the level of historical taxable income, the opportunity for net
operating loss carrybacks, and projections for future taxable income over
the periods which deferred tax assets are deductible, management believes
it is more likely than not the Company will realize the benefits of these
deductible differences at December 31, 2004.
During 2003, the Company sold its wholly-owned subsidiary, NOVA Healthcare
Administrators, Inc., which generated a pre-tax gain of $2.1 million. For
income tax purposes, this sale was treated as an asset sale, which
resulted in approximately $1.9 million in federal and state tax expense.
A financial institution may carry net operating losses back to the
preceding two taxable years and forward to the succeeding twenty taxable
years, subject to certain limitations. At December 31, 2004, First Niagara
had net operating loss carryforwards of $28.7 million for federal income
tax purposes and $28.6 million for New York State income tax purposes,
which will expire in 2023. These losses were obtained through the
acquisition of Troy Financial Corporation and the usage of these losses is
subject to an annual limitation.
70
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
First Niagara is subject to routine audits of its tax returns by the
Internal Revenue Service and New York State Department of Taxation and
Finance. There are no indications of any material adjustments for any
examination currently being conducted by these taxing authorities.
(14) Earnings Per Share
The following is the computation of basic and diluted earnings per share
for the periods indicated. All references to the number of shares
outstanding for purposes of calculating 2002 per share amounts have been
restated to give recognition to the 2.58681 exchange ratio applied in the
January 17, 2003 Conversion (in thousands except per share amounts):
2004 2003 2002
-------- -------- --------
Net income available to common stockholders $ 51,817 36,106 30,795
======== ======== ========
Weighted average shares outstanding:
Total shares issued 83,703 71,069 76,973
Unallocated ESOP shares (3,991) (4,050) (2,227)
Unvested restricted stock awards (385) (433) (567)
Treasury shares (577) (475) (9,734)
-------- -------- --------
Total basic weighted average shares outstanding 78,750 66,111 64,445
Incremental shares from assumed exercise of
stock options 1,103 1,436 1,224
Incremental shares from assumed vesting of
restricted stock awards 117 207 214
-------- -------- --------
Total diluted weighted average shares outstanding 79,970 67,754 65,883
======== ======== ========
Basic earnings per share $ 0.66 0.55 0.48
======== ======== ========
Diluted earnings per share $ 0.65 0.53 0.47
======== ======== ========
The above diluted weighted average share calculations do not include 347
thousand, 60 thousand and 182 thousand of stock option and restricted
stock awards for 2004, 2003 and 2002, respectively, as they are not
dilutive to the earnings per share calculations.
(15) Benefit Plans
401(k) Plan
Employees of the Company that meet certain age and service requirements
are eligible to participate in the Company sponsored 401(k) plan. Under
the plan, participants may make contributions, in the form of salary
reductions, up to the maximum Internal Revenue Code limit. The Company
contributes an amount to the plan equal to 100% of the first 2% of
employee contributions plus 75% of employee contributions between 3% and
6%. The Company's contribution to these plans amounted to $1.6 million,
$1.4 million and $1.3 million for 2004, 2003 and 2002, respectively.
Employee Stock Ownership Plan ("ESOP")
Employees of the Company that meet certain age and service requirements
are eligible to participate in the Company's ESOP. The ESOP holds shares
of FNFG common stock that were purchased in the 1998 initial public
offering, the Offering and in the open market. The 2,050,000 shares
purchased in the Offering were purchased at the $10 per share offering
price. The purchased shares were funded by loans in 1998 and 2003
71
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
from FNFG payable in equal annual installments over 30 years bearing a
fixed interest rate. Loan payments are funded by cash contributions from
First Niagara and dividends on allocated and unallocated FNFG stock held
by the ESOP. The loan can be prepaid without penalty. Shares purchased by
the ESOP are maintained in a suspense account and held for allocation
among the participants. As annual loan payments are made, shares are
released and allocated to employee accounts. Compensation expense is
recognized in an amount equal to the average market price of the shares
released during the respective year. Compensation expense of $1.9 million,
$2.0 million and $1.1 million was recognized for 2004, 2003 and 2002,
respectively, in connection with the 154,499, 154,499 and 45,786 shares
allocated to participants during those respective years. The amount of
unallocated and allocated FNFG shares held by the ESOP were 3,895,159 and
822,201, respectively, at December 31, 2004 and 4,049,658 and 713,245,
respectively, at December 31, 2003. The fair value of unallocated ESOP
shares was $54.3 million and $60.6 million at December 31, 2004 and 2003,
respectively.
Pension Plans
Effective February 1, 2002, the Company froze all benefit accruals and
participation in the First Niagara pension plan. Accordingly, subsequent
to that date, no employees are permitted to commence participation in the
plan and future salary increases and years of credited service will not be
considered when computing an employee's benefits under the plan.
Additionally, all pension plans acquired by the Company in connection with
its previous whole-bank acquisitions are frozen prior to the completion of
the transaction.
Information regarding the Company's pension plans at December 31, 2004 and
2003 are as follows (in thousands):
2004 2003
-------- --------
Change in projected benefit obligation:
Projected benefit obligation at beginning of year $ 16,818 11,173
Projected benefit obligation assumed in acquisition 22,380 4,353
Interest cost 2,115 868
Actuarial loss 2,178 1,245
Benefits paid (1,724) (615)
Settlements (69) (206)
Plan amendments 203 --
-------- --------
Projected benefit obligation at end of year 41,901 16,818
-------- --------
Change in fair value of plan assets:
Fair value of plan assets at beginning of year 14,675 8,186
Plan assets acquired 23,067 2,412
Employer contributions 2,945 3,839
Actual gain on plan assets 1,434 1,059
Benefits paid (1,724) (615)
Settlements (69) (206)
-------- --------
Fair value of plan assets at end of year 40,328 14,675
-------- --------
Projected benefit obligation in excess of plan
assets at end of year (1,573) (2,143)
Unrecognized actuarial loss 8,087 4,508
-------- --------
Prepaid pension costs $ 6,514 2,365
======== ========
Accumulated benefit obligation $ 41,901 16,818
======== ========
72
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
On January 16, 2004, in connection with its acquisition of TFC, the
Company became the sponsor of TSB's retirement plan, which was frozen on
December 31, 2003. This plan had an accumulated benefit obligation of
$22.4 million and a fair value of plan assets of $23.1 million at the time
of acquisition.
During 2004 the Company contributed $2.9 million to its defined benefit
pension plans and anticipates making $177 thousand of contributions in
2005. As of December 31, 2004, the Company has met all minimum ERISA
funding requirements. As of October 1, 2004 and 2003 the accumulated
benefit obligation of one of First Niagara's unfunded pension plans
exceeded the fair value of its assets. Accordingly, the Company has
recorded within stockholders' equity a $552 thousand (gross) additional
minimum pension liability net of taxes of $221 thousand for 2004 and a
$665 thousand (gross) additional minimum pension liability net of taxes of
$266 thousand for 2003. The projected benefit obligation for this plan was
$2.0 million at October 1, 2004 and 2003.
Net pension cost is comprised of the following (in thousands):
2004 2003 2002
------- ------- -------
Interest cost $ 2,115 868 751
Expected return on plan assets (2,934) (871) (892)
Amortization of unrecognized loss 275 207 --
Service cost -- -- 288
Amortization of unrecognized
prior service liability -- -- 58
Curtailment credit -- -- (998)
------- ------- -------
Net periodic pension cost (income) $ (544) 204 (793)
======= ======= =======
As a result of freezing the First Niagara plan in 2002, the Company
recognized a one-time pension curtailment gain of $998 thousand.
The principal actuarial assumptions used were as follows:
2004 2003 2002
------- ------- -------
Discount rate 5.75% 6.00% 6.50%
Expected long-term rate of return on plan assets 9.00% 9.00% 8.50%
======= ======= =======
The expected long-term rate of return on plan assets was determined based
on historical returns earned by equities and fixed income securities,
adjusted to reflect expectations of future returns as applied to the
plans' target allocation of asset classes. Equities and fixed income
securities were assumed to earn a return above the inflation rate in the
ranges of 5% to 9% and 2% to 6%, respectively. The long-term inflation
rate was estimated to be 3%. When these overall return expectations are
applied to the plan's target allocation, the expected rate of return is
determined to be 9.0% which is approximately the midpoint of the range of
expected return.
The weighted average asset allocation of the Company's pension plans at
October 1, 2004 and 2003, the plans measurement date, were as follows (in
thousands):
2004 2003
-------- --------
Asset Category:
Equity mutual funds 69% 67%
Bond mutual funds 31% 33%
-------- --------
100% 100%
======== ========
73
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
The Company's target allocation for investment in equity mutual funds is
60% - 70% with a mix between large cap core and value, small cap and
international companies. The target allocation for bond mutual fund
investments is 30% - 40% with a mix between actively managed and
intermediate bond funds. This allocation is consistent with the Company's
goal of diversifying the pension plans assets in order to preserve capital
while achieving investment results that will contribute to the proper
funding of pension obligations and cash flow requirements. If the plans
are underfunded, the bond fund portion will be temporarily increased to
50% in order to lessen asset value volatility. Asset rebalancing is
performed at least annually, with interim adjustments made when the
investment mix varies by more than 5% from the target.
Estimated benefit payments under the Company's pension plans over the next
ten years at December 31, 2004 is as follows (in thousands):
2005 $ 1,894
2006 1,901
2007 1,902
2008 1,974
2009 2,059
2010-2014 11,734
Other Post-retirement Benefits
The Company has modified its post-retirement plan so that participation is
closed to those employees who did not meet the retirement eligibility
requirements by December 31, 2001. A reconciliation of the benefit
obligation and accrued benefit cost of the Company's post-retirement plan
at December 31, 2004 and 2003 are as follows (in thousands):
2004 2003
------- -------
Change in accumulated post-retirement benefit obligation:
Accumulated post-retirement benefit
obligation at beginning of year $ 4,987 4,011
Post-retirement benefit obligation assumed in
acquisition 3,576 610
Interest cost 434 277
Actuarial loss 5 408
Benefits paid (387) (319)
------- -------
Accumulated post-retirement benefit obligation
at end of year 8,615 4,987
Fair value of plan assets at end of year -- --
------- -------
Post-retirement benefit obligation in excess
of plan assets at end of year (8,615) (4,987)
Unrecognized actuarial loss 1,583 1,667
Unrecognized prior service cost (691) (755)
------- -------
Accrued post-retirement benefit
cost at end of year $(7,723) (4,075)
======= =======
Accumulated post-retirement benefit obligation $ 8,615 4,987
======= =======
74
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
The components of net periodic post-retirement benefit cost are as follows
(in thousands):
2004 2003 2002
----- ----- -----
Interest cost $ 434 277 230
Amortization of unrecognized loss 90 53 13
Amortization of unrecognized prior service cost (64) (64) (64)
----- ----- -----
Total periodic cost $ 460 266 179
===== ===== =====
The principal actuarial assumptions used were as follows:
2004 2003 2002
------- ------- -------
Discount rate 5.75% 6.00% 6.50%
Assumed rate of future compensation increase 4.00% 4.00% 4.00%
======= ======= =======
The Company uses an October 1 measurement date for its post-retirement
plan. The assumed health care cost trend rate used in measuring the
accumulated post-retirement benefit obligation was 7.0% for 2005, and
gradually decreased to 4.5% by 2008 and thereafter. This assumption can
have a significant effect on the amounts reported. If the rate were
increased one percent, the accumulated post-retirement benefit obligation
as of December 31, 2004 would have increased by 12% and total periodic
cost would have increased by 7%. If the rate were decreased one percent,
the accumulated post-retirement benefit obligation as of December 31, 2004
would have decreased by 10% and the total periodic cost would have
decreased by 6%. The Company does not anticipate making any contributions
to its post-retirement plan in 2005.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
(the "Medicare Act") introduced prescription drug benefits under Medicare
Part D as well as a federal subsidy to sponsors of retiree health care
benefit plans that provide a benefit that is at least actuarially
equivalent to Medicare Part D. As permitted, the Company has elected to
defer recognizing the effects of the Medicare Act from the calculation of
its accumulated post-retirement benefit obligation and cost. In January
2005, the Centers for Medicare and Medicaid Services released final
regulations implementing the Medicare Act. An estimate of the Medicare
Act's effect on the Company's post-retirement benefit obligation and cost
has not yet been determined but is not expected to be significant to the
Company's consolidated statement of condition or results of operations.
Estimated benefit payments under the Company's post-retirement plan over
the next ten years at December 31, 2004 is as follows (in thousands):
2005 $ 543,451
2006 560,802
2007 572,143
2008 580,037
2009 587,791
2010-2014 3,046,560
Other Plans
The Company also sponsors various non-qualified compensation plans for
officers and employees. Awards are payable if certain earnings and
performance objectives are met. Awards under these plans amounted to $4.5
million, $3.7 million and $2.5 million for 2004, 2003 and 2002,
respectively. The Company also maintains various unfunded supplemental
benefit plans for certain former and present executive officers. The
accrued benefit liability under these plans was $2.5 million and $2.4
million at December 31, 2004 and 2003, respectively.
75
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
(16) Fair Value of Financial Instruments
The carrying value and estimated fair value of the Company's financial
instruments at December 31, 2004 and 2003 are as follows (in thousands):
Carrying Estimated fair
value value
----------- --------------
December 31, 2004:
Financial assets:
Cash and cash equivalents $ 67,642 67,642
Securities available for sale 1,170,129 1,170,129
Loans and leases, net 3,215,255 3,262,380
FHLB stock 28,485 28,485
Financial liabilities:
Deposits $ 3,337,682 3,331,553
Borrowings 750,686 769,257
December 31, 2003:
Financial assets:
Cash and cash equivalents $ 174,252 174,252
Securities available for sale 845,883 845,883
Loans and leases, net 2,269,203 2,335,908
FHLB stock 19,221 19,221
Financial liabilities:
Deposits $ 2,355,216 2,362,520
Borrowings 457,966 485,777
Fair value estimates are based on existing on and off balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that
are not considered financial instruments. In addition, the tax
ramifications related to the realization of the unrealized gains and
losses can have a significant effect on fair value estimates and have not
been considered in these estimates.
Fair value estimates are made as of the dates indicated, based on relevant
market information and information about the financial instruments,
including judgments regarding future expected loss experience, current
economic conditions, risk characteristics of various financial
instruments, and other factors. These estimates are subjective in nature
and involve uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in assumptions
could significantly affect the estimates. Fair value estimates, methods,
and assumptions are set forth below for each type of financial instrument.
Cash and Cash Equivalents
The carrying value approximates the fair value because the instruments
have original maturities of three months or less.
76
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
Securities Available for Sale
The carrying value and fair value are estimated based on year-end quoted
market prices.
Loans and Leases
Variable-rate loans reprice as the rate they are indexed to changes.
Therefore, the carrying value of such loans approximates their fair value.
The fair value of fixed-rate loans and leases are calculated by
discounting scheduled cash flows through estimated maturity using year-end
origination rates. The estimate of maturity is based on the contractual
cash flows adjusted for prepayment estimates based on current economic and
lending conditions.
FHLB Stock
FHLB stock carrying value approximates fair value.
Deposits
The fair value of deposits with no stated maturity, such as savings and
checking, as well as mortgagors' payments held in escrow, is equal to the
amount payable on demand. The fair value of certificates of deposit is
based on the discounted value of contractual cash flows, using rates
currently offered for deposits of similar remaining maturities.
Borrowings
The fair value of borrowings is calculated by discounting scheduled cash
flows through the estimated maturity using current market rates.
Commitments
The fair value of commitments to extend credit, standby letters of credit
and financial guarantees are not included in the above table as the
carrying value generally approximates fair value. These instruments
generate fees that approximate those currently charged to originate
similar commitments. Additional information about these instruments is
included in note 10.
(17) Segment Information
The Company has two business segments, banking and financial services. The
financial services segment includes the Company's insurance, investment
advisory and trust operations. The banking segment includes the results of
First Niagara excluding financial services. The results of operations from
NOVA Healthcare Administrators, Inc., the third-party benefit plan
administrator subsidiary sold in February 2003, are included as
discontinued operations in the financial services segment. Transactions
between the banking and financial services segments are primarily related
to interest income and expense on intercompany deposit accounts, and are
eliminated in consolidation.
77
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
Information for the Company's segments for the years ended December 31,
2004, 2003 and 2002 is presented in the following table (in thousands):
Financial Consolidated
Banking services Eliminations total
-------- -------- ------------ ------------
2004
Net interest income $156,071 31 -- 156,102
Provision for credit losses 8,442 -- -- 8,442
-------- -------- -------- --------
Net interest income after
provision for credit losses 147,629 31 -- 147,660
Noninterest income 29,705 22,227 (66) 51,866
Amortization of core deposit and
other intangibles 3,435 1,170 -- 4,605
Other noninterest expense 98,961 17,350 (66) 116,245
-------- -------- -------- --------
Income before income taxes 74,938 3,738 -- 78,676
Income tax expense 25,364 1,495 -- 26,859
-------- -------- -------- --------
Net income $ 49,574 2,243 -- 51,817
======== ======== ======== ========
2003
Net interest income $107,354 61 -- 107,415
Provision for credit losses 7,929 -- -- 7,929
-------- -------- -------- --------
Net interest income after
provision for credit losses 99,425 61 -- 99,486
Noninterest income 25,070 18,346 (37) 43,379
Amortization of core deposit and
other intangibles 439 945 -- 1,384
Other noninterest expense 72,420 14,510 (37) 86,893
-------- -------- -------- --------
Income from continuing operations
before income taxes 51,636 2,952 -- 54,588
Income taxes from continuing
operations 17,465 1,181 -- 18,646
-------- -------- -------- --------
Income from continuing operations 34,171 1,771 -- 35,942
Income from discontinued operations -- 164 -- 164
-------- -------- -------- --------
Net income $ 34,171 1,935 -- 36,106
======== ======== ======== ========
2002
Net interest income $ 91,425 105 -- 91,530
Provision for credit losses 6,824 -- -- 6,824
-------- -------- -------- --------
Net interest income after
provision for credit losses 84,601 105 -- 84,706
Noninterest income 25,500 16,372 (85) 41,787
Amortization of core deposit and
other intangibles -- 677 -- 677
Other noninterest expense 63,873 12,866 (85) 76,654
-------- -------- -------- --------
Income from continuing operations
before income taxes 46,228 2,934 -- 49,162
Income taxes from continuing
operations 17,578 1,174 -- 18,752
-------- -------- -------- --------
Income from continuing operations 28,650 1,760 -- 30,410
Income from discontinued operations -- 385 -- 385
-------- -------- -------- --------
Net income $ 28,650 2,145 -- 30,795
======== ======== ======== ========
78
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
(18) Condensed Parent Company Only Financial Statements
The following condensed statements of condition of FNFG as of December 31,
2004 and 2003 and the related condensed statements of income and cash
flows for 2004, 2003 and 2002 should be read in conjunction with the
consolidated financial statements and related notes (in thousands):
2004 2003
-------- --------
Condensed Statements of Condition
Assets:
Cash and cash equivalents $ 4,230 167,777
Investment securities available for sale 2,565 55
Loan receivable from ESOP 31,410 31,980
Investment in subsidiary 883,249 525,846
Other assets 7,275 3,217
-------- --------
Total assets $928,729 728,875
======== ========
Accounts payable and other liabilities $ 567 701
Stockholders' equity 928,162 728,174
-------- --------
Total liabilities and stockholders'
equity $928,729 728,875
======== ========
2004 2003 2002
-------- -------- --------
Condensed Statements of Income
Interest income $ 1,815 2,958 736
Dividends received from subsidiary 38,600 32,500 10,900
-------- -------- --------
Total interest income 40,415 35,458 11,636
Interest expense -- -- 166
-------- -------- --------
Net interest income 40,415 35,458 11,470
Net realized gains (losses) on securities
available for sale -- (79) 397
Noninterest expense 3,575 2,770 1,817
-------- -------- --------
Income before income taxes and
undisbursed income of subsidiary 36,840 32,609 10,050
Income tax benefit (808) (101) (355)
-------- -------- --------
Income before undisbursed
income of subsidiary 37,648 32,710 10,405
Undisbursed income of subsidiary 14,169 3,396 20,390
-------- -------- --------
Net income $ 51,817 36,106 30,795
======== ======== ========
79
FIRST NIAGARA FINANCIAL GROUP, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2004, 2003 and 2002
Condensed Statements of Cash Flows 2004 2003 2002
--------- --------- ---------
Cash flows from operating activities:
Net income $ 51,817 36,106 30,795
Adjustments to reconcile net income to
net cash provided by operating activities:
Undisbursed income of subsidiary (14,169) (3,396) (20,390)
Net realized (gains) losses on securities
available for sale -- 79 (397)
Stock based compensation expense 1,099 1,501 927
Deferred income tax expense (benefit) (207) (130) 36
(Increase) decrease in other assets 267 (4,201) (476)
Increase (decrease) in other liabilities (760) (1,169) 189
--------- --------- ---------
Net cash provided by operating
activities 38,047 28,790 10,684
--------- --------- ---------
Cash flow from investing activities:
Proceeds from sales of securities available for
sale 206 3,543 986
Purchases of securities available for sale (1,000) -- (582)
Principal payments on securities available for sale -- -- 3,405
Acquisitions, net of cash acquired (146,538) (28,128) --
Repayment of ESOP loan receivable 570 681 477
--------- --------- ---------
Net cash provided by (used in)
investing activities (146,762) (23,904) 4,286
--------- --------- ---------
Cash flows from financing activities:
Purchase of treasury stock (34,961) (1,604) --
Net proceeds from second step offering -- 195,454 --
Purchase of common stock by ESOP -- (20,500) --
Repayment of short-term borrowings -- -- (4,500)
Proceeds from exercise of stock options 4,049 459 942
Dividends paid on common stock (23,920) (14,642) (10,794)
--------- --------- ---------
Net cash provided by (used in)
financing activities (54,832) 159,167 (14,352)
--------- --------- ---------
Net increase (decrease) in cash and
cash equivalents (163,547) 164,053 618
Cash and cash equivalents at beginning
of year 167,777 3,724 3,106
--------- --------- ---------
Cash and cash equivalents at end of year $ 4,230 167,777 3,724
========= ========= =========
80
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
- --------------------------------------------------------------------------------
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
- --------------------------------------------------------------------------------
Evaluation of Disclosure Controls and Procedures - With the participation
of management, the Chief Executive Officer and Chief Financial Officer
have evaluated the effectiveness of the design and operation of the
Company's disclosure controls and procedures (as defined in Rule 13a-15(e)
and 15d-15(e) under the Exchange Act) as of December 31, 2004. Based upon
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that, as of that date, the Company's disclosure controls and
procedures are effective to ensure that information required to be
disclosed in the reports that the Company files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission's rules and forms. There has been no change in the Company's
internal control over financial reporting during the most recent fiscal
quarter that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial
reporting.
Management's Report on Internal Control Over Financial Reporting - Filed
herewith under Part II, Item 8, "Financial Statements and Supplementary
Data."
ITEM 9B. OTHER INFORMATION
- --------------------------------------------------------------------------------
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- --------------------------------------------------------------------------------
Information regarding directors and executive officers of FNFG in the
Proxy Statement for the 2005 Annual Meeting of Stockholders is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------------------------------------------------------
Information regarding executive compensation in the Proxy Statement for
the 2005 Annual Meeting of Stockholders is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- --------------------------------------------------------------------------------
Information regarding security ownership of certain beneficial owners of
FNFG management in the Proxy Statement for the 2005 Annual Meeting of
Stockholders is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------------------------------
Information regarding certain relationships and related transactions in
the Proxy Statement for the 2005 Annual Meeting of Stockholders is
incorporated herein by reference.
81
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
- --------------------------------------------------------------------------------
Information regarding the fees paid to and services provided by KPMG LLP,
the Company's independent registered public accounting firm in the Proxy
Statement for the 2005 Annual Meeting of Stockholders is incorporated
herein by reference.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Financial statements are filed as part of this Annual Report on Form
10-K. See Part II, Item 8. "Financial Statements and Supplementary
Data."
(b) Reports on Form 8-K
On October 18, 2004, the Company filed a Current Report on Form 8-K
which disclosed third quarter 2004 financial results. Such Current
Report, as an Item 9.01 exhibit included the Company's press release
dated October 18, 2004.
On December 7, 2004, the Company filed a Current Report on Form 8-K
which disclosed that it amended its revolving credit agreement (the
Agreement) with Fifth Third Bank to increase the maximum amount the
Company may borrow from $25.0 million to $50.0 million. The Company
also disclosed that the amended Agreement calls for the Company to
increase the amount of shares of First Niagara pledged to secure the
Agreement, and that it must continue to comply with the financial
covenants set forth in the original agreement. This Current Report
on Form 8-K also disclosed that on December 2, 2004, the Company
issued a joint press release with Hudson River Bancorp, Inc.
disclosing that they have received all necessary regulatory
approvals to proceed with their merger. Such Current Report, as Item
9.01 exhibits included the amended and restated revolving credit
promissory note and the Company's press release dated December 2,
2004.
82
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (Continued)
- --------------------------------------------------------------------------------
(c) Exhibits
The exhibits listed below are filed herewith or are incorporated by
reference to other filings.
Exhibit Index to Form 10-K
--------------------------
Exhibit 3.3 Certificate of Incorporation (1)
Exhibit 3.4 Bylaws (2)
Exhibit 10.1 Form of Employment Agreement with the Named
Executive Officers (3)
Exhibit 10.2 First Niagara Bank Deferred Compensation Plan (4)
Exhibit 10.3 First Niagara Financial Group, Inc. 1999 Stock
Option Plan (5)
Exhibit 10.4 First Niagara Financial Group, Inc. 1999
Recognition and Retention Plan(5)
Exhibit 10.5 First Niagara Financial Group, Inc. 2002 Long-Term
Incentive Stock Benefit Plan (6)
Exhibit 10.6 First Amended and Restated Revolving Credit
Promissory Note with Fifth Third Bank (7)
Exhibit 10.7 Residential Mortgage Program Agreement with
Homestead Funding Corp. (8)
Exhibit 11 Calculations of Basic Earnings Per Share and
Diluted Earnings Per Share (See Note 14 to Notes
to Consolidated Financial Statements)
Exhibit 14 Code of Ethics for Senior Financial Officers (9)
Exhibit 21 Subsidiary of First Niagara Financial Group, Inc.
(See Part I, Item 1 of Form 10-K)
Exhibit 23 Consent of Independent Registered Public
Accounting Firm
Exhibit 31.1 Certification of Chief Executive Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification of Chief Financial Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32 Certification of Chief Executive Officer and Chief
Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1, originally filed with the Securities and Exchange Commission on
September 18, 2002.
(2) Incorporated by reference to the Company's Registration Statement on Form
S-1, originally filed with the Securities and Exchange Commission on
September 18, 2002, as amended by the Company's Current Report on Form 8-K
filed with the Securities and Exchange Commission on September 29, 2004.
(3) Incorporated by reference to the Company's Pre-effective Amendment No. 1
to the Registration Statement on Form S-1, filed with the Securities and
Exchange Commission on November 14, 2002.
(4) Incorporated by reference to the Company's Registration Statement on Form
S-1, originally filed with the Securities and Exchange Commission on
December 22, 1997.
(5) Incorporated by reference to the Company's Proxy Statement for the 1999
Annual Meeting of Stockholders filed with the Securities and Exchange
Commission on March 31, 1999.
(6) Incorporated by reference to the Company's Proxy Statement for the 2002
Annual Meeting of Stockholders filed with the Securities and Exchange
Commission on March 27, 2002.
(7) Incorporated by reference to the Company's Current Report on Form 8-K
filed with the Securities and Exchange Commission on December 7, 2004.
(8) Confidential treatment requested for portions of this exhibit.
(9) Incorporated by reference to the Company's 2003 Annual Report on Form 10K
filed with the Securities and Exchange Commission on March 12, 2004.
83
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FIRST NIAGARA FINANCIAL GROUP, INC.
Date: March 14, 2005 By: /s/ Paul J. Kolkmeyer
-------------------------------------
Paul J. Kolkmeyer
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signatures Title Date
---------- ----- ----
/s/ Paul J. Kolkmeyer President and Chief Executive Officer March 14, 2005
- ---------------------
Paul J. Kolkmeyer
/s/ John R. Koelmel Executive Vice President, March 14, 2005
- ------------------- Chief Financial Officer
John R. Koelmel
/s/ Gordon P. Assad Director March 14, 2005
- -------------------
Gordon P. Assad
/s/ John J. Bisgrove, Jr. Director March 14, 2005
- -------------------------
John J. Bisgrove, Jr.
/s/ G. Thomas Bowers Director March 14, 2005
- --------------------
G. Thomas Bowers
/s/ James W. Currie Director March 14, 2005
- -------------------
James W. Currie
/s/ Daniel J. Hogarty, Jr. Vice Chairman March 14, 2005
- --------------------------
Daniel J. Hogarty, Jr.
/s/ William H. Jones Vice Chairman March 14, 2005
- --------------------
William H. Jones
/s/ Daniel W. Judge Director March 14, 2005
- -------------------
Daniel W. Judge
/s/ Richard P. Koskey Director March 14, 2005
- ---------------------
Richard Koskey
/s/ B. Thomas Mancuso Director March 14, 2005
- ---------------------
B. Thomas Mancuso
/s/ James Miklinski Director March 14, 2005
- -------------------
James Miklinski
84
/s/ Sharon D. Randaccio Director March 14, 2005
- -----------------------
Sharon D. Randaccio
/s/ Robert G. Weber Chairman March 14, 2005
- -------------------
Robert G. Weber
/s/ Louise Woerner Director March 14, 2005
- ------------------
Louise Woerner
/s/ David M. Zebro Director March 14, 2005
- ------------------
David M. Zebro
85