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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: SEPTEMBER 30, 2015

OR

 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______

Commission File No. 000-13580
SUFFOLK BANCORP
(Exact Name of Registrant as Specified in Its Charter)

NEW YORK
 
11-2708279
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)

4 WEST SECOND STREET, P.O. BOX 9000, RIVERHEAD, NY 11901
(Address of Principal Executive Offices) (Zip Code)

(631) 208-2400
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes
 
No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes
 
No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes
 
No

As of October 15, 2015, there were 11,792,756 shares of registrant’s Common Stock outstanding.
 


SUFFOLK BANCORP
Form 10-Q
For the Quarterly Period Ended September 30, 2015

Table of Contents

   
Page
 
PART I
 
     
Item 1.
Financial Statements
 
     
 
2
     
 
3
     
 
4
     
 
5
     
 
6
     
 
7
     
Item 2.
28
     
Item 3.
42
     
Item 4.
43
     
 
PART II
 
     
Item 1.
43
     
Item 1A.
43
     
Item 2.
44
     
Item 3.
44
     
Item 4.
44
     
Item 5.
44
     
Item 6.
44
     
 
45
 
PART I
ITEM 1. – FINANCIAL STATEMENTS

SUFFOLK BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CONDITION (UNAUDITED)
September 30, 2015 and December 31, 2014
(dollars in thousands, except per share data)

   
September 30, 2015
   
December 31, 2014
 
ASSETS
       
Cash and cash equivalents
       
Cash and non-interest-bearing deposits due from banks
 
$
79,049
   
$
41,140
 
Interest-bearing deposits due from banks
   
18,751
     
13,376
 
Federal funds sold
   
-
     
1,000
 
Total cash and cash equivalents
   
97,800
     
55,516
 
Interest-bearing time deposits in other banks
   
-
     
10,000
 
Federal Reserve and Federal Home Loan Bank stock and other investments
   
5,581
     
8,600
 
Investment securities:
               
Available for sale, at fair value
   
261,232
     
298,670
 
Held to maturity (fair value of $69,402 and $64,796, respectively)
   
66,427
     
62,270
 
Total investment securities
   
327,659
     
360,940
 
Loans
   
1,559,520
     
1,355,427
 
Allowance for loan losses
   
20,315
     
19,200
 
Net loans
   
1,539,205
     
1,336,227
 
Loans held for sale
   
745
     
26,495
 
Premises and equipment, net
   
23,144
     
23,641
 
Bank owned life insurance
   
46,027
     
45,109
 
Deferred taxes
   
14,422
     
15,714
 
Accrued interest and loan fees receivable
   
6,349
     
5,676
 
Goodwill and other intangibles
   
2,915
     
2,991
 
Other assets
   
2,997
     
4,374
 
TOTAL ASSETS
 
$
2,066,844
   
$
1,895,283
 
                 
LIABILITIES & STOCKHOLDERS' EQUITY
               
Demand deposits
 
$
801,212
   
$
683,634
 
Savings, N.O.W. and money market deposits
   
759,080
     
653,667
 
Subtotal core deposits
   
1,560,292
     
1,337,301
 
Time deposits
   
235,539
     
218,759
 
Total deposits
   
1,795,831
     
1,556,060
 
Borrowings
   
50,000
     
130,000
 
Unfunded pension liability
   
5,969
     
6,303
 
Capital leases
   
4,426
     
4,511
 
Other liabilities
   
14,078
     
15,676
 
TOTAL LIABILITIES
   
1,870,304
     
1,712,550
 
COMMITMENTS AND CONTINGENT LIABILITIES
               
STOCKHOLDERS' EQUITY
               
Common stock (par value $2.50; 15,000,000 shares authorized; 13,956,250 shares and 13,836,508 shares issued at September 30, 2015 and December 31, 2014, respectively; 11,790,512 shares and 11,670,770 shares outstanding at September 30, 2015 and December 31, 2014, respectively)
   
34,890
     
34,591
 
Surplus
   
45,656
     
44,230
 
Retained earnings
   
127,636
     
116,169
 
Treasury stock at par (2,165,738 shares)
   
(5,414
)
   
(5,414
)
Accumulated other comprehensive loss, net of tax
   
(6,228
)
   
(6,843
)
TOTAL STOCKHOLDERS' EQUITY
   
196,540
     
182,733
 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
2,066,844
   
$
1,895,283
 

See accompanying notes to unaudited condensed consolidated financial statements.
 
SUFFOLK BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
For the Three and Nine Months Ended September 30, 2015 and 2014
(dollars in thousands, except per share data)

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
INTEREST INCOME
               
Loans and loan fees
 
$
15,798
   
$
13,396
   
$
46,362
   
$
39,476
 
U.S. Government agency obligations
   
530
     
553
     
1,602
     
1,772
 
Obligations of states and political subdivisions
   
1,114
     
1,428
     
3,725
     
4,422
 
Collateralized mortgage obligations
   
149
     
198
     
507
     
672
 
Mortgage-backed securities
   
441
     
474
     
1,329
     
1,475
 
Corporate bonds
   
96
     
38
     
179
     
215
 
Federal funds sold, securities purchased under agreements to resell and interest-bearing deposits due from banks
   
7
     
35
     
50
     
123
 
Dividends
   
71
     
42
     
221
     
115
 
Total interest income
   
18,206
     
16,164
     
53,975
     
48,270
 
INTEREST EXPENSE
                               
Savings, N.O.W. and money market deposits
   
338
     
291
     
906
     
870
 
Time deposits
   
396
     
322
     
1,043
     
1,004
 
Borrowings
   
94
     
2
     
310
     
7
 
Total interest expense
   
828
     
615
     
2,259
     
1,881
 
Net interest income
   
17,378
     
15,549
     
51,716
     
46,389
 
Provision for loan losses
   
350
     
250
     
600
     
750
 
Net interest income after provision for loan losses
   
17,028
     
15,299
     
51,116
     
45,639
 
NON-INTEREST INCOME
                               
Service charges on deposit accounts
   
749
     
887
     
2,319
     
2,834
 
Other service charges, commissions and fees
   
759
     
778
     
2,032
     
2,349
 
Fiduciary fees
   
-
     
265
     
-
     
824
 
Net gain (loss) on sale of securities available for sale
   
133
     
11
     
319
     
(12
)
Net gain on sale of portfolio loans
   
370
     
217
     
568
     
217
 
Net gain on sale of mortgage loans originated for sale
   
85
     
51
     
290
     
214
 
Net gain on sale of premises and equipment
   
-
     
-
     
-
     
752
 
Income from bank owned life insurance
   
306
     
316
     
918
     
1,036
 
Other operating income
   
25
     
25
     
122
     
106
 
Total non-interest income
   
2,427
     
2,550
     
6,568
     
8,320
 
OPERATING EXPENSES
                               
Employee compensation and benefits
   
7,980
     
8,628
     
25,102
     
25,977
 
Occupancy expense
   
1,401
     
1,295
     
4,236
     
4,141
 
Equipment expense
   
410
     
418
     
1,199
     
1,301
 
Consulting and professional services
   
609
     
693
     
1,491
     
1,883
 
FDIC assessment
   
226
     
202
     
802
     
737
 
Data processing
   
506
     
549
     
1,590
     
1,681
 
Branch consolidation credits
   
-
     
-
     
-
     
(449
)
Other operating expenses
   
1,536
     
1,451
     
4,530
     
4,426
 
Total operating expenses
   
12,668
     
13,236
     
38,950
     
39,697
 
Income before income tax expense
   
6,787
     
4,613
     
18,734
     
14,262
 
Income tax expense
   
1,864
     
875
     
4,684
     
3,033
 
NET INCOME
 
$
4,923
   
$
3,738
   
$
14,050
   
$
11,229
 
EARNINGS PER COMMON SHARE - BASIC
 
$
0.42
   
$
0.32
   
$
1.20
   
$
0.97
 
EARNINGS PER COMMON SHARE - DILUTED
 
$
0.42
   
$
0.32
   
$
1.19
   
$
0.96
 
WEIGHTED AVERAGE COMMON SHARES - BASIC
   
11,785,731
     
11,661,544
     
11,743,076
     
11,611,790
 
WEIGHTED AVERAGE COMMON SHARES - DILUTED
   
11,863,299
     
11,716,286
     
11,817,899
     
11,667,991
 
CASH DIVIDENDS DECLARED PER COMMON SHARE
 
$
0.10
   
$
0.06
   
$
0.22
   
$
0.06
 

See accompanying notes to unaudited condensed consolidated financial statements.
 
SUFFOLK BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
For the Three and Nine Months Ended September 30, 2015 and 2014
(in thousands)

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
                 
Net income
 
$
4,923
   
$
3,738
   
$
14,050
   
$
11,229
 
                               
Other comprehensive income (loss), net of tax and reclassification adjustments:
                               
Change in unrealized gain (loss) on securities available for sale arising during the period, net of tax of $700, ($416), $354 and $3,851, respectively
   
1,008
     
(641
)
   
479
     
6,430
 
Change in unrealized gain (loss) on securities transferred from available for sale to held to maturity, net of tax of $14, $26, $67 and ($1,201), respectively
   
55
     
40
     
136
     
(1,850
)
Total other comprehensive income (loss), net of tax
   
1,063
     
(601
)
   
615
     
4,580
 
Total comprehensive income
 
$
5,986
   
$
3,137
   
$
14,665
   
$
15,809
 

See accompanying notes to unaudited condensed consolidated financial statements.
 
SUFFOLK BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
For the Nine Months Ended September 30, 2015 and 2014
(in thousands, except per share data)

   
Nine Months Ended September 30,
 
   
2015
   
2014
 
Common stock
       
Balance, January 1
 
$
34,591
   
$
34,348
 
Dividend reinvestment (23,524 and 2,291 shares issued, respectively)
   
59
     
5
 
Stock options exercised (39,334 and 18,735 shares issued, respectively)
   
98
     
46
 
Stock-based compensation
   
142
     
184
 
Ending balance
   
34,890
     
34,583
 
Surplus
               
Balance, January 1
   
44,230
     
43,280
 
Dividend reinvestment
   
501
     
38
 
Stock options exercised
   
441
     
200
 
Stock-based compensation
   
484
     
416
 
Ending balance
   
45,656
     
43,934
 
Retained earnings
               
Balance, January 1
   
116,169
     
102,273
 
Net income
   
14,050
     
11,229
 
Cash dividends on common stock ($0.22 and $0.06 per share, respectively)
   
(2,583
)
   
(699
)
Ending balance
   
127,636
     
112,803
 
Treasury stock
               
Balance, January 1
   
(5,414
)
   
(5,414
)
Ending balance
   
(5,414
)
   
(5,414
)
Accumulated other comprehensive loss, net of tax
               
Balance, January 1
   
(6,843
)
   
(7,289
)
Other comprehensive income
   
615
     
4,580
 
Ending balance
   
(6,228
)
   
(2,709
)
Total stockholders' equity
 
$
196,540
   
$
183,197
 

See accompanying notes to unaudited condensed consolidated financial statements.
 
SUFFOLK BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the Nine Months Ended September 30, 2015 and 2014
(in thousands)

   
Nine Months Ended September 30,
 
   
2015
   
2014
 
NET INCOME
 
$
14,050
   
$
11,229
 
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
               
Provision for loan losses
   
600
     
750
 
Depreciation and amortization
   
1,740
     
1,775
 
Stock-based compensation - net
   
626
     
600
 
Net amortization of premiums
   
863
     
889
 
Originations of mortgage loans held for sale
   
(31,613
)
   
(10,745
)
Proceeds from sale of mortgage loans originated for sale
   
32,517
     
11,134
 
Gain on sale of mortgage loans originated for sale
   
(290
)
   
(214
)
Gain on sale of portfolio loans
   
(568
)
   
(217
)
Decrease (increase) in other intangibles
   
76
     
(9
)
Deferred tax expense (benefit)
   
872
     
(1,914
)
Increase in accrued interest and loan fees receivable
   
(673
)
   
(786
)
Decrease in other assets
   
1,377
     
613
 
Adjustment to unfunded pension liability
   
(334
)
   
(274
)
Decrease in other liabilities
   
(1,598
)
   
(3,133
)
Income from bank owned life insurance
   
(918
)
   
(1,036
)
Gain on sale of premises and equipment
   
-
     
(752
)
Net (gain) loss on sale of securities available for sale
   
(319
)
   
12
 
Net cash provided by operating activities
   
16,408
     
7,922
 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Principal payments on investment securities - available for sale
   
8,030
     
9,692
 
Proceeds from sale of investment securities - available for sale
   
10,080
     
20,604
 
Maturities of investment securities - available for sale
   
26,505
     
20,807
 
Purchases of investment securities - available for sale
   
(6,800
)
   
(800
)
Maturities of investment securities - held to maturity
   
1,957
     
994
 
Purchases of investment securities -  held to maturity
   
(6,000
)
   
(3,434
)
Decrease in interest-bearing time deposits in other banks
   
10,000
     
-
 
Decrease (increase) in Federal Reserve and Federal Home Loan Bank stock and other investments
   
3,019
     
(337
)
Proceeds from sale of portfolio loans
   
49,871
     
25,371
 
Loan originations - net
   
(227,745
)
   
(217,580
)
Proceeds from sale of premises and equipment
   
-
     
1,064
 
Increase in bank owned life insurance
   
-
     
(5,000
)
Purchases of premises and equipment - net
   
(1,243
)
   
(727
)
Net cash used in investing activities
   
(132,326
)
   
(149,346
)
CASH FLOWS FROM FINANCING ACTIVITIES
               
Net increase in deposit accounts
   
239,771
     
70,708
 
Net (decrease) increase in short-term borrowings
   
(95,000
)
   
10,000
 
Net increase in long-term borrowings
   
15,000
     
-
 
Proceeds from stock options exercised
   
539
     
246
 
Cash dividends paid on common stock
   
(2,583
)
   
(699
)
Proceeds from shares issued under the dividend reinvestment plan
   
560
     
43
 
Decrease  in capital lease payable
   
(85
)
   
(74
)
Net cash provided by financing activities
   
158,202
     
80,224
 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
   
42,284
     
(61,200
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
   
55,516
     
132,352
 
CASH AND CASH EQUIVALENTS, END OF PERIOD
 
$
97,800
   
$
71,152
 
SUPPLEMENTAL DATA:
               
Interest paid
 
$
2,208
   
$
1,892
 
Income taxes paid
 
$
3,148
   
$
5,264
 
Loans transferred to held-for-sale
 
$
24,164
   
$
25,221
 
Investment securities transferred from available for sale to held to maturity
 
$
-
   
$
48,147
 

See accompanying notes to unaudited condensed consolidated financial statements.
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. FINANCIAL STATEMENT PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Suffolk Bancorp (the “Company”) was incorporated in 1985 as a bank holding company. The Company currently owns all of the outstanding capital stock of Suffolk County National Bank (the “Bank”). The Bank was organized under the national banking laws of the United States in 1890. The Bank formed Suffolk Greenway, Inc. (the “REIT”), a real estate investment trust, and owns 100% of an insurance agency and two corporations used to acquire foreclosed real estate. The insurance agency and the two corporations used to acquire foreclosed real estate are immaterial to the Company’s operations. The unaudited interim condensed consolidated financial statements include the accounts of the Company and the Bank and its subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation. Unless the context otherwise requires, references herein to the Company include the Company and the Bank and subsidiaries on a consolidated basis.

In the opinion of the Company’s management, the preceding unaudited interim condensed consolidated financial statements contain all adjustments, consisting of normal accruals, necessary for a fair presentation of its condensed consolidated statement of condition as of September 30, 2015, its condensed consolidated statements of income for the three and nine months ended September 30, 2015 and 2014, its condensed consolidated statements of comprehensive income for the three and nine months ended September 30, 2015 and 2014, its condensed consolidated statements of changes in stockholders’ equity for the nine months ended September 30, 2015 and 2014 and its condensed consolidated statements of cash flows for the nine months ended September 30, 2015 and 2014.

The preceding unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X, as well as in accordance with predominant practices within the banking industry. They do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. The results of operations for the three and nine months ended September 30, 2015 are not necessarily indicative of the results of operations to be expected for the remainder of the year. For further information, please refer to the audited consolidated financial statements and footnotes thereto included in the Company’s 2014 Annual Report on Form 10-K.

Earnings Per Share - Basic earnings per share is computed based on the weighted average number of common shares and unvested restricted shares outstanding for each period. The Company’s unvested restricted shares are considered participating securities as they contain rights to non-forfeitable dividends and thus they are included in the basic earnings per share computation. Diluted earnings per share include the dilutive effect of additional potential common shares issuable under stock options. In the event a net loss is reported, restricted shares and stock options are excluded from earnings per share computations.

The reconciliation of basic and diluted weighted average number of common shares outstanding for the three and nine months ended September 30, 2015 and 2014 follows.

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
                 
Weighted average common shares outstanding
   
11,674,697
     
11,586,564
     
11,636,155
     
11,578,350
 
Weighted average unvested restricted shares
   
111,034
     
74,980
     
106,921
     
33,440
 
Weighted average shares for basic earnings per share
   
11,785,731
     
11,661,544
     
11,743,076
     
11,611,790
 
Additional diluted shares:
                               
Stock options
   
77,568
     
54,742
     
74,823
     
56,201
 
Weighted average shares for diluted earnings per share
   
11,863,299
     
11,716,286
     
11,817,899
     
11,667,991
 

Loans and Loan Interest Income Recognition – Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned discounts, deferred loan fees and costs. Unearned discounts on installment loans are credited to income using methods that result in a level yield. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income over the respective term of the loan without anticipating prepayments.
 
Interest income is accrued on the unpaid loan principal balance. Recognition of interest income is discontinued when reasonable doubt exists as to whether principal or interest due can be collected. Loans of all classes will generally no longer accrue interest when over 90 days past due unless the loan is well-secured and in process of collection. When a loan is placed on non-accrual status, all interest previously accrued, but not collected, is reversed against current-year interest income. Interest received on such loans is applied against principal or interest, according to management’s judgment as to the collectability of the principal, until qualifying for return to accrual status. Loans may start accruing interest again when they become current as to principal and interest for at least six months, and when, after a well-documented analysis by management, it has been determined that the loans can be collected in full.  For all classes of loans, an impaired loan is defined as a loan for which it is probable that the lender will not collect all amounts due under the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties are considered troubled debt restructurings (“TDRs”) and are classified as impaired. Generally, TDRs are initially classified as non-accrual until sufficient time has passed to assess whether the restructured loan will continue to perform. For impaired, accruing loans, interest income is recognized on an accrual basis with cash offsetting the recorded accruals upon receipt.

Allowance for Loan Losses - The allowance for loan losses is a valuation allowance for probable incurred losses, increased by the provision for loan losses and recoveries, and decreased by loan charge-offs. For all classes of loans, when a loan, in full or in part, is deemed uncollectible, it is charged against the allowance for loan losses. This happens when the loan is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have sufficient assets to pay the debt, or the value of the collateral is less than the balance of the loan and is not considered likely to improve soon. The allowance for loan losses is determined by a quarterly analysis of the loan portfolio. Such analysis includes changes in the size and composition of the portfolio, the Company’s own historical loan losses, industry-wide losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions and other relevant factors. All non-accrual loans over $250 thousand in the commercial and industrial, commercial real estate and real estate construction loan classes and all TDRs are evaluated individually for impairment. All other loans are generally evaluated as homogeneous pools with similar risk characteristics. In assessing the adequacy of the allowance for loan losses, management reviews the loan portfolio by separate classes that have similar risk and collateral characteristics. These classes are commercial and industrial, commercial real estate, multifamily, mixed use commercial, real estate construction, residential mortgages, home equity and consumer loans.

The allowance for loan losses consists of specific and general components, as well as an unallocated component. The specific component relates to loans that are individually classified as impaired. Specific reserves are established based on an analysis of the most probable sources of repayment or liquidation of collateral. Impaired loans that are collateral dependent are reviewed based on the fair market value of collateral and the estimated time required to recover the Company’s investment in the loans, as well as the cost of doing so, and the estimate of the recovery. Non-collateral dependent impaired loans are reviewed based on the present value of estimated future cash flows, including balloon payments, if any, using the loan’s effective interest rate. While every impaired loan is evaluated individually, not every loan requires a specific reserve. Specific reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs. The general component covers non-impaired loans and is based on historical loss experience for each loan class from a rolling twelve quarter period and modifying those percentages, if necessary, after adjusting for current qualitative and environmental factors that reflect changes in the estimated collectability of the loan class not captured by historical loss data. These factors augment actual loss experience and help estimate the probability of loss within the loan portfolio based on emerging or inherent risk trends. These qualitative factors are applied as an adjustment to historical loss rates and require judgments that cannot be subjected to exact mathematical calculation. These adjustments reflect management’s overall estimate of the extent to which current losses on a pool of loans will differ from historical loss experience. These adjustments are subjective estimates and management reviews them on a quarterly basis. TDRs are also considered impaired with impairment generally measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception or using the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

Loans Held For Sale – Loans held for sale are carried at the lower of aggregate cost or fair value, based on observable inputs in the secondary market. Changes in fair value of loans held for sale are recognized in earnings.

Bank Owned Life Insurance – Bank owned life insurance is recorded at the lower of the cash surrender value or the amount that can be realized under the insurance policy and is included as an asset in the consolidated statements of condition. Changes in the cash surrender value and insurance benefit payments are recorded in non-interest income in the consolidated statements of income.

Derivatives - Derivatives are contracts between counterparties that specify conditions under which settlements are to be made. The only derivatives held by the Company are swap contracts with the purchaser of its Visa Class B shares. The Company records its derivatives on the consolidated statements of condition at fair value. The Company’s derivatives do not qualify for hedge accounting. As a result, changes in fair value are recognized in earnings in the period in which they occur. (See also Note 3. Investment Securities contained herein.)
 
Recent Accounting Guidance – In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), “Revenue from Contracts with Customers,” which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of the ASU is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. The ASU defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The FASB recently issued ASU 2015-14 to defer the effective date of the new revenue recognition standard by one year. As such, it now takes effect for public entities in fiscal years beginning after December 15, 2017, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting the ASU recognized at the date of adoption (which includes additional footnote disclosures). Early adoption is permitted for any entity that chooses to adopt the new standard as of the original effective date. The Company has not yet determined the method by which it will adopt ASU 2014-09 in 2018 and does not believe that the adoption will have a material effect on the Company’s consolidated financial statements.

In January 2014, the FASB issued ASU 2014-04, Receivables—Troubled Debt Restructurings by Creditors (Topic 310), “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure,” to clarify when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The ASU requires interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. The Company’s adoption of ASU 2014-04 on January 1, 2015 did not have a material effect on the Company’s consolidated financial statements.

Reclassifications — Certain reclassifications have been made to prior period information in order to conform to the current period’s presentation. Such reclassifications had no impact on the Company’s consolidated results of operations or financial condition.

2. ACCUMULATED OTHER COMPREHENSIVE INCOME (“AOCI”)
The changes in the Company’s AOCI by component, net of tax, for the three and nine months ended September 30, 2015 and 2014 follow (in thousands).

   
Three Months Ended September 30, 2015
   
Three Months Ended September 30, 2014
 
   
Unrealized
Gains and
Losses on
Available for
Sale Securities
   
Unrealized Losses
on Securities
Transferred from
Available for Sale
to Held to
Maturity
   
Pension and
Post-
Retirement
Plan Items
   
Total
   
Unrealized
Gains and
Losses on
Available for
Sale Securities
   
Unrealized Losses
on Securities
Transferred from
Available for Sale
to Held to
Maturity
   
Pension and
 Post-
Retirement
Plan Items
   
Total
 
Beginning balance
 
$
2,108
   
$
(1,724
)
 
$
(7,675
)
 
$
(7,291
)
 
$
2,976
   
$
(1,890
)
 
$
(3,194
)
 
$
(2,108
)
Other comprehensive income (loss) before reclassifications
   
1,087
     
-
     
-
     
1,087
     
(634
)
   
(1
)
   
-
     
(635
)
Amounts reclassified from AOCI
   
(79
)
   
55
     
-
     
(24
)
   
(7
)
   
41
     
-
     
34
 
Net other comprehensive income (loss)
   
1,008
     
55
     
-
     
1,063
     
(641
)
   
40
     
-
     
(601
)
Ending balance
 
$
3,116
   
$
(1,669
)
 
$
(7,675
)
 
$
(6,228
)
 
$
2,335
   
$
(1,850
)
 
$
(3,194
)
 
$
(2,709
)
 
   
Nine Months Ended September 30, 2015
   
Nine Months Ended September 30, 2014
 
   
Unrealized
Gains and
 Losses on
Available for
Sale Securities
   
Unrealized Losses
on Securities
Transferred from
Available for Sale
 to Held to
Maturity
   
Pension and
Post-
Retirement
Plan Items
   
Total
   
Unrealized
Gains and
Losses on
Available for
Sale Securities
   
Unrealized Losses
on Securities
Transferred from
Available for Sale
 to Held to
Maturity
   
Pension and
Post-
Retirement
Plan Items
   
Total
 
Beginning balance
 
$
2,637
   
$
(1,805
)
 
$
(7,675
)
 
$
(6,843
)
 
$
(4,095
)
 
$
-
   
$
(3,194
)
 
$
(7,289
)
Other comprehensive income (loss) before reclassifications
   
670
     
-
     
-
     
670
     
6,423
     
(1,944
)
   
-
     
4,479
 
Amounts reclassified from AOCI
   
(191
)
   
136
     
-
     
(55
)
   
7
     
94
     
-
     
101
 
Net other comprehensive income (loss)
   
479
     
136
     
-
     
615
     
6,430
     
(1,850
)
   
-
     
4,580
 
Ending balance
 
$
3,116
   
$
(1,669
)
 
$
(7,675
)
 
$
(6,228
)
 
$
2,335
   
$
(1,850
)
 
$
(3,194
)
 
$
(2,709
)
 
Reclassifications out of AOCI for the three and nine months ended September 30, 2015 and 2014 follow (in thousands).
 
   
Amount Reclassified from AOCI         
   
   
Three Months Ended September 30,  
   
Nine Months Ended September 30,  
 
Affected Line Item in
the Statement
Details about AOCI
Components
 
2015
   
2014
   
2015
   
2014
 
Where Net Income is
Presented
Unrealized gains and losses on available for sale securities
 
$
133
   
$
11
   
$
319
   
$
(12
)
Net gain (loss) on sale of securities available for sale
                                                 
Unrealized losses on securities transferred from available for sale to held to maturity
   
(69
)
   
(67
)
   
(203
)
   
(153
)
Interest income - U.S. Government agency obligations
     
(40
)
   
22
     
(61
)
   
64
 
Income tax expense
Total, net of tax
 
$
24
   
$
(34
)
 
$
55
   
$
(101
)
 
 
3. INVESTMENT SECURITIES
At the time of purchase of a security, the Company designates the security as either available for sale or held to maturity, depending upon investment objectives, liquidity needs and intent. Securities held to maturity are stated at cost, adjusted for premium amortized or discount accreted, if any. The Company has the positive intent and ability to hold such securities to maturity. Securities available for sale are stated at estimated fair value. Unrealized gains and losses are excluded from income and reported net of tax in AOCI as a separate component of stockholders’ equity until realized. Changes in unrealized gains and losses are reported, net of tax, in the consolidated statements of comprehensive income. Interest earned on securities is included in interest income. Realized gains and losses on the sale of securities are reported in the consolidated statements of income and determined using the adjusted cost of the specific security sold.

In 2014, investment securities with a fair value of $48 million and unrealized loss of $3.2 million were transferred from available for sale to held to maturity. In accordance with U.S. GAAP, the securities were transferred at fair value, which became the amortized cost. The discount will be accreted to interest income over the remaining life of the security. The unrealized holding losses at the date of transfer remained in AOCI and will be amortized simultaneously against interest income. Those entries will offset or mitigate each other.
 
The amortized cost, fair value and gross unrealized gains and losses of the Company’s investment securities available for sale and held to maturity at September 30, 2015 and December 31, 2014 were as follows (in thousands):
 
   
September 30, 2015
   
December 31, 2014
 
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
Available for sale:
                               
U.S. Government agency securities
 
$
38,977
   
$
18
   
$
(201
)
 
$
38,794
   
$
42,474
   
$
-
   
$
(897
)
 
$
41,577
 
Obligations of states and political subdivisions
   
105,217
     
5,155
     
-
     
110,372
     
131,300
     
6,469
     
-
     
137,769
 
Collateralized mortgage obligations
   
16,547
     
48
     
(129
)
   
16,466
     
22,105
     
423
     
(531
)
   
21,997
 
Mortgage-backed securities
   
89,299
     
589
     
(258
)
   
89,630
     
92,095
     
88
     
(1,264
)
   
90,919
 
Corporate bonds
   
6,000
     
-
     
(30
)
   
5,970
     
6,336
     
90
     
(18
)
   
6,408
 
Total available for sale securities
   
256,040
     
5,810
     
(618
)
   
261,232
     
294,310
     
7,070
     
(2,710
)
   
298,670
 
Held to maturity:
                                                               
U.S. Government agency securities
   
48,568
     
2,290
     
-
     
50,858
     
48,365
     
1,717
     
-
     
50,082
 
Obligations of states and political subdivisions
   
11,859
     
633
     
-
     
12,492
     
13,905
     
809
     
-
     
14,714
 
Corporate bonds
   
6,000
     
52
     
-
     
6,052
     
-
     
-
     
-
     
-
 
Total held to maturity securities
   
66,427
     
2,975
     
-
     
69,402
     
62,270
     
2,526
     
-
     
64,796
 
Total investment securities
 
$
322,467
   
$
8,785
   
$
(618
)
 
$
330,634
   
$
356,580
   
$
9,596
   
$
(2,710
)
 
$
363,466
 
 
At September 30, 2015 and December 31, 2014, investment securities carried at $268 million and $245 million, respectively, were pledged primarily for public funds on deposit and as collateral for the Company’s derivative swap contracts.

The amortized cost, contractual maturities and fair value of the Company’s investment securities at September 30, 2015 (in thousands) are presented in the table below. Collateralized mortgage obligations (“CMOs”) and mortgage-backed securities (“MBS”) assume maturity dates pursuant to average lives.

   
September 30, 2015
 
   
Amortized
Cost
   
Fair
Value
 
Securities available for sale:
       
Due in one year or less
 
$
29,275
   
$
29,688
 
Due from one to five years
   
134,171
     
138,558
 
Due from five to ten years
   
92,594
     
92,986
 
Total securities available for sale
   
256,040
     
261,232
 
Securities held to maturity:
               
Due in one year or less
   
836
     
859
 
Due from one to five years
   
4,363
     
4,650
 
Due from five to ten years
   
38,141
     
39,351
 
Due after ten years
   
23,087
     
24,542
 
Total securities held to maturity
   
66,427
     
69,402
 
Total investment securities
 
$
322,467
   
$
330,634
 
 
The proceeds from sales of securities available for sale and the associated realized gains and losses are shown below for the periods indicated (in thousands). Realized gains are also inclusive of gains on called securities.
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
                 
Proceeds
 
$
3,077
   
$
-
   
$
10,080
   
$
20,604
 
                                 
Gross realized gains
 
$
133
   
$
11
   
$
334
   
$
240
 
Gross realized losses
   
-
     
-
     
(15
)
   
(252
)
Net realized gains (losses)
 
$
133
   
$
11
   
$
319
   
$
(12
)
 
Information pertaining to securities with unrealized losses at September 30, 2015 and December 31, 2014, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows (in thousands):

   
Less than 12 months
   
12 months or longer
   
Total
 
September 30, 2015
 
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
U.S. Government agency securities
 
$
13,941
   
$
(52
)
 
$
19,851
   
$
(149
)
 
$
33,792
   
$
(201
)
Collateralized mortgage obligations
   
-
     
-
     
8,447
     
(129
)
   
8,447
     
(129
)
Mortgage-backed securities
   
13,841
     
(79
)
   
18,495
     
(179
)
   
32,336
     
(258
)
Corporate bonds
   
5,970
     
(30
)
   
-
     
-
     
5,970
     
(30
)
Total
 
$
33,752
   
$
(161
)
 
$
46,793
   
$
(457
)
 
$
80,545
   
$
(618
)
 
 
Less than 12 months
 
12 months or longer
 
Total
 
December 31, 2014
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
U.S. Government agency securities
 
$
-
   
$
-
   
$
41,577
   
$
(897
)
 
$
41,577
   
$
(897
)
Collateralized mortgage obligations
   
-
     
-
     
8,417
     
(531
)
   
8,417
     
(531
)
Mortgage-backed securities
   
-
     
-
     
81,510
     
(1,264
)
   
81,510
     
(1,264
)
Corporate bonds
   
-
     
-
     
2,982
     
(18
)
   
2,982
     
(18
)
Total
 
$
-
   
$
-
   
$
134,486
   
$
(2,710
)
 
$
134,486
   
$
(2,710
)

All securities with unrealized losses for twelve months or longer at September 30, 2015 are issued or guaranteed by U.S. Government agencies or sponsored enterprises and the related unrealized losses resulted solely from the current interest rate environment and the corresponding shape of the yield curve. The Company does not intend to sell and it is not more likely than not that the Company will be required to sell these securities prior to their recovery to a level equal to or greater than amortized cost. Management has determined that no other-than-temporary impairment (“OTTI”) was present at September 30, 2015.

The Bank was a member of the Visa USA payment network and was issued Class B shares upon Visa’s initial public offering in March 2008. The Visa Class B shares are transferable only under limited circumstances until they can be converted into shares of the publicly traded class of stock. This conversion cannot happen until the settlement of certain litigation, which is indemnified by Visa members. Since its initial public offering, Visa has funded a litigation reserve based upon a change in the conversion ratio of Visa Class B shares into Visa Class A shares. At its discretion, Visa may continue to increase the conversion rate in connection with any settlements in excess of amounts then in escrow for that purpose and reduce the conversion rate to the extent that it adds any funds to the escrow in the future. Based on the existing transfer restriction and the uncertainty of the litigation, the Company has recorded its Visa Class B shares on its balance sheet at zero value.

In conjunction with the sale of Visa Class B shares in 2013, the Company entered into derivative swap contracts with the purchaser of these Visa Class B shares which provide for settlements between the purchaser and the Company based upon a change in the conversion ratio of Visa Class B shares into Visa Class A shares. The Company’s recorded liability representing the fair value of the derivative was $752 thousand at September 30, 2015 and December 31, 2014.

The present value of estimated future fees to be paid to the derivative counterparty, or carrying costs, calculated by reference to the market price of the Visa Class A shares at a fixed rate of interest are expensed as incurred. For the three and nine months ended September 30, 2015, $73 thousand and $214 thousand, respectively, in such carrying costs was expensed. For the three and nine months ended September 30, 2014, $57 thousand and $172 thousand, respectively, was expensed. The Company has pledged U.S. Government agency securities held in its available for sale portfolio, with a market value of approximately $3 million at both September 30, 2015 and December 31, 2014, as collateral for the derivative swap contracts.
 
Subjectivity has been used in estimating the fair value of both the derivative liability and the associated fees, but management believes that these fair value estimates are adequate based on available information. However, future developments in the litigation could require potentially significant changes to these estimates.

At September 30, 2015, the Company still owned 38,638 Visa Class B shares subsequent to the sales described here. Upon termination of the existing transfer restriction and settlement of the litigation, and to the extent that the Company continues to own such Visa Class B shares in the future, the Company expects to record its Visa Class B shares at fair value.

4. LOANS
At September 30, 2015 and December 31, 2014, net loans disaggregated by class consisted of the following (in thousands):

   
September 30, 2015
   
December 31, 2014
 
Commercial and industrial
 
$
181,116
   
$
177,813
 
Commercial real estate
   
648,132
     
560,524
 
Multifamily
   
392,921
     
309,666
 
Mixed use commercial
   
64,381
     
34,806
 
Real estate construction
   
32,896
     
26,206
 
Residential mortgages
   
186,545
     
187,828
 
Home equity
   
46,990
     
50,982
 
Consumer
   
6,539
     
7,602
 
Gross loans
   
1,559,520
     
1,355,427
 
Allowance for loan losses
   
(20,315
)
   
(19,200
)
Net loans at end of period
 
$
1,539,205
   
$
1,336,227
 

The following summarizes the activity in the allowance for loan losses disaggregated by class for the periods indicated (in thousands).

   
Three Months Ended September 30, 2015
   
Three Months Ended September 30, 2014
 
   
Balance at
beginning of
period
   
Charge-offs
   
Recoveries
   
(Credit) provision for loan losses
   
Balance at
end of
period
   
Balance at
beginning of
period
   
Charge-offs
   
Recoveries
   
(Credit) provision for loan losses
   
Balance at
end of
period
 
Commercial and industrial
 
$
2,073
   
$
(252
)
 
$
138
   
$
(62
)
 
$
1,897
   
$
2,932
   
$
(104
)
 
$
160
   
$
(1,121
)
 
$
1,867
 
Commercial real estate
   
6,000
     
-
     
10
     
420
     
6,430
     
7,899
     
-
     
11
     
(499
)
   
7,411
 
Multifamily
   
4,065
     
-
     
-
     
252
     
4,317
     
2,444
     
-
     
-
     
238
     
2,682
 
Mixed use commercial
   
465
     
-
     
-
     
129
     
594
     
212
     
-
     
-
     
(6
)
   
206
 
Real estate construction
   
478
     
-
     
-
     
8
     
486
     
230
     
-
     
-
     
36
     
266
 
Residential mortgages
   
2,571
     
-
     
4
     
120
     
2,695
     
2,650
     
-
     
4
     
193
     
2,847
 
Home equity
   
672
     
-
     
10
     
(6
)
   
676
     
761
     
-
     
3
     
(55
)
   
709
 
Consumer
   
150
     
(1
)
   
5
     
(29
)
   
125
     
166
     
(15
)
   
13
     
13
     
177
 
Unallocated
   
3,577
     
-
     
-
     
(482
)
   
3,095
     
1,184
     
-
     
-
     
1,451
     
2,635
 
Total
 
$
20,051
   
$
(253
)
 
$
167
   
$
350
   
$
20,315
   
$
18,478
   
$
(119
)
 
$
191
   
$
250
   
$
18,800
 
 
   
Nine Months Ended September 30, 2015
   
Nine Months Ended September 30, 2014
 
   
Balance at
beginning of
period
   
Charge-offs
   
Recoveries
   
(Credit) provision for loan losses
   
Balance at
end of
period
   
Balance at
beginning of
 period
   
Charge-offs
   
Recoveries
   
(Credit) provision for loan losses
   
Balance at
 end of
period
 
Commercial and industrial
 
$
1,560
   
$
(744
)
 
$
1,174
   
$
(93
)
 
$
1,897
   
$
2,615
   
$
(419
)
 
$
663
   
$
(992
)
 
$
1,867
 
Commercial real estate
   
6,777
     
-
     
28
     
(375
)
   
6,430
     
6,572
     
-
     
508
     
331
     
7,411
 
Multifamily
   
4,018
     
-
     
-
     
299
     
4,317
     
2,159
     
-
     
-
     
523
     
2,682
 
Mixed use commercial
   
261
     
-
     
-
     
333
     
594
     
54
     
-
     
-
     
152
     
206
 
Real estate construction
   
383
     
-
     
-
     
103
     
486
     
88
     
-
     
-
     
178
     
266
 
Residential mortgages
   
3,027
     
-
     
31
     
(363
)
   
2,695
     
2,463
     
(32
)
   
12
     
404
     
2,847
 
Home equity
   
709
     
-
     
17
     
(50
)
   
676
     
745
     
-
     
48
     
(84
)
   
709
 
Consumer
   
166
     
(11
)
   
20
     
(50
)
   
125
     
241
     
(19
)
   
26
     
(71
)
   
177
 
Unallocated
   
2,299
     
-
     
-
     
796
     
3,095
     
2,326
     
-
     
-
     
309
     
2,635
 
Total
 
$
19,200
   
$
(755
)
 
$
1,270
   
$
600
   
$
20,315
   
$
17,263
   
$
(470
)
 
$
1,257
   
$
750
   
$
18,800
 

Factors considered by management in determining loan impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

The general component of the allowance covers non-impaired loans and is based on historical loss experience, adjusted for qualitative factors. These qualitative factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures and practices; experience, ability, and depth of lending management and other relevant staff; local, regional and national economic trends and conditions; industry conditions; and effects of changes in credit concentrations.

At September 30, 2015 and December 31, 2014, the ending balance in the allowance for loan losses disaggregated by class and impairment methodology is as follows (in thousands). Also in the tables below are total loans at September 30, 2015 and December 31, 2014 disaggregated by class and impairment methodology (in thousands).

   
Allowance for Loan Losses
   
Loan Balances
 
September 30, 2015
 
Individually
evaluated for
impairment
   
Collectively
evaluated for
impairment
   
Ending balance
   
Individually
evaluated for
impairment
   
Collectively
evaluated for
impairment
   
Ending balance
 
Commercial and industrial
 
$
-
   
$
1,897
   
$
1,897
   
$
4,674
   
$
176,442
   
$
181,116
 
Commercial real estate
   
-
     
6,430
     
6,430
     
5,285
     
642,847
     
648,132
 
Multifamily
   
-
     
4,317
     
4,317
     
-
     
392,921
     
392,921
 
Mixed use commercial
   
-
     
594
     
594
     
-
     
64,381
     
64,381
 
Real estate construction
   
-
     
486
     
486
     
-
     
32,896
     
32,896
 
Residential mortgages
   
749
     
1,946
     
2,695
     
5,747
     
180,798
     
186,545
 
Home equity
   
182
     
494
     
676
     
1,852
     
45,138
     
46,990
 
Consumer
   
60
     
65
     
125
     
384
     
6,155
     
6,539
 
Unallocated
   
-
     
3,095
     
3,095
     
-
     
-
     
-
 
Total
 
$
991
   
$
19,324
   
$
20,315
   
$
17,942
   
$
1,541,578
   
$
1,559,520
 
 
   
Allowance for Loan Losses
   
Loan Balances
 
December 31, 2014
 
Individually
evaluated for
impairment
   
Collectively
evaluated for
impairment
   
Ending balance
   
Individually
evaluated for
impairment
   
Collectively
evaluated for
impairment
   
Ending balance
 
Commercial and industrial
 
$
16
   
$
1,544
   
$
1,560
   
$
4,889
   
$
172,924
   
$
177,813
 
Commercial real estate
   
-
     
6,777
     
6,777
     
10,214
     
550,310
     
560,524
 
Multifamily
   
-
     
4,018
     
4,018
     
-
     
309,666
     
309,666
 
Mixed use commercial
   
-
     
261
     
261
     
-
     
34,806
     
34,806
 
Real estate construction
   
-
     
383
     
383
     
-
     
26,206
     
26,206
 
Residential mortgages
   
809
     
2,218
     
3,027
     
5,422
     
182,406
     
187,828
 
Home equity
   
92
     
617
     
709
     
1,567
     
49,415
     
50,982
 
Consumer
   
88
     
78
     
166
     
323
     
7,279
     
7,602
 
Unallocated
   
-
     
2,299
     
2,299
     
-
     
-
     
-
 
Total
 
$
1,005
   
$
18,195
   
$
19,200
   
$
22,415
   
$
1,333,012
   
$
1,355,427
 
 
The following table presents the Company’s impaired loans disaggregated by class at September 30, 2015 and December 31, 2014 (in thousands).

   
September 30, 2015
   
December 31, 2014
 
   
Unpaid
Principal
Balance
   
Recorded Balance
   
Allowance Allocated
   
Unpaid
Principal Balance
   
Recorded Balance
   
Allowance Allocated
 
With no allowance recorded:
                       
Commercial and industrial
 
$
4,668
   
$
4,668
   
$
-
   
$
4,833
   
$
4,833
   
$
-
 
Commercial real estate
   
5,703
     
5,285
     
-
     
10,632
     
10,214
     
-
 
Residential mortgages
   
2,209
     
2,080
     
-
     
1,645
     
1,516
     
-
 
Home equity
   
1,398
     
1,398
     
-
     
1,377
     
1,377
     
-
 
Consumer
   
210
     
210
     
-
     
137
     
137
     
-
 
Subtotal
   
14,188
     
13,641
     
-
     
18,624
     
18,077
     
-
 
                                                 
With an allowance recorded:
                                               
Commercial and industrial
   
6
     
6
     
-
     
57
     
56
     
16
 
Residential mortgages
   
3,667
     
3,667
     
749
     
3,906
     
3,906
     
809
 
Home equity
   
590
     
454
     
182
     
326
     
190
     
92
 
Consumer
   
175
     
174
     
60
     
185
     
186
     
88
 
Subtotal
   
4,438
     
4,301
     
991
     
4,474
     
4,338
     
1,005
 
Total
 
$
18,626
   
$
17,942
   
$
991
   
$
23,098
   
$
22,415
   
$
1,005
 

The following table presents the Company’s average recorded investment in impaired loans and the related interest income recognized disaggregated by class for the three and nine months ended September 30, 2015 and 2014 (in thousands). No interest income was recognized on a cash basis on impaired loans for any of the periods presented. The interest income recognized on accruing impaired loans is shown in the following table.
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
   
Average
recorded
investment in
 impaired
 loans
   
Interest
 income
recognized on
impaired
loans
   
Average
recorded
investment in
impaired
loans
   
Interest
income
recognized on
impaired
loans
   
Average
recorded
investment in
impaired
 loans
   
Interest
income
recognized on
impaired
loans
   
Average
 recorded
 investment in
 impaired
 loans
   
Interest
income
 recognized on
impaired
 loans
 
Commercial and industrial
 
$
2,322
   
$
226
   
$
7,061
   
$
128
   
$
3,331
   
$
485
   
$
7,304
   
$
679
 
Commercial real estate
   
6,213
     
48
     
10,424
     
49
     
8,590
     
647
     
11,045
     
204
 
Residential mortgages
   
5,817
     
166
     
5,148
     
24
     
5,604
     
245
     
5,069
     
100
 
Home equity
   
1,752
     
15
     
811
     
6
     
1,687
     
43
     
767
     
26
 
Consumer
   
349
     
5
     
289
     
7
     
374
     
11
     
222
     
14
 
Total
 
$
16,453
   
$
460
   
$
23,733
   
$
214
   
$
19,586
   
$
1,431
   
$
24,407
   
$
1,023
 
 
TDRs are modifications or renewals where the Company has granted a concession to a borrower in financial distress. The Company reviews all modifications and renewals for determination of TDR status. The Company allocated $748 thousand and $790 thousand of specific reserves to customers whose loan terms have been modified as TDRs as of September 30, 2015 and December 31, 2014, respectively. These loans involved the restructuring of terms to allow customers to mitigate the risk of default by meeting a lower payment requirement based upon their current cash flow. These may also include loans that renewed at existing contractual rates, but below market rates for comparable credit.

A total of $45 thousand and $100 thousand were committed to be advanced in connection with TDRs as of September 30, 2015 and December 31, 2014, respectively, representing the amount the Company is legally required to advance under existing loan agreements. These loans are not in default under the terms of the loan agreements and are accruing interest. It is the Company’s policy to evaluate advances on such loans on a case-by-case basis. Absent a legal obligation to advance pursuant to the terms of the loan agreement, the Company generally will not advance funds for which it has outstanding commitments, but may do so in certain circumstances.

Outstanding TDRs, disaggregated by class, at September 30, 2015 and December 31, 2014 are as follows (dollars in thousands):

   
September 30, 2015
   
December 31, 2014
 
TDRs Outstanding
 
Number of
Loans
   
Outstanding
Recorded
Balance
   
Number of
Loans
   
Outstanding
Recorded
Balance
 
Commercial and industrial
   
18
   
$
1,217
     
31
   
$
3,683
 
Commercial real estate
   
6
     
5,068
     
8
     
10,179
 
Residential mortgages
   
21
     
4,576
     
19
     
4,314
 
Home equity
   
6
     
1,391
     
5
     
1,216
 
Consumer
   
8
     
308
     
7
     
281
 
Total
   
59
   
$
12,560
     
70
   
$
19,673
 

The following presents, disaggregated by class, information regarding TDRs executed during the three and nine months ended September 30, 2015 and 2014 (dollars in thousands):

   
Three Months Ended September 30,
 
   
2015
   
2014
 
New TDRs
 
Number
 of
Loans
   
Pre-Modification
Outstanding
Recorded
Balance
   
Post-Modification
Outstanding
Recorded
Balance
   
Number
of
Loans
   
Pre-Modification
Outstanding
Recorded
Balance
   
Post-Modification
Outstanding
Recorded
Balance
 
Commercial and industrial
   
1
   
$
8
   
$
8
     
-
   
$
-
   
$
-
 
Home equity
   
1
     
192
     
192
     
1
     
98
     
98
 
Consumer
   
1
     
43
     
43
     
1
     
46
     
46
 
Total
   
3
   
$
243
   
$
243
     
2
   
$
144
   
$
144
 
 
   
Nine Months Ended September 30,
 
   
2015
   
2014
 
New TDRs
 
Number
of
Loans
   
Pre-Modification
Outstanding
Recorded
Balance
   
Post-Modification
Outstanding
Recorded
Balance
   
Number
of
Loans
   
Pre-Modification
Outstanding
Recorded
Balance
   
Post-Modification
Outstanding
Recorded
Balance
 
Commercial and industrial
   
3
   
$
343
   
$
343
     
10
   
$
1,877
   
$
1,877
 
Commercial real estate
   
-
     
-
     
-
     
2
     
5,161
     
5,161
 
Residential mortgages
   
2
     
194
     
199
     
3
     
273
     
273
 
Home equity
   
1
     
192
     
192
     
3
     
207
     
207
 
Consumer
   
1
     
43
     
43
     
4
     
145
     
145
 
Total
   
7
   
$
772
   
$
777
     
22
   
$
7,663
   
$
7,663
 

Presented below and disaggregated by class is information regarding loans modified as TDRs that had payment defaults of 90 days or more within twelve months of restructuring during the nine months ended September 30, 2015 and 2014 (dollars in thousands). There were no such loans during the three months ended September 30, 2015 and 2014.

   
Nine Months Ended September 30,
 
   
2015
   
2014
 
Defaulted TDRs
 
Number
of Loans
   
Outstanding
Recorded
Balance
   
Number
of Loans
   
Outstanding
Recorded
Balance
 
Commercial real estate
   
-
   
$
-
     
2
   
$
1,536
 
Consumer
   
1
     
46
     
-
     
-
 
Total
   
1
   
$
46
     
2
   
$
1,536
 
 
Not all loan modifications are TDRs. In some cases, the Company might provide a concession, such as a reduction in interest rate, but the borrower is not experiencing financial distress. This could be the case if the Company is matching a competitor’s interest rate.

The following table presents a summary of non-performing assets for each period (in thousands):

   
September 30, 2015
   
December 31, 2014
 
Non-accrual loans
 
$
7,501
   
$
12,981
 
Non-accrual loans held for sale
   
-
     
-
 
Loans 90 days past due and still accruing
   
-
     
-
 
OREO
   
-
     
-
 
Total non-performing assets
 
$
7,501
   
$
12,981
 
TDRs accruing interest
 
$
10,172
   
$
9,380
 
TDRs non-accruing
 
$
2,388
   
$
10,293
 
 
At September 30, 2015 and December 31, 2014, non-accrual loans disaggregated by class were as follows (dollars in thousands):
 
   
September 30, 2015
   
December 31, 2014
 
   
Non-
accrual
loans
   
% of
Total
   
Total Loans
   
% of Total
Loans
   
Non-
accrual
loans
   
% of
Total
   
Total Loans
   
% of Total
Loans
 
Commercial and industrial
 
$
3,662
     
48.8
%
 
$
181,116
     
0.2
%
 
$
4,060
     
31.3
%
 
$
177,813
     
0.3
%
Commercial real estate
   
1,746
     
23.3
     
648,132
     
0.1
     
6,556
     
50.5
     
560,524
     
0.5
 
Multifamily
   
-
     
-
     
392,921
     
-
     
-
     
-
     
309,666
     
-
 
Mixed use commercial
   
-
     
-
     
64,381
     
-
     
-
     
-
     
34,806
     
-
 
Real estate construction
   
-
     
-
     
32,896
     
-
     
-
     
-
     
26,206
     
-
 
Residential mortgages
   
1,424
     
19.0
     
186,545
     
0.1
     
2,020
     
15.6
     
187,828
     
0.1
 
Home equity
   
548
     
7.3
     
46,990
     
0.1
     
303
     
2.3
     
50,982
     
0.1
 
Consumer
   
121
     
1.6
     
6,539
     
-
     
42
     
0.3
     
7,602
     
-
 
Total
 
$
7,501
     
100.0
%
 
$
1,559,520
     
0.5
%
 
$
12,981
     
100.0
%
 
$
1,355,427
     
1.0
%
 
Additional interest income of approximately $138 thousand and $185 thousand would have been recorded during the three months ended September 30, 2015 and 2014, respectively, and $270 thousand and $824 thousand during the nine months ended September 30, 2015 and 2014, respectively, if non-accrual loans had performed in accordance with their original terms.

At September 30, 2015 and December 31, 2014, past due loans disaggregated by class were as follows (in thousands).

   
Past Due
         
September 30, 2015
 
30 - 59 days
   
60 - 89 days
   
90 days and over
   
Total
   
Current
   
Total
 
Commercial and industrial
 
$
-
   
$
-
   
$
3,662
   
$
3,662
   
$
177,454
   
$
181,116
 
Commercial real estate
   
-
     
-
     
1,746
     
1,746
     
646,386
     
648,132
 
Multifamily
   
-
     
-
     
-
     
-
     
392,921
     
392,921
 
Mixed use commercial
   
-
     
-
     
-
     
-
     
64,381
     
64,381
 
Real estate construction
   
-
     
-
     
-
     
-
     
32,896
     
32,896
 
Residential mortgages
   
523
     
176
     
1,424
     
2,123
     
184,422
     
186,545
 
Home equity
   
302
     
-
     
548
     
850
     
46,140
     
46,990
 
Consumer
   
-
     
-
     
121
     
121
     
6,418
     
6,539
 
Total
 
$
825
   
$
176
   
$
7,501
   
$
8,502
   
$
1,551,018
   
$
1,559,520
 
% of Total Loans
   
0.1
%
   
0.0
%
   
0.5
%
   
0.6
%
   
99.4
%
   
100.0
%

   
Past Due
         
December 31, 2014
 
30 - 59 days
   
60 - 89 days
   
90 days and over
   
Total
   
Current
   
Total
 
Commercial and industrial
 
$
52
   
$
241
   
$
4,060
   
$
4,353
   
$
173,460
   
$
177,813
 
Commercial real estate
   
-
     
-
     
6,556
     
6,556
     
553,968
     
560,524
 
Multifamily
   
-
     
-
     
-
     
-
     
309,666
     
309,666
 
Mixed use commercial
   
-
     
-
     
-
     
-
     
34,806
     
34,806
 
Real estate construction
   
-
     
-
     
-
     
-
     
26,206
     
26,206
 
Residential mortgages
   
822
     
-
     
2,020
     
2,842
     
184,986
     
187,828
 
Home equity
   
-
     
112
     
303
     
415
     
50,567
     
50,982
 
Consumer
   
59
     
77
     
42
     
178
     
7,424
     
7,602
 
Total
 
$
933
   
$
430
   
$
12,981
   
$
14,344
   
$
1,341,083
   
$
1,355,427
 
% of Total Loans
   
0.1
%
   
0.0
%
   
1.0
%
   
1.1
%
   
98.9
%
   
100.0
%

The Bank utilizes an eight-grade risk-rating system for commercial and industrial loans, commercial real estate and construction loans. Loans in risk grades 1- 4 are considered pass loans. The Bank’s risk grades are as follows:

Risk Grade 1, Excellent - Loans secured by liquid collateral such as certificates of deposit, reputable bank letters of credit, or other cash equivalents; loans that are guaranteed or otherwise backed by the full faith and credit of the United States government or an agency thereof, such as the Small Business Administration; or loans to any publicly held company with a current long-term debt rating of A or better.
 
Risk Grade 2, Good -  Loans to businesses that have strong financial statements containing an unqualified opinion from a CPA firm and at least three consecutive years of profits; loans supported by un-audited financial statements containing strong balance sheets, five consecutive years of profits, a five-year satisfactory relationship with the Bank, and key balance sheet and income statement trends that are either stable or positive; loans secured by publicly traded marketable securities where there is no impediment to liquidation; loans to individuals backed by liquid personal assets, established credit history, and unquestionable character; or loans to publicly held companies with current long-term debt ratings of Baa or better.
 
Risk Grade 3, Satisfactory - Loans supported by financial statements (audited or un-audited) that indicate average or slightly below average risk and having some deficiency or vulnerability to changing economic conditions; loans with some weakness but offsetting features of other support are readily available; loans that are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered. Loans may be graded Satisfactory when there is no recent information on which to base a current risk evaluation and the following conditions apply:

· At inception, the loan was properly underwritten, did not possess an unwarranted level of credit risk, and the loan met the above criteria for a risk grade of Excellent, Good, or Satisfactory.

· At inception, the loan was secured with collateral possessing a loan value adequate to protect the Bank from loss.

· The loan has exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance.

· During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants or the borrower is in an industry known to be experiencing problems. If any of these credit weaknesses is observed, a lower risk grade may be warranted.

Risk Grade 4, Satisfactory/Monitored - Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than satisfactory loans due to weak balance sheets, marginal earnings or cash flow, or other uncertainties. These loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in a Satisfactory/Monitored loan is within acceptable underwriting guidelines so long as the loan is given the proper level of management supervision.

Risk Grade 5, Special Mention - Loans in this category possess potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the institution’s credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. The key distinctions of a Special Mention classification are that (1) it is indicative of an unwarranted level of risk and (2) weaknesses are considered potential not defined impairments to the primary source of repayment.

Risk Grade 6, Substandard - One or more of the following characteristics may be exhibited in loans classified Substandard:

· Loans which possess a defined credit weakness. The likelihood that a loan will be paid from the primary source of repayment is uncertain. Financial deterioration is under way and very close attention is warranted to ensure that the loan is collected without loss.

· Loans are inadequately protected by the current net worth and paying capacity of the obligor.

· The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees.

· Loans have a distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

· Unusual courses of action are needed to maintain a high probability of repayment.

· The borrower is not generating enough cash flow to repay loan principal; however, it continues to make interest payments.

· The lender is forced into a subordinated or unsecured position due to flaws in documentation.

· Loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to the normal loan terms.
 
· The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan.

· There is a significant deterioration in market conditions to which the borrower is highly vulnerable.

Risk Grade 7, Doubtful - One or more of the following characteristics may be present in loans classified Doubtful:

· Loans have all of the weaknesses of those classified as Substandard. However, based on existing conditions, these weaknesses make full collection of principal highly improbable.

· The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment.

· The possibility of loss is high but because of certain important pending factors which may strengthen the loan, loss classification is deferred until the exact status of repayment is known.

Risk Grade 8, Loss - Loans are considered uncollectible and of such little value that continuing to carry them as assets is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

The Bank annually reviews the ratings on all loans greater than $750 thousand. Semi-annually, the Bank engages an independent third-party to review a significant portion of loans within the commercial and industrial, commercial real estate, multifamily, mixed use commercial and real estate construction loan classes. Management uses the results of these reviews as part of its ongoing review process.

The following presents the Company’s loan portfolio credit risk profile by internally assigned grade disaggregated by class of loan at September 30, 2015 and December 31, 2014 (in thousands).

   
September 30, 2015
   
December 31, 2014
 
   
Grade
       
Grade
     
   
Pass
   
Special
mention
   
Substandard
   
Total
   
Pass
   
Special
mention
   
Substandard
   
Total
 
Commercial and industrial
 
$
170,122
   
$
1,788
   
$
9,206
   
$
181,116
   
$
167,922
   
$
1,225
   
$
8,666
   
$
177,813
 
Commercial real estate
   
632,330
     
12,292
     
3,510
     
648,132
     
536,536
     
9,182
     
14,806
     
560,524
 
Multifamily
   
392,921
     
-
     
-
     
392,921
     
309,666
     
-
     
-
     
309,666
 
Mixed use commercial
   
64,369
     
-
     
12
     
64,381
     
34,806
     
-
     
-
     
34,806
 
Real estate construction
   
32,896
     
-
     
-
     
32,896
     
26,206
     
-
     
-
     
26,206
 
Residential mortgages
   
184,747
     
-
     
1,798
     
186,545
     
183,263
     
-
     
4,565
     
187,828
 
Home equity
   
46,442
     
-
     
548
     
46,990
     
49,569
     
-
     
1,413
     
50,982
 
Consumer
   
6,375
     
-
     
164
     
6,539
     
7,279
     
-
     
323
     
7,602
 
Total
 
$
1,530,202
   
$
14,080
   
$
15,238
   
$
1,559,520
   
$
1,315,247
   
$
10,407
   
$
29,773
   
$
1,355,427
 
% of Total
   
98.1
%
   
0.9
%
   
1.0
%
   
100.0
%
   
97.0
%
   
0.8
%
   
2.2
%
   
100.0
%

5. EMPLOYEE BENEFITS

Retirement Plan - The Company’s retirement plan is noncontributory and covers substantially all eligible employees. The plan conforms to the provisions of the Employee Retirement Income Security Act of 1974, as amended, and the Pension Protection Act of 2006, which requires certain funding rules for defined benefit plans. The Company’s policy is to accrue for all pension costs and to fund the maximum amount allowable for tax purposes. Actuarial gains and losses that arise from changes in assumptions concerning future events are amortized over a period that reflects the long-term nature of pension expense used in estimating pension costs. On December 31, 2012, the Company’s retirement plan was frozen such that no additional pension benefits would accumulate. For the three months ended September 30, 2015 and 2014, the Company’s net periodic pension credit was $111 thousand and $91 thousand, respectively, and $333 thousand and $273 thousand, respectively, for the nine months ended September 30, 2015 and 2014.

In December 2014, the Company made an optional contribution of $1 million for the plan year ended September 30, 2015. No minimum contribution was required. The Company does not presently expect to contribute to its pension plan in 2015.
 
6. STOCK-BASED COMPENSATION
Stock Options
Under the terms of the Company’s stock option plans adopted in 1999 and 2009, options have been granted to key employees and directors to purchase shares of the Company’s stock. Options are awarded by the Compensation Committee of the Board of Directors. Both plans provide that the option price shall not be less than the fair value of the common stock on the date the option is granted. All options are exercisable for a period of ten years or less.

No options were granted in 2015 or 2014. Options granted in 2013 and 2012 are exercisable over a three-year period commencing one year from the date of grant at a rate of one-third per year. Options granted in 2011 are exercisable over a three-year period commencing three years from the date of grant at a rate of one-third per year.

The total intrinsic value of options exercised during the first nine months of 2015 and 2014 was $438 thousand and $145 thousand, respectively. The total cash received from such option exercises was $539 thousand and $246 thousand, respectively, excluding the tax benefit realized. In exercising those options, 39,334 shares and 18,735 shares, respectively, of the Company’s common stock were issued.

Both plans provide for but do not require the grant of stock appreciation rights (“SARs”) that the holder may exercise instead of the underlying option. At September 30, 2015, there were 6,000 SARs outstanding related to options granted before 2011. The SARs had no intrinsic value at September 30, 2015. When the SAR is exercised, the underlying option is canceled. The optionee receives shares of common stock or cash with a fair market value equal to the excess of the fair value of the shares subject to the option at the time of exercise (or the portion thereof so exercised) over the aggregate option price of the shares set forth in the option agreement. The exercise of SARs is treated as the exercise of the underlying option.

A summary of stock option activity follows:

   
Number
of Shares
   
Weighted-Average
Exercise Price
Per Share
 
Outstanding, January 1, 2015
   
251,100
   
$
16.33
 
Granted
   
-
     
-
 
Exercised
   
(39,334
)
 
$
13.71
 
Forfeited or expired
   
(16,666
)
 
$
19.67
 
Outstanding, September 30, 2015
   
195,100
   
$
16.58
 
 
The following summarizes shares subject to purchase from stock options outstanding and exercisable as of September 30, 2015:

   
Outstanding
   
Exercisable
 
Range of
Exercise Prices
 
Shares
 
Weighted-Average
 Remaining 
Contractual Life
 
Weighted-Average
Exercise Price
   
Shares
 
Weighted-Average
 Remaining 
Contractual Life
 
Weighted-Average
Exercise Price
 
$10.00 - $14.00
   
90,000
 
 6.3 years
 
$
11.68
     
56,667
 
 6.4 years
 
$
12.20
 
$14.01 - $20.00
   
83,100
 
 7.8 years
 
$
17.80
     
50,774
 
 7.8 years
 
$
17.64
 
$20.01 - $30.00
   
5,000
 
 3.3 years
 
$
28.30
     
5,000
 
 3.3 years
 
$
28.30
 
$30.01 - $40.00
   
17,000
 
 1.3 years
 
$
33.12
     
17,000
 
 1.3 years
 
$
33.12
 
     
195,100
 
 6.4 years
 
$
16.58
     
129,441
 
 6.1 years
 
$
17.70
 
 
Restricted Stock Awards
Under the Company’s Amended and Restated 2009 Stock Incentive Plan (the “2009 Plan”), the Company can award options, SARs and restricted stock. During the first nine months of 2015, the Company awarded 71,612 shares of restricted stock to certain key employees and directors. Generally, the restricted stock awards vest over a three-year period commencing one year from the date of grant at a rate of one-third per year. The fair value of the 25,948 restricted shares that vested during the first nine months of 2015 was $585 thousand. Of the 25,948 vested shares, 4,787 were withheld to pay taxes due upon vesting. A summary of restricted stock activity follows:
 
   
Number
of Shares
   
Weighted-Average
Grant-Date
Fair Value
 
Nonvested, January 1, 2015
   
72,350
   
$
22.51
 
Granted
   
71,612
   
$
23.18
 
Vested
   
(25,948
)
 
$
22.55
 
Forfeited or expired
   
(9,941
)
 
$
22.61
 
Nonvested, September 30, 2015
   
108,073
   
$
22.94
 
 
The Company recognizes compensation expense for the fair value of stock options and restricted stock on a straight line basis over the requisite service period of the grants. Compensation expense related to stock-based compensation amounted to $626 thousand and $600 thousand for the nine months ended September 30, 2015 and 2014, respectively. The remaining unrecognized compensation cost of approximately $94 thousand and $1.9 million at September 30, 2015 related to stock options and restricted stock, respectively, will be expensed over the remaining weighted average vesting period of approximately 1.0 year and 2.1 years, respectively.

Under the 2009 Plan, a total of 500,000 shares of the Company’s common stock were reserved for issuance, of which 162,930 shares remain for possible issuance at September 30, 2015. There are no remaining shares reserved for issuance under the 1999 Stock Option Plan.

7. INCOME TAXES
The deferred tax assets and liabilities are netted and presented in a single amount which is included in deferred taxes in the accompanying consolidated statements of condition. The realization of deferred tax assets (“DTAs”) (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carry back losses to available tax years. In assessing the need for a valuation allowance, the Company considers positive and negative evidence, including taxable income in carryback years, scheduled reversals of deferred tax liabilities, expected future taxable income and tax planning strategies. At September 30, 2015 the Company had no remaining Federal net operating loss carryforwards and had net operating loss carryforwards of approximately $15.0 million for New York State (“NYS”) income tax purposes, which may be applied against future taxable income. The Company has a full valuation allowance of $668 thousand, tax effected, on the NYS net operating loss carryforward due to the Company’s significant tax-exempt investment income. The valuation allowance may be reversed to income in future periods to the extent that the related DTAs are realized or when the Company returns to consistent, taxable earnings in NYS. The NYS unused net operating loss carryforwards are expected to expire in varying amounts through the year 2032.

The Company recorded income tax expense of $4.7 million in the year-to-date September 2015 period resulting in an effective tax rate of 25.0% versus an income tax expense of $3.0 million and an effective tax rate of 21.3% in the comparable period a year ago. The increase in both income tax expense and the effective tax rate in 2015 resulted from an increase in earnings relative to tax-exempt income which has decreased year over year and, additionally, the change in the federal tax rate from 34% to 35% based on the federal tax rates expected to be in effect during the periods in which the temporary differences reverse.

The Company has no unrecognized tax benefits at September 30, 2015 as compared to $34 thousand at December 31, 2014. The Company files income tax returns in the U.S. federal jurisdiction and in New York State. Federal returns are subject to audits by tax authorities and the Company is currently under an audit for the tax year 2013. It is not anticipated that the unrecognized tax benefits will significantly change over the next 12 months.

8. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital requirements that involve quantitative measures of the Company’s and the Bank’s assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and the Bank’s classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total, tier 1 and common equity tier 1 capital, as defined in the federal banking regulations, to risk-weighted assets and of tier 1 capital to adjusted average assets (leverage). Management believes, as of September 30, 2015, that the Company and the Bank met all such capital adequacy requirements to which it is subject.
 
In July 2013, the Office of the Comptroller of the Currency (“OCC”) approved new rules on regulatory capital applicable to national banks, implementing Basel III. Most banking organizations were required to apply the new capital rules on January 1, 2015. The final rules set a new common equity tier 1 requirement and higher minimum tier 1 requirements for all banking organizations. They also place limits on capital distributions and certain discretionary bonus payments if a banking organization does not maintain a buffer of common equity tier 1 capital above minimum capital requirements. The rules revise the prompt corrective action framework to incorporate the new regulatory capital minimums. They also enhance risk sensitivity and address weaknesses identified over recent years with the measure of risk-weighted assets, including through new measures of creditworthiness to replace references to credit ratings, consistent with section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Company’s implementation of the new rules on January 1, 2015 did not have a material impact on its capital needs.

The Bank’s capital amounts (in thousands) and ratios are as follows:

   
Actual capital ratios
   
Minimum
for capital
adequacy
   
Minimum to be Well
Capitalized under prompt
corrective action provisions
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
September 30, 2015
                       
Total capital to risk-weighted assets
 
$
216,671
     
13.01
%
 
$
133,233
     
8.00
%
 
$
166,541
     
10.00
%
Tier 1 capital to risk-weighted assets
   
196,066
     
11.77
%
   
99,925
     
6.00
%
   
133,233
     
8.00
%
Common equity tier 1 capital to risk-weighted assets
   
196,066
     
11.77
%
   
74,944
     
4.50
%
   
108,252
     
6.50
%
Tier 1 capital to adjusted average assets (leverage)
   
196,066
     
9.78
%
   
80,223
     
4.00
%
   
100,279
     
5.00
%
                                                 
December 31, 2014
                                               
Total capital to risk-weighted assets
 
$
201,476
     
13.25
%
 
$
121,608
     
8.00
%
 
$
152,010
     
10.00
%
Tier 1 capital to risk-weighted assets
   
182,469
     
12.00
%
   
60,804
     
4.00
%
   
91,206
     
6.00
%
Tier 1 capital to adjusted average assets (leverage)
   
182,469
     
9.96
%
   
73,312
     
4.00
%
   
91,640
     
5.00
%

The Company’s tier 1 leverage, common equity tier 1 risk-based, tier 1 risk-based and total risk-based capital ratios were 9.95%, 11.98%, 11.98% and 13.21%, respectively, at September 30, 2015. The Company’s tier 1 leverage, tier 1 risk-based and total risk-based capital ratios were 10.04%, 12.10% and 13.35%, respectively, at December 31, 2014.

The ability of the Bank to pay dividends to the Company is subject to certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock. In addition, a national bank may not pay dividends in an amount greater than its undivided profits or declare any dividends if such declaration would leave the bank inadequately capitalized.

9. FAIR VALUE
Fair value measurement is determined based on the assumptions that market participants would use in pricing the asset or liability in an exchange. The definition of fair value includes the exchange price which is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal market for the asset or liability. Market participant assumptions include assumptions about risk, the risk inherent in a particular valuation technique used to measure fair value and/or the risk inherent in the inputs to the valuation technique, as well as the effect of credit risk on the fair value of liabilities. The Company uses three levels of the fair value inputs to measure assets, as described below.

Basis of Fair Value Measurement:

Level 1 – Valuations based on quoted prices in active markets for identical investments.

Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Level 2 inputs include: (i) quoted prices for similar investments in active markets, (ii) quoted prices for identical investments traded in non-active markets (i.e., dealer or broker markets) and (iii) inputs other than quoted prices that are observable or inputs derived from or corroborated by market data for substantially the full term of the investment.

Level 3 – Valuations based on inputs that are unobservable, supported by little or no market activity, and significant to the overall fair value measurement.
 
The types of instruments valued based on quoted market prices in active markets include most U.S. Treasury securities. Such instruments are generally classified within Level 1 and Level 2 of the fair value hierarchy. The Company does not adjust the quoted price for such instruments.

The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include U.S. Government agency securities, state and municipal obligations, MBS, CMOs and corporate bonds. Such instruments are generally classified within Level 2 of the fair value hierarchy.

The types of instruments valued based on significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability are generally classified within Level 3 of the fair value hierarchy.

The following table presents the carrying amounts and fair values of the Company’s financial instruments (in thousands).

Level in
 
September 30, 2015
   
December 31, 2014
 
Fair Value
 
Carrying
   
Fair
   
Carrying
   
Fair
 
Hierarchy
 
Amount
   
Value
   
Amount
   
Value
 
                   
Financial Assets:
                 
Cash and due from banks
Level 1
 
$
97,800
   
$
97,800
   
$
54,516
   
$
54,516
 
Federal funds sold
Level 2
   
-
     
-
     
1,000
     
1,000
 
Interest-bearing time deposits in other banks
Level 2
   
-
     
-
     
10,000
     
10,017
 
Investment securities held to maturity
Level 2
   
66,427
     
69,402
     
62,270
     
64,796
 
Investment securities available for sale
Level 2
   
261,232
     
261,232
     
298,670
     
298,670
 
Loans held for sale
Level 2
   
745
     
745
     
26,495
     
26,495
 
Loans, net of allowance
Level 2, 3 (1)
   
1,539,205
      1,537,750      
1,336,227
     
1,329,041
 
Accrued interest and loan fees receivable
Level 2
   
6,349
     
6,349
     
5,676
     
5,676
 
                                   
Financial Liabilities:
                                 
Non-maturity deposits
Level 2
   
1,560,292
     
1,560,292
     
1,337,301
     
1,337,301
 
Time deposits
Level 2
   
235,539
      235,883      
218,759
     
219,089
 
Borrowings
Level 2
   
50,000
      50,052      
130,000
     
130,004
 
Accrued interest payable
Level 2
   
187
     
187
     
136
     
136
 
Derivatives
Level 3
   
752
     
752
     
752
     
752
 

(1)
Impaired loans are generally classified within Level 3 of the fair value hierarchy.

Fair value estimates are made at a specific point in time and may be based on judgments regarding losses expected in the future, risk, and other factors that are subjective in nature. The methods and assumptions used to produce the fair value estimates follow.

For securities held to maturity and securities available for sale, the fair value equals quoted market price if available. If a quoted market price is not available, fair value is estimated using a quoted market price for similar securities. For cash and due from banks, federal funds sold, accrued interest and loan fees receivable, non-maturity deposits and accrued interest payable, the carrying amount is a reasonable estimate of fair value. Determining the fair value of Federal Reserve and Federal Home Loan Bank stock and other investments is not practicable due to restrictions placed on its transferability. Interest-bearing time deposits in other banks, time deposits and borrowings are valued using a replacement cost of funds approach.

Fair values are estimated for portfolios of loans with similar characteristics. The fair value of performing loans was calculated by discounting projected cash flows through their estimated maturity using market discount rates that reflect the general credit and interest rate characteristics of the loan category. The maturity horizon is based on the Bank’s history of repayments for each type of loan and an estimate of the effect of current economic conditions. Assumptions regarding credit risk, cash flows, and discount rates are made using available market information and specific borrower information.

Loans identified as impaired are measured using one of three methods: the fair value of collateral less estimated costs to sell, the present value of expected future cash flows or the loan’s observable market price. Those measured using the fair value of collateral or the loan’s observable market price are recorded at fair value. For each period presented, no impaired loans were measured using the loan’s observable market price. If an impaired loan has had a charge-off or if the fair value of the collateral is less than the recorded investment in the loan, the Company establishes a specific reserve and reports the loan as non-recurring Level 3. The fair value of collateral of impaired loans is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
 
For the periods presented, loans held for sale were performing and carried at cost. The carrying cost is a reasonable estimate of fair value due to their short-term nature.

In conjunction with the sale of Visa Class B shares in 2013, the Company entered into derivative swap contracts with the purchaser of its Visa Class B shares. The fair value of these derivatives is measured using an internal model that includes the use of probability weighted scenarios for estimates of Visa’s aggregate exposure to the litigation matters, with consideration of amounts funded by Visa into its escrow account for this litigation. At September 30, 2015, the Company estimates a fair value for these derivatives at approximately 10% of the net proceeds from the Company’s sale of the related Visa Class B shares. Since this estimation process requires application of judgment in developing significant unobservable inputs used to determine the possible outcomes and the probability weighting assigned to each scenario, these derivatives have been classified as Level 3 within the valuation hierarchy. (See also Note 3. Investment Securities contained herein.)

The fair value of commitments to extend credit is estimated by either discounting cash flows or using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the current creditworthiness of the counter-parties. The estimated fair value of written financial guarantees and letters of credit is based on fees currently charged for similar agreements. The fees charged for the commitments were not material in amount.

Assets measured at fair value on a non-recurring basis are as follows (in thousands):

Assets:
 
September 30, 2015
   
Fair Value
Measurements Using
Significant Unobservable
Inputs (Level 3)
 
Impaired loans
 
$
3,304
   
$
3,304
 
Total
 
$
3,304
   
$
3,304
 

Assets:
 
December 31, 2014
   
Fair Value
Measurements Using
Significant Unobservable
Inputs (Level 3)
 
Impaired loans
 
$
3,293
   
$
3,293
 
Total
 
$
3,293
   
$
3,293
 
 
The Company had no liabilities measured at fair value on a non-recurring basis at September 30, 2015 and December 31, 2014.

The following presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis (dollars in thousands):
 
   
Fair Value at
         
Assets:
 
September 30,
2015
   
December 31,
2014
 
Valuation
Technique
Unobservable
Inputs
 
Discount
 
Impaired loans:
               
                 
Residential mortgages
   
2,918
     
3,097
 
Third party appraisal
Discount to appraised value
   
25
% (1)
                             
Home equity
   
272
     
98
 
Third party appraisal
Discount to appraised value
   
25
% (1)
                             
Consumer
   
114
     
98
 
Third party appraisal
Discount to appraised value
   
25
% (2)
Total
 
$
3,304
   
$
3,293
             
 
(1) Of which estimated selling costs are approximately 9% - 15% of the total discount.
(2) Of which estimated selling costs are approximately 10% - 12% of the total discount.

The following presents fair value measurements on a recurring basis at September 30, 2015 and December 31, 2014 (in thousands):

       
Fair Value Measurements Using
 
       
Significant Other
Observable Inputs
   
Significant
Unobservable Inputs
 
Assets:
 
September 30, 2015
   
(Level 2)
   
(Level 3)
 
U.S. Government agency securities
 
$
38,794
   
$
38,794
   
$
-
 
Obligations of states and political subdivisions
   
110,372
     
110,372
     
-
 
Collateralized mortgage obligations
   
16,466
     
16,466
     
-
 
Mortgage-backed securities
   
89,630
     
89,630
     
-
 
Corporate bonds
   
5,970
     
5,970
     
-
 
Total
 
$
261,232
   
$
261,232
   
$
-
 
                         
Liabilities:
                       
Derivatives
   
752
   
$
-
   
$
752
 
Total
 
$
752
   
$
-
   
$
752
 


       
Fair Value Measurements Using
 
       
Significant Other
Observable Inputs
   
Significant
Unobservable Inputs
 
Assets:
 
December 31, 2014
   
(Level 2)
   
(Level 3)
 
U.S. Government agency securities
 
$
41,577
   
$
41,577
   
$
-
 
Obligations of states and political subdivisions
   
137,769
     
137,769
     
-
 
Collateralized mortgage obligations
   
21,997
     
21,997
     
-
 
Mortgage-backed securities
   
90,919
     
90,919
     
-
 
Corporate bonds
   
6,408
     
6,408
     
-
 
Total
 
$
298,670
   
$
298,670
   
$
-
 
                         
Liabilities:
                       
Derivatives
   
752
   
$
-
   
$
752
 
Total
 
$
752
   
$
-
   
$
752
 
 
Reconciliations for assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) follow (in thousands).

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
 
                 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
   
Liabilities
Derivatives
   
Liabilities
Derivatives
   
Liabilities
Derivatives
   
Liabilities
Derivatives
 
Beginning balance
 
$
752
   
$
932
   
$
752
   
$
932
 
Net change
   
-
     
-
     
-
     
-
 
Ending balance
 
$
752
   
$
932
   
$
752
   
$
932
 

10. LEGAL PROCEEDINGS
Certain lawsuits and claims arising in the ordinary course of business may be filed or pending against us or our affiliates from time to time. In accordance with applicable accounting guidance, we establish accruals for all lawsuits, claims and expected settlements when we believe it is probable that a loss has been incurred and the amount of the loss is reasonably estimable. When a loss contingency is not both probable and estimable, we do not establish an accrual. Any such loss estimates are inherently uncertain, based on currently available information and are subject to management’s judgment and various assumptions. Due to the inherent subjectivity of these estimates and unpredictability of outcomes of legal proceedings, any amounts accrued may not represent the ultimate resolution of such matters.

To the extent we believe any potential loss relating to such lawsuits and claims may have a material impact on our liquidity, consolidated financial position, results of operations, and/or our business as a whole and is reasonably possible but not probable, we disclose information relating to any such potential loss, whether in excess of any established accruals or where there is no established accrual. We also disclose information relating to any material potential loss that is probable but not reasonably estimable. Where reasonably practicable, we will provide an estimate of loss or range of potential loss. No disclosures are generally made for any loss contingencies that are deemed to be remote.

Based upon information available to us and our review of lawsuits and claims filed or pending against us to date, we have not recognized a material accrual liability for these matters, nor do we currently expect it is reasonably possible that these matters will result in a material liability to the Company. However, the outcome of litigation and other legal and regulatory matters is inherently uncertain, and it is possible that one or more of such matters currently pending or threatened could have an unanticipated material adverse effect on our liquidity, consolidated financial position, results of operations, and/or our business as a whole, in the future.

11. BORROWINGS
The following summarizes borrowed funds at September 30, 2015 and December 31, 2014 (dollars in thousands):

As of or for the Nine Months Ended
September 30, 2015
 
Federal Home Loan
Bank Borrowings
Short-Term
   
Federal Home Loan
Bank Borrowings
Long-Term
   
Federal Funds
Purchased
 
Daily average outstanding
 
$
69,066
   
$
9,396
   
$
2
 
Total interest cost
   
186
     
124
     
-
 
Average interest rate paid
   
0.36
%
   
1.76
%
   
0.45
%
Maximum amount outstanding at any month-end
 
$
155,000
   
$
15,000
   
$
-
 
Ending balance
   
35,000
     
15,000
     
-
 
Weighted-average interest rate on balances outstanding
   
0.40
%
   
1.76
%
   
-
%
 
As of or for the Year Ended
December 31, 2014
 
Federal Home Loan
Bank Borrowings
Short-Term
   
Federal Home Loan
Bank Borrowings
Long-Term
   
Federal Funds
Purchased
 
Daily average outstanding
 
$
13,051
   
$
-
   
$
8
 
Total interest cost
   
48
     
-
     
-
 
Average interest rate paid
   
0.37
%
   
-
%
   
0.46
%
Maximum amount outstanding at any month-end
 
$
130,000
   
$
-
   
$
-
 
Ending balance
   
130,000
     
-
     
-
 
Weighted-average interest rate on balances outstanding
   
0.32
%
   
-
%
   
-
%
 
Assets pledged as collateral to the Federal Home Loan Bank (“FHLB”), consisting of eligible loans and investment securities, at September 30, 2015 and December 31, 2014 resulted in a maximum borrowing potential of $673 million and $505 million, respectively. The Company had $50 million and $130 million in FHLB borrowings at September 30, 2015 and December 31, 2014, respectively.

ITEM 2. - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Safe Harbor Statement Pursuant to the Private Securities Litigation Reform Act of 1995 - Certain statements contained in this discussion are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These can include remarks about the Company, the banking industry, the economy in general, expectations of the business environment in which the Company operates, projections of future performance, and potential future credit experience. These remarks are based upon current management expectations, and may, therefore, involve risks and uncertainties that cannot be predicted or quantified, that are beyond the Company’s control and that could cause future results to vary materially from the Company’s historical performance or from current expectations. These remarks may be identified by such forward-looking statements as “should,” “expect,” “believe,” “view,” “opportunity,” “allow,” “continues,” “reflects,” “typically,” “usually,” “anticipate,” or similar statements or variations of such terms. Factors that could affect the Company include particularly, but are not limited to: increased capital requirements mandated by the Company’s regulators; the Company’s ability to raise capital; competitive factors, including price competition; changes in interest rates; increases or decreases in retail and commercial economic activity in the Company’s market area; variations in the ability and propensity of consumers and businesses to borrow, repay, or deposit money, or to use other banking and financial services; results of regulatory examinations or changes in law, regulations or regulatory practices; the Company’s ability to attract and retain key management and staff; any failure by the Company to maintain effective internal control over financial reporting; larger-than-expected losses from the sale of assets; and the potential that net charge-offs are higher than expected or for further increases in our provision for loan losses. Further, it could take the Company longer than anticipated to implement its strategic plans to increase revenue and manage non-interest expense, or it may not be possible to implement those plans at all. Finally, new and unanticipated legislation, regulation, or accounting standards may require the Company to change its practices in ways that materially change the results of operations. We have no obligation to update any forward-looking statements to reflect events or circumstances after the date of this document. For more information, see the risk factors described in the Company’s Annual Report on Form 10-K and other filings with the Securities and Exchange Commission.

Non-GAAP Disclosure - This discussion includes non-GAAP financial measures of the Company’s tangible common equity (“TCE”)  ratio, tangible common equity, tangible assets, core net income, core FTE net interest income, core FTE net interest margin, core operating expenses, core non-interest income, core FTE non-interest income and core operating efficiency ratio. A non-GAAP financial measure is a numerical measure of historical or future financial performance, financial position or cash flows that excludes or includes amounts that are required to be disclosed in the most directly comparable measure calculated and presented in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). The Company believes that these non-GAAP financial measures provide both management and investors a more complete understanding of the underlying operational results and trends and the Company’s marketplace performance. The presentation of this additional information is not meant to be considered in isolation or as a substitute for the numbers prepared in accordance with U.S. GAAP and may not be comparable to similarly titled measures used by other financial institutions.

With respect to the calculations and reconciliations of tangible common equity, tangible assets and the TCE ratio, please see Liquidity and Capital Resources contained herein. For the calculation and reconciliation of core FTE net interest margin, please see Material Changes in Results of Operations contained herein. For all other calculations and reconciliations pertaining to non-GAAP financial measures, please see Executive Summary contained herein.
 
Executive Summary - The Company is a one-bank holding company incorporated in 1985. The Company operates as the parent for its wholly owned subsidiary, the Bank, a national bank founded in 1890. The income of the Company is primarily derived through the operations of the Bank and the REIT.

The Bank is a full-service bank serving the needs of its local residents through 27 branch offices in Nassau, Suffolk and Queens Counties, New York and loan production offices in Garden City, Melville and Long Island City. The Bank’s 27 branches include the three opened in Long Island City (2015), Melville (2014) and Garden City (2013). The Bank offers a full line of domestic commercial and retail banking services. The Bank’s primary market area includes all of Suffolk County and the adjacent markets of Nassau County and New York City. The Bank makes commercial real estate floating and fixed rate loans, multifamily and mixed use commercial loans primarily in the boroughs of New York City, commercial and industrial loans to manufacturers, wholesalers, distributors, developers/contractors and retailers and agricultural loans. The Bank also makes loans secured by residential mortgages, and both floating and fixed rate second mortgage loans with a variety of plans for repayment. Real estate construction loans are also offered.

In order to expand the Company geographically into western Suffolk, Nassau and Queens Counties and to diversify the lending business of the Company, loan production offices were opened in Long Island City (2015), Garden City (2013) and Melville (2012). As part of the Company’s strategy to move westward, the loan production office and business banking center branch in Long Island City serves Queens and nearby Brooklyn.

The Bank finances most of its activities through a combination of deposits, including demand, savings, N.O.W. and money market deposits as well as time deposits, and borrowings which could include federal funds with correspondent banks, securities sold under agreements to repurchase and Federal Home Loan Bank (“FHLB”) short-term and long-term borrowings. The Company’s chief competition includes local banks within its market area, as well as New York City money center banks and regional banks.

Financial Performance Summary
As of or for the quarters and nine months ended September 30, 2015 and 2014
(dollars in thousands, except per share data)

   
Quarters ended September 30,
   
Over/
(under)
     
Nine months ended September 30,
   
Over/
(under)
   
   
2015
   
2014
   
2014
     
2015
   
2014
   
2014
   
Revenue (1)
 
$
19,805
   
$
18,099
     
9.4
%
   
$
58,284
   
$
54,709
     
6.5
%
 
Operating expenses
 
$
12,668
   
$
13,236
     
(4.3
%)
   
$
38,950
   
$
39,697
     
(1.9
%)
 
Provision for loan losses
 
$
350
   
$
250
     
40.0
%
   
$
600
   
$
750
     
(20.0
%)
 
Net income
 
$
4,923
   
$
3,738
     
31.7
%
   
$
14,050
   
$
11,229
     
25.1
%
 
Net income per common share - diluted
 
$
0.42
   
$
0.32
     
31.3
%
   
$
1.19
   
$
0.96
     
24.0
%
 
Return on average assets
   
0.97
%
   
0.84
%
   
13
bp    
0.96
%
   
0.87
%
   
9
 
bp
Return on average stockholders' equity
   
10.15
%
   
8.18
%
   
197
  
bp    
9.95
%
   
8.51
%
   
144
 
bp
Tier 1 leverage ratio
   
9.95
%
   
10.21
%
   
(26
)
bp    
9.95
%
   
10.21
%
   
(26
)
bp
Common equity tier 1 risk-based capital ratio
   
11.98
%
   
N/A
   
N/A
     
11.98
%
   
N/A
   
N/A
 
Tier 1 risk-based capital ratio
   
11.98
%
   
12.84
%
   
(86
)
bp    
11.98
%
   
12.84
%
   
(86
)
bp
Total risk-based capital ratio
   
13.21
%
   
14.09
%
   
(88
)
bp    
13.21
%
   
14.09
%
   
(88
)
bp
Tangible common equity ratio (non-GAAP)
   
9.38
%
   
10.07
%
   
(69
)
bp    
9.38
%
   
10.07
%
   
(69
)
bp
Total stockholders' equity/total assets (2)
   
9.51
%
   
10.22
%
   
(71
)
bp    
9.51
%
   
10.22
%
   
(71
)
bp

bp - denotes basis points; 100 bp equals 1%.
(1)
Represents net interest income plus total non-interest income.
(2)
The ratio of total stockholders' equity to total assets is the most comparable U.S. GAAP measure to the non-GAAP tangible common equity ratio presented herein.

At September 30, 2015, the Company, on a consolidated basis, had total assets of $2.1 billion, total deposits of $1.8 billion and total stockholders’ equity of $197 million. The Company recorded net income of $4.9 million, or $0.42 per diluted common share, for the third quarter of 2015, compared to $3.7 million, or $0.32 per diluted common share, for the same period in 2014. The 31.7% improvement in third quarter 2015 net income resulted from a $1.8 million increase in net interest income and a $568 thousand reduction in total operating expenses in 2015 versus the comparable 2014 period. Partially offsetting these improvements was a $123 thousand reduction in non-interest income and a $100 thousand increase in the provision for loan losses in 2015 versus 2014. The Company’s effective tax rate increased to 27.5% in 2015 from 19.0% a year ago.  Excluding net non-accrual interest received, core net income increased by 31.2% to $4.8 million in the third quarter of 2015 from $3.6 million in the comparable 2014 period. (See also Non-GAAP Disclosure contained herein.)
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
(in thousands)
 
2015
   
2014
   
2015
   
2014
 
CORE NET INCOME:
               
Net income, as reported
 
$
4,923
   
$
3,738
   
$
14,050
   
$
11,229
 
                                 
Less:
                               
Gain on sale of branch building and parking lot
   
-
     
-
     
-
     
(746
)
Branch consolidation credits
   
-
     
-
     
-
     
(449
)
Net non-accrual interest adjustment
   
(199
)
   
(117
)
   
(1,173
)
   
(789
)
Total adjustments, before income taxes
   
(199
)
   
(117
)
   
(1,173
)
   
(1,984
)
Adjustment for reported effective income tax rate
   
(55
)
   
(22
)
   
(293
)
   
(422
)
Total adjustments, after income taxes
   
(144
)
   
(95
)
   
(880
)
   
(1,562
)
                                 
Core net income
 
$
4,779
   
$
3,643
   
$
13,170
   
$
9,667
 

The Company’s return on average assets and return on average common stockholders’ equity were 0.97% and 10.15%, respectively, in the third quarter of 2015 versus 0.84% and 8.18%, respectively, in the third quarter of 2014.

The Company continues to increase market share by preserving its eastern Suffolk lending franchise while simultaneously expanding west. This strategy has allowed the Company to expand into markets in Nassau County and New York City that are very attractive from a demographic standpoint and have an abundance of small and middle market businesses, the kinds of businesses that have comprised the Company’s core customer base throughout its history.

Thus far in 2015, the Company has experienced a $204 million or 15.1% increase in the total loan portfolio, from $1.4 billion at December 31, 2014 to $1.6 billion at September 30, 2015. Linked-quarter growth was approximately $83 million, from $1.5 billion at June 30, 2015, a 5.6% increase. Total loans at September 30, 2015 represented a 23.6% increase from the comparable 2014 date. Loan growth was net of the third quarter 2015 sale of approximately $25 million in multifamily loans, generating a net gain of $370 thousand. The Company’s strong loan origination capability as it expands west gives it the ability to take advantage of a deep and attractive market for the high quality multifamily loans the Company is originating in New York City. This presents the Company with flexibility to periodically complete strategic sales, such as that in the third quarter of 2015, in order to generate non-interest income, protect net interest margin and avoid becoming too concentrated in a single product line. The Company’s loan pipeline continues to be robust and management remains optimistic about the prospect for continued strong loan growth for the rest of 2015 and into early 2016.

Third quarter 2015 lending results indicate that the Company’s core growth strategy of protecting and enhancing traditional markets on the east end of Long Island, while simultaneously expanding west, is working as envisioned. As the local economy has improved, loan demand has strengthened in the Company’s traditional markets. In addition, the loan production offices opened during the last three years in Melville, Garden City and Long Island City, are all contributing substantially to the Company’s results. Management believes the Company is only in the early stages of its proven and successful expansion strategy.

The credit quality of the Company’s loan portfolio continues to be very strong in all categories. Total non-accrual loans at September 30, 2015 were $7.5 million, or 0.48% of total loans, compared to $5.5 million, or 0.37% of total loans at June 30, 2015, with the increase largely the result of a single relationship that was paid down significantly early in the fourth quarter of 2015. All other key credit metrics remain solid and reflect management’s steadfast commitment to a strong credit culture. Early delinquencies (30-89 days past due), which are managed aggressively as a harbinger of future credit issues, were extremely low at $1.0 million, or 0.06% of total loans at September 30, 2015. Given the continuous improvement in the credit quality of the Company’s loan portfolio, as well as the strengthening economic conditions in the Company’s markets, management believes the Company is well reserved. The Company’s allowance for loan losses at September 30, 2015 was $20.3 million, or 1.30% of total loans and 271% of total non-accrual loans.
 
Quarterly deposit generation results continue to indicate that the core deposit franchise the Company has built over 125 years is unique in the local marketplace and gives it a significant competitive advantage, particularly in a rising rate environment. At the end of the 2015 third quarter, 45% of the Company’s total deposits were demand deposits, resulting in a cost of funds of 18 basis points and a core net interest margin of 3.85%. In addition, core deposits represented 87% of total deposits at September 30, 2015. The Company’s continuing ability to bring in new customer relationships, provide superior customer service and focus on low funding costs is how the Company does business and it has benefitted from that approach throughout all interest rate cycles over many decades. Management continues to maintain an asset sensitive balance sheet for the Company so that, over time, the Company will be positioned to benefit from positive earnings leverage as interest rates rise and the yields on its relatively short duration assets grow faster than the costs of its deposit liabilities.

The Company’s management continues to be vigilant in controlling operating expenses and improving efficiency. The successful expansion strategies that have resulted in strong overall financial results during the last three years require significant investment, particularly in attracting the best lending and credit professionals to drive performance. Nevertheless, management has been successful in finding ways to fund these investments by reducing expenses in other areas, a trend clearly reflected in third quarter 2015 results. Total operating expenses in the third quarter were $12.7 million, which is less than the $13.2 million in operating expenses incurred in both the second quarter of 2015 and the comparable quarter a year ago. This improvement in operating leverage, which was accomplished notwithstanding the significant revenue enhancing investments funded during the last year, translated into an improvement in the Company’s core operating efficiency ratio during the third quarter of 2015 to 61.8%, from 69.2% in the comparable quarter a year ago. (See also Non-GAAP Disclosure contained herein.) As the Company moves forward, management will continue to balance the need for investment to generate revenue with expense reductions in other areas. The Company’s management has proven its ability to do this and believes it will build shareholder value over the long term.

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
(in thousands)
 
2015
   
2014
   
2015
   
2014
 
                 
Core operating expenses:
               
Total operating expenses
 
$
12,668
   
$
13,236
   
$
38,950
   
$
39,697
 
Adjust for branch consolidation credits
   
-
     
-
     
-
     
449
 
Core operating expenses
   
12,668
     
13,236
     
38,950
     
40,146
 
                                 
Core non-interest income:
                               
Total non-interest income
   
2,427
     
2,550
     
6,568
     
8,320
 
Adjust for gain on sale of branch building and parking lot
   
-
     
-
     
-
     
(746
)
Core non-interest income
   
2,427
     
2,550
     
6,568
     
7,574
 
Adjust for tax-equivalent basis
   
200
     
190
     
600
     
622
 
Core FTE non-interest income
   
2,627
     
2,740
     
7,168
     
8,196
 
                                 
Core net interest income:
                               
FTE net interest income
   
18,220
     
16,515
     
54,475
     
49,310
 
Net non-accrual interest adjustment
   
(199
)
   
(117
)
   
(1,173
)
   
(789
)
Core FTE net interest income
   
18,021
     
16,398
     
53,302
     
48,521
 
                                 
Core operating efficiency ratio:
                               
Core operating expenses
   
12,668
     
13,236
     
38,950
     
40,146
 
Core FTE net interest income
   
18,021
     
16,398
     
53,302
     
48,521
 
Core FTE non-interest income
   
2,627
     
2,740
     
7,168
     
8,196
 
Less net (gain) loss on sale of securities available for sale
   
(133
)
   
(11
)
   
(319
)
   
12
 
Total FTE revenue
   
20,515
     
19,127
     
60,151
     
56,729
 
Core operating expenses/total FTE revenue
   
61.75
%
   
69.20
%
   
64.75
%
   
70.77
%
 
Critical Accounting Policies, Judgments and Estimates - The Company’s accounting and reporting policies conform to U.S. GAAP and general practices within the banking industry. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
 
Allowance for Loan Losses - One  of  the  most  critical  accounting policies impacting the Company’s financial statements is the evaluation of the allowance for loan losses. The allowance for loan losses is a valuation allowance for probable incurred losses, increased by the provision for loan losses and recoveries, and decreased by loan charge-offs. For all classes of loans, when a loan, in full or in part, is deemed uncollectible, it is charged against the allowance for loan losses. This happens when the loan is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have sufficient assets to pay the debt, or the value of the collateral is less than the balance of the loan and is not considered likely to improve soon. The allowance for loan losses is determined by a quarterly analysis of the loan portfolio. Such analysis includes changes in the size and composition of the portfolio, the Company’s own historical loan losses, industry-wide losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions and other relevant factors. All non-accrual loans over $250 thousand in the commercial and industrial, commercial real estate and real estate construction loan classes and all troubled debt restructurings (“TDRs”) are evaluated individually for impairment. All other loans are generally evaluated as homogeneous pools with similar risk characteristics. In assessing the adequacy of the allowance for loan losses, management reviews the loan portfolio by separate classes that have similar risk and collateral characteristics. These classes are commercial and industrial, commercial real estate, multifamily, mixed use commercial, real estate construction, residential mortgages, home equity and consumer loans.

The allowance for loan losses consists of specific and general components, as well as an unallocated component. The specific component relates to loans that are individually classified as impaired. Specific reserves are established based on an analysis of the most probable sources of repayment or liquidation of collateral. Impaired loans that are collateral dependent are reviewed based on the fair market value of collateral and the estimated time required to recover the Company’s investment in the loans, as well as the cost of doing so, and the estimate of the recovery. Non-collateral dependent impaired loans are reviewed based on the present value of estimated future cash flows, including balloon payments, if any, using the loan’s effective interest rate. While every impaired loan is evaluated individually, not every loan requires a specific reserve. Specific reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs. The general component covers non-impaired loans and is based on historical loss experience for each loan class from a rolling twelve quarter period and modifying those percentages, if necessary, after adjusting for current qualitative and environmental factors that reflect changes in the estimated collectability of the loan class not captured by historical loss data. These factors augment actual loss experience and help estimate the probability of loss within the loan portfolio based on emerging or inherent risk trends. These qualitative factors are applied as an adjustment to historical loss rates and require judgments that cannot be subjected to exact mathematical calculation. These adjustments reflect management’s overall estimate of the extent to which current losses on a pool of loans will differ from historical loss experience. These adjustments are subjective estimates and management reviews them on a quarterly basis. TDRs are also considered impaired with impairment generally measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception or using the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
 
Deferred Tax Assets and Liabilities – Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities, computed using enacted tax rates. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.  The realization of deferred tax assets (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years. In assessing the need for a valuation allowance, the Company considers all relevant positive and negative evidence, including taxable income in carryback years, scheduled reversals of deferred tax liabilities, expected future taxable income and available tax planning strategies.

Other-Than-Temporary Impairment (“OTTI”) of Investment Securities – Management evaluates securities for OTTI on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the statement of income and 2) OTTI related to other factors, which is recognized in other comprehensive income (loss). The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
 
Material Changes in Financial Condition - Total assets of the Company were $2.1 billion at September 30, 2015. When compared to December 31, 2014, total assets increased by $172 million. This change was primarily due to loan growth and an increase in total cash and cash equivalents of $204 million and $42 million, respectively, partially offset by decreases in loans held for sale, investment securities available for sale and interest-bearing time deposits in other banks of $26 million, $37 million and $10 million, respectively.

Total loans were $1.6 billion at September 30, 2015 compared to $1.4 billion at December 31, 2014. The increase in the loan portfolio was primarily due to growth of commercial real estate, multifamily and mixed use commercial loans of $88 million, $83 million and $30 million, respectively, in the first nine months of 2015.

The decrease in loans held for sale reflected the sale of $24 million in multifamily loans, at a premium, in the first quarter of 2015. Total investment securities available for sale were $261 million at September 30, 2015 and $299 million at December 31, 2014. The decrease in available for sale securities largely reflected maturities and calls of municipal obligations and U.S. Government agency securities totaling $27 million, coupled with principal paydowns of collateralized mortgage obligations and mortgage-backed securities of U.S. Government-sponsored enterprises totaling $8 million and sales of corporate bonds and municipal obligations totaling $10 million for the first nine months of 2015. These decreases were partially offset by purchases of corporate bonds and municipal obligations totaling $7 million during the same period. The available for sale securities portfolio had an unrealized pre-tax gain of $5.2 million at September 30, 2015 compared to a gain of $4.4 million at year-end 2014.

At September 30, 2015, total deposits were $1.8 billion, an increase of $240 million when compared to December 31, 2014. This increase was primarily due to higher balances of demand, savings, N.O.W. and money market deposits of $117 million, $28 million, $3 million and $75 million, respectively. Additionally, time deposit balances increased $17 million over the same period. Core deposit balances, which consist of demand, savings, N.O.W. and money market deposits, represented 87% of total deposits at September 30, 2015 and 86% of total deposits at December 31, 2014. Demand deposit balances represented 45% and 44% of total deposits at September 30, 2015 and December 31, 2014, respectively. At September 30, 2015 and December 31, 2014, the Company had $50 million and $130 million, respectively, in borrowings used to fund the growth in the Company’s loan portfolio. The 2015 amount includes $15 million in five-year FHLB borrowings with a fixed rate of 1.76%.

Liquidity and Capital Resources - Liquidity management is defined as both the Company’s and the Bank’s ability to meet their financial obligations on a continuous basis without material loss or disruption of normal operations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the repayment of borrowings as they mature, funding new and existing loan commitments and the ability to take advantage of business opportunities as they arise. Asset liquidity is provided by short-term investments and the marketability of securities available for sale. The Company may also leave excess reserve balances at the Federal Reserve Bank (“FRB”) if the rate being paid is higher than would be available from other short-term investments. Liquid assets, consisting of federal funds sold, securities available for sale and balances at the FRB, decreased to $278 million at September 30, 2015 compared to $311 million at December 31, 2014. These liquid assets may include assets that have been pledged primarily against municipal deposits or borrowings. In addition, the Company has pledged U.S. Government agency securities held in its available for sale portfolio, with a market value of approximately $3 million at September 30, 2015, as collateral for the derivative swap contracts. Liquidity is also provided by the maintenance of a base of core deposits, maturing short-term assets including cash and due from banks, the ability to sell or pledge marketable assets and access to lines of credit.

Liquidity is continuously monitored, thereby allowing management to better understand and react to emerging balance sheet trends, including temporary mismatches with regard to sources and uses of funds. After assessing actual and projected cash flow needs, management seeks to obtain funding at the most economical cost. These funds can be obtained by converting liquid assets to cash or by attracting new deposits or other sources of funding. Many factors affect the Company’s ability to meet liquidity needs, including variations in the markets served, loan demand, its asset/liability mix, its reputation and credit standing in its markets and general economic conditions. Borrowings and the scheduled amortization of investment securities and loans are more predictable funding sources. Deposit flows and securities prepayments are somewhat less predictable as they are often subject to external factors. Among these are changes in the local and national economies, competition from other financial institutions and changes in market interest rates.

The Company’s primary sources of funds are cash provided by deposits and borrowings, proceeds from maturities and sales of securities available for sale and cash provided by operating activities. At September 30, 2015, total deposits were $1.8 billion, an increase of $240 million when compared to December 31, 2014. Of the $236 million in total time deposits at September 30, 2015, $183 million are scheduled to mature within the next 12 months. Based on historical experience, the Company expects to be able to replace a substantial portion of those maturing deposits with comparable deposit products. At September 30, 2015 and December 31, 2014, the Company had $50 million and $130 million, respectively, in borrowings used to fund the growth in the Company’s loan portfolio. For the nine months ended September 30, 2015 and 2014, proceeds from sales and maturities of securities available for sale totaled $37 million and $41 million, respectively.
 
The Company’s primary uses of funds are for the origination of loans and the purchase of investment securities. For the nine months ended September 30, 2015, the Company had net loan originations for portfolio of $228 million compared to $218 million for the same period in 2014. For the nine months ended September 30, 2015 and 2014, the Company purchased investment securities totaling $13 million and $4 million, respectively.

The Bank’s Asset/Liability and Funds Management Policy establishes specific policies and operating procedures governing liquidity levels to assist management in developing plans to address future and current liquidity needs. Management monitors the rates and cash flows from the loan and investment portfolios while also examining the maturity structure and volatility characteristics of liabilities to develop an optimum asset/liability mix. Available funding sources include retail, commercial and municipal deposits, purchased liabilities and stockholders’ equity. At September 30, 2015, access to approximately $673 million in FHLB lines of credit for overnight or term borrowings with maturities of up to thirty years was available. At September 30, 2015, approximately $60 million and $10 million in unsecured and secured lines of credit, respectively, extended by correspondent banks were also available to be utilized, if needed, for short-term funding purposes. At September 30, 2015, $50 million in borrowings were outstanding with the FHLB. No borrowings were outstanding under lines of credit with correspondent banks.

The Bank also has the ability to access the brokered deposit market. Deposits gathered through the Certificate of Deposit Account Registry Service (“CDARS”) are considered for regulatory purposes to be brokered deposits. At September 30, 2015, the Bank had $1 million in CDARS deposits outstanding.

The Company strives to maintain an efficient level of capital, commensurate with its risk profile, on which a competitive rate of return to stockholders will be realized over both the short and long term. Capital is managed to enhance stockholder value while providing flexibility for management to act opportunistically in a changing marketplace. Management continually evaluates the Company’s capital position in light of current and future growth objectives and regulatory guidelines. Total stockholders’ equity was $197 million at September 30, 2015 compared to $183 million at December 31, 2014. The increase in stockholders’ equity versus December 31, 2014 was primarily due to net income, net of dividends paid, recorded during 2015.

The Company and the Bank are subject to regulatory capital requirements. The Company’s tier 1 leverage, common equity tier 1 risk-based, tier 1 risk-based and total risk-based capital ratios were 9.95%, 11.98%, 11.98% and 13.21%, respectively, at September 30, 2015, exceeding all regulatory requirements. The Bank’s tier 1 leverage, common equity tier 1 risk-based, tier 1 risk-based and total risk-based capital ratios were 9.78%, 11.77%, 11.77% and 13.01%, respectively, at September 30, 2015. Each of these ratios exceeds the regulatory guidelines for a well-capitalized institution, the highest regulatory capital category.

The Company did not repurchase any shares of its common stock during the first nine months of 2015. Repurchase of shares will occur only if management believes that the purchase will be at prices that are accretive to earnings per share and is the most efficient use of the Company’s capital.

The Company’s tangible common equity ratio was 9.38% at September 30, 2015 compared to 9.50% at December 31, 2014 and 10.07% at September 30, 2014. The ratio of tangible common equity to tangible assets, or TCE ratio, is calculated by dividing total common stockholders’ equity by total assets, after reducing both amounts by intangible assets. The TCE ratio is not required by U.S. GAAP or by applicable bank regulatory requirements, but is a metric used by management to evaluate the adequacy of our capital levels. Since there is no authoritative requirement to calculate the TCE ratio, our TCE ratio is not necessarily comparable to similar capital measures disclosed or used by other companies in the financial services industry. Tangible common equity and tangible assets are non-GAAP financial measures and should be considered in addition to, not as a substitute for or superior to, financial measures determined in accordance with U.S. GAAP. Set forth below are the reconciliations of tangible common equity to U.S. GAAP total common stockholders’ equity and tangible assets to U.S. GAAP total assets at September 30, 2015 (in thousands). (See also Non-GAAP Disclosure contained herein.)
 
             
Ratios
 
Total stockholders' equity
 
$
196,540
 
Total assets
 
$
2,066,844
     
9.51
% (1)
Less: intangible assets
   
(2,915
)
Less: intangible assets
   
(2,915
)
       
Tangible common equity
 
$
193,625
 
Tangible assets
 
$
2,063,929
     
9.38
% (2)
 
(1) The ratio of total stockholders' equity to total assets is the most comparable U.S. GAAP measure to the non-GAAP tangible common equity ratio presented herein.
(2) TCE ratio.
 
All dividends must conform to applicable statutory requirements. The Company’s ability to pay dividends to stockholders depends on the Bank’s ability to pay dividends to the Company. Under 12 USC 56-9, a national bank may not pay a dividend on its common stock if the dividend would exceed net undivided profits then on hand. Further, under 12 USC 60, a national bank must obtain prior approval from the OCC to pay dividends on either common or preferred stock that would exceed the bank’s net profits for the current year combined with retained net profits (net profits minus dividends paid during that period) of the prior two years. The ability of the Bank to pay dividends to the Company is subject to certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock. In addition, a national bank may not pay dividends in an amount greater than its undivided profits or declare any dividends if such declaration would leave the bank inadequately capitalized. The Company’s Board of Directors declared three quarterly cash dividends totaling $0.22 per common share during the first nine months of 2015. Dividends totaling $0.06 per common share were declared during the comparable 2014 period.

Off-Balance Sheet Arrangements - The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby and documentary letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated financial statements. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

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 many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the customer. Collateral required varies, but may include accounts receivable, inventory, equipment, real estate and income-producing commercial properties. At September 30, 2015 and December 31, 2014, commitments to originate loans and commitments under unused lines of credit for which the Bank is obligated amounted to approximately $150 million and $180 million, respectively.

Letters of credit are conditional commitments guaranteeing payments of drafts in accordance with the terms of the letter of credit agreements. Commercial letters of credit are used primarily to facilitate trade or commerce and are also issued to support public and private borrowing arrangements, bond financing and similar transactions. Collateral may be required to support letters of credit based upon management’s evaluation of the creditworthiness of each customer. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Most letters of credit expire within one year. At September 30, 2015 and December 31, 2014, letters of credit outstanding were approximately $15 million and $17 million, respectively.

Material Changes in Results of Operations – Comparison of the Quarters Ended September 30, 2015 and 2014 - The Company recorded net income of $4.9 million during the third quarter of 2015 versus $3.7 million in the comparable quarter a year ago. The 31.7% improvement in third quarter 2015 net income resulted from a $1.8 million increase in net interest income and a $568 thousand reduction in total operating expenses in 2015 versus the comparable 2014 period. Partially offsetting these improvements was a $123 thousand reduction in non-interest income and a $100 thousand increase in the provision for loan losses in 2015 versus 2014. The Company’s effective tax rate increased to 27.5% in 2015 from 19.0% a year ago.

The $1.8 million or 11.8% improvement in third quarter 2015 net interest income resulted from a $220 million (13.4%) increase in average total interest-earning assets. Partially offsetting the earning asset growth was an 11 basis point decline in the Company’s net interest margin to 3.89% in 2015 from 4.00% in 2014. Adjusting for the impact of net non-accrual interest received in each period, the Company’s core net interest margin was 3.85% in the third quarter of 2015 versus 3.97% in the third quarter of 2014. (See also Non-GAAP Disclosure contained herein.)

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
Core net interest margin:
               
FTE net interest margin
   
3.89
%
   
4.00
%
   
4.02
%
   
4.11
%
Net non-accrual interest adjustment
   
(0.04
)
   
(0.03
)
   
(0.09
)
   
(0.07
)
Core FTE net interest margin
   
3.85
%
   
3.97
%
   
3.93
%
   
4.04
%
 
The Company’s third quarter 2015 average total interest-earning asset yield was 4.06% versus 4.14% in the comparable 2014 quarterly period. The decline in the interest-earning asset yield in 2015 resulted from reductions in the average yields on the loan and investment portfolios of 22 and nine basis points, respectively, when compared to the third quarter of 2014. The Company’s average balance sheet mix continued to improve as average loans increased by $292 million (24.0%) versus third quarter 2014 and low-yielding overnight interest-bearing deposits and federal funds sold declined by $30 million (71.3%) during the same period. The average securities portfolio decreased by $45 million to $331 million in the third quarter of 2015 versus the comparable 2014 period.  The average yield on the investment portfolio was 3.62% in the third quarter of 2015 versus 3.71% a year ago.

The Company’s average cost of total interest-bearing liabilities increased by five basis points to 0.32% in the third quarter of 2015 versus 0.27% in the third quarter of 2014. The Company’s total cost of funds, among the lowest in the industry, increased nominally to 0.18% in the third quarter of 2015 versus 0.16% a year ago. Average core deposits increased $170 million (12.7%) to $1.5 billion during the third quarter of 2015 versus the comparable 2014 period, with average demand deposits representing 44% of third quarter 2015 average total deposits. Total deposits increased by $215 million or 13.6% to $1.8 billion at September 30, 2015 versus September 30, 2014. Core deposit balances, which represented 87% of total deposits at September 30, 2015, grew by $204 million or 15.0% during the same period. Average borrowings increased $41 million during the third quarter of 2015 compared to 2014 and were used, in part, to fund the growth in the Company’s loan portfolio, which increased by $292 million on average during that same period.

NET INTEREST INCOME ANALYSIS
For the Three Months Ended September 30, 2015 and 2014
(unaudited, dollars in thousands)

   
2015
   
2014
 
   
Average
Balance
   
Interest
   
Average
Yield/Cost
   
Average
Balance
   
Interest
   
Average
Yield/Cost
 
Assets:
                       
Interest-earning assets:
                       
Investment securities (1)
 
$
330,891
   
$
3,022
     
3.62
%
 
$
376,097
   
$
3,521
     
3.71
%
Federal Reserve and Federal Home Loan Bank stock and other investments
   
5,251
     
71
     
5.36
     
2,990
     
42
     
5.57
 
Federal funds sold and interest-bearing deposits due from banks
   
12,040
     
7
     
0.23
     
41,978
     
35
     
0.33
 
Loans and performing loans held for sale (2)
   
1,511,936
     
15,948
     
4.18
     
1,219,508
     
13,532
     
4.40
 
Total interest-earning assets
   
1,860,118
   
$
19,048
     
4.06
%
   
1,640,573
   
$
17,130
     
4.14
%
Non-interest-earning assets
   
153,001
                     
129,941
                 
Total assets
 
$
2,013,119
                   
$
1,770,514
                 
                                                 
Liabilities and stockholders' equity:
                                               
Interest-bearing liabilities:
                                               
Savings, N.O.W. and money market deposits
 
$
733,365
   
$
338
     
0.18
%
 
$
668,850
   
$
291
     
0.17
%
Time deposits
   
241,427
     
396
     
0.65
     
228,207
     
322
     
0.56
 
Total savings and time deposits
   
974,792
     
734
     
0.30
     
897,057
     
613
     
0.27
 
Borrowings
   
42,783
     
94
     
0.88
     
1,957
     
2
     
0.37
 
Total interest-bearing liabilities
   
1,017,575
     
828
     
0.32
     
899,014
     
615
     
0.27
 
Demand deposits
   
779,215
                     
673,441
                 
Other liabilities
   
23,836
                     
16,818
                 
Total liabilities
   
1,820,626
                     
1,589,273
                 
Stockholders' equity
   
192,493
                     
181,241
                 
Total liabilities and stockholders' equity
 
$
2,013,119
                   
$
1,770,514
                 
Total cost of funds
                   
0.18
%
                   
0.16
%
Net interest rate spread
                   
3.74
%
                   
3.87
%
Net interest income/margin
           
18,220
     
3.89
%
           
16,515
     
4.00
%
Less tax-equivalent basis adjustment
           
(842
)
                   
(966
)
       
Net interest income
         
$
17,378
                   
$
15,549
         

(1) Interest on securities includes the effects of tax-equivalent basis adjustments of $692 and $830 in 2015 and 2014, respectively.
(2) Interest on loans includes the effects of tax-equivalent basis adjustments of $150 and $136 in 2015 and 2014, respectively.
 
As a result of continued growth in the loan portfolio, the Company recorded a $350 thousand provision for loan losses during the third quarter of 2015. The Company recorded a provision for loan losses of $250 thousand in the third quarter of 2014.The adequacy of the provision and the resulting allowance for loan losses, which was $20.3 million at September 30, 2015, is determined by management’s ongoing review of the loan portfolio, including identification and review of individual problem situations that may affect a borrower’s ability to repay, delinquency and non-performing loan data including the current status of criticized and classified loans, collateral values and changes in the size and mix of the loan portfolio. (See also Critical Accounting Policies, Judgments and Estimates and Asset Quality contained herein.)

Non-interest income declined by $123 thousand or 4.8% in the third quarter of 2015 versus the comparable 2014 period.  This reduction was due to several factors, most notably reductions in fiduciary fees (down $265 thousand) and service charges on deposits (down $138 thousand). Fiduciary fees declined as a result of the Company’s decision to exit the wealth management market during the fourth quarter of 2014 through the sale of its wealth management business. Deposit service charges declined due to reductions in overdraft fees and demand deposit account analysis charges in 2015. Somewhat offsetting these reductions were higher net gains on the sale of securities available for sale (up $122 thousand) and on the sale of portfolio loans (up $153 thousand).  Excluding the impact of the wealth management sale in 2014 and the net gain on the sale of securities in each period, non-interest income increased by $20 thousand in 2015.

Non-Interest Income
For the quarters and nine months ended September 30, 2015 and 2014
(dollars in thousands)

   
Quarters ended September 30,
   
Over/
(under)
   
Nine months ended September 30,
   
Over/
(under)
 
   
2015
   
2014
   
2014
   
2015
   
2014
   
2014
 
Service charges on deposit accounts
 
$
749
   
$
887
     
(15.6
)%
 
$
2,319
   
$
2,834
     
(18.2
)%
Other service charges, commissions and fees
   
759
     
778
     
(2.4
)
   
2,032
     
2,349
     
(13.5
)
Fiduciary fees
   
-
     
265
     
(100.0
)
   
-
     
824
     
(100.0
)
Net gain (loss) on sale of securities available for sale
   
133
     
11
     
1,109.1
     
319
     
(12
)
   
N/M
(1)
Net gain on sale of portfolio loans
   
370
     
217
     
70.5
     
568
     
217
     
161.8
 
Net gain on sale of mortgage loans originated for sale
   
85
     
51
     
66.7
     
290
     
214
     
35.5
 
Net gain on sale of premises and equipment
   
-
     
-
     
-
     
-
     
752
     
(100.0
)
Income from bank owned life insurance
   
306
     
316
     
(3.2
)
   
918
     
1,036
     
(11.4
)
Other operating income
   
25
     
25
     
-
     
122
     
106
     
15.1
 
Total non-interest income
 
$
2,427
   
$
2,550
     
(4.8
)%
 
$
6,568
   
$
8,320
     
(21.1
)%

(1) N/M - denotes % variance not meaningful for statistical purposes.
 
Total operating expenses declined by $568 thousand or 4.3% in the third quarter of 2015 versus 2014 principally the result of a $648 thousand reduction in employee compensation and benefits expense in 2015, reflecting lower expense levels for incentive compensation, pension, 401(k) and medical insurance in 2015. The Company’s core operating efficiency ratio improved to 61.8% in the third quarter of 2015 from 69.2% a year ago. The core operating efficiency ratio is calculated by making certain adjustments to the operating efficiency ratio calculation. The core operating efficiency ratio is not required by U.S. GAAP or by applicable bank regulatory requirements, but is a metric used by management to evaluate core operating efficiency. Since there is no authoritative requirement to calculate this ratio, our ratio is not necessarily comparable to similar efficiency measures disclosed or used by other companies in the financial services industry. The core operating efficiency ratio is a non-GAAP financial measure and should be considered in addition to, not as a substitute for or superior to, financial measures determined in accordance with U.S. GAAP. The calculation of the core operating efficiency ratio, the reconciliation of core operating expenses to U.S. GAAP total operating expenses, core non-interest income to U.S. GAAP total non-interest income and core FTE net interest income to FTE net interest income are provided elsewhere herein. (See also Non-GAAP Disclosure contained herein.)
 
Operating Expenses
For the quarters and nine months ended September 30, 2015 and 2014
(dollars in thousands)

   
Quarters ended September 30,
   
Over/
 (under)
   
Nine months ended September 30,
   
Over/
(under)
 
   
2015
   
2014
   
2014
   
2015
   
2014
   
2014
 
Employee compensation and benefits
 
$
7,980
   
$
8,628
     
(7.5
)%
 
$
25,102
   
$
25,977
     
(3.4
)%
Occupancy expense
   
1,401
     
1,295
     
8.2
     
4,236
     
4,141
     
2.3
 
Equipment expense
   
410
     
418
     
(1.9
)
   
1,199
     
1,301
     
(7.8
)
Consulting and professional services
   
609
     
693
     
(12.1
)
   
1,491
     
1,883
     
(20.8
)
FDIC assessment
   
226
     
202
     
11.9
     
802
     
737
     
8.8
 
Data processing
   
506
     
549
     
(7.8
)
   
1,590
     
1,681
     
(5.4
)
Branch consolidation credits
   
-
     
-
     
-
     
-
     
(449
)
   
(100.0
)
Other operating expenses
   
1,536
     
1,451
     
5.9
     
4,530
     
4,426
     
2.3
 
Total operating expenses
 
$
12,668
   
$
13,236
     
(4.3
)%
 
$
38,950
   
$
39,697
     
(1.9
)%

The Company recorded income tax expense of $1.9 million in the third quarter of 2015 resulting in an effective tax rate of 27.5% versus an income tax expense of $875 thousand and an effective tax rate of 19.0% in the comparable period a year ago. The increase in the 2015 effective tax rate resulted from growth in pre-tax income taxed at the 35% federal rate, coupled with a reduction in tax-exempt income versus the comparable 2014 period.

Material Changes in Results of Operations – Comparison of the Nine Months Ended September 30, 2015 and 2014 – The Company recorded net income of $14.1 million during the first nine months of 2015 versus $11.2 million in the comparable 2014 period. The 25.1% improvement in 2015 net income resulted principally from a $5.3 million increase in net interest income in the first nine months of 2015 coupled with a $747 thousand reduction in total operating expenses and a $150 thousand decline in the provision for loan losses. Partially offsetting these positive factors was a $1.8 million reduction in non-interest income and an increase in the Company’s effective tax rate in 2015.

The $5.3 million or 11.5% improvement in September year-to-date 2015 net interest income resulted from a $205 million increase in average total interest-earning assets, offset in part by a nine basis point contraction of the Company’s net interest margin to 4.02% in 2015 from 4.11% in 2014. The Company’s September year-to-date 2015 average total interest-earning asset yield was 4.19% versus 4.27% in the comparable 2014 year-to-date period. A lower average yield on the Company’s loan portfolio in the first nine months of 2015 versus the comparable 2014 period, down 27 basis points to 4.35%, was the primary contributing factor in the reduction in the interest-earning asset yield.  The Company’s average balance sheet mix continued to improve as average loans increased by $286 million (24.9%) versus September year-to-date 2014 and low-yielding overnight interest-bearing deposits, federal funds sold and securities purchased under agreements to resell declined by $31 million during the same period. The average securities portfolio decreased by $53 million to $346 million in the September year-to-date 2015 period versus 2014.  The average yield on the investment portfolio was 3.74% in the 2015 period versus 3.73% a year ago.

The Company’s average cost of total interest-bearing liabilities increased by two basis points to 0.30% in the first nine months of 2015 versus 0.28% in the comparable 2014 period. The Company’s total cost of funds was 0.17% in the first nine months of 2015 versus 0.16% in 2014. Average core deposits increased by $123 million to $1.4 billion during the first nine months of 2015 versus the comparable 2014 period, with average demand deposits representing 44% of year-to-date 2015 average total deposits. Average total deposits increased by $124 million or 8.1% to $1.7 billion during the September 2015 year-to-date period versus 2014. Average core deposit balances represented 86% of average total deposits during the 2015 period. Average borrowings increased by $76 million during the first nine months of 2015 compared to 2014 and represented 4.5% of total average funding during the September 2015 year-to-date period.
 
NET INTEREST INCOME ANALYSIS
For the Nine Months Ended September 30, 2015 and 2014
(unaudited, dollars in thousands)

   
2015
   
2014
 
   
Average
Balance
   
Interest
   
Average
Yield/Cost
   
Average
Balance
   
Interest
   
Average
Yield/Cost
 
Assets:
                       
Interest-earning assets:
                       
Investment securities (1)
 
$
345,958
   
$
9,669
     
3.74
%
 
$
399,261
   
$
11,129
     
3.73
%
Federal Reserve and Federal Home Loan Bank stock and other investments
   
6,609
     
221
     
4.47
     
3,099
     
115
     
4.96
 
Federal funds sold, securities purchased under agreements to resell and interest-bearing deposits due from banks
   
19,373
     
50
     
0.35
     
50,629
     
123
     
0.32
 
Loans and performing loans held for sale (2)
   
1,437,639
     
46,794
     
4.35
     
1,151,260
     
39,824
     
4.62
 
Total interest-earning assets
   
1,809,579
   
$
56,734
     
4.19
%
   
1,604,249
   
$
51,191
     
4.27
%
Non-interest-earning assets
   
142,691
                     
129,739
                 
Total assets
 
$
1,952,270
                   
$
1,733,988
                 
                                                 
Liabilities and stockholders' equity:
                                               
Interest-bearing liabilities:
                                               
Savings, N.O.W. and money market deposits
 
$
707,786
   
$
906
     
0.17
%
 
$
664,386
   
$
870
     
0.18
%
Time deposits
   
230,211
     
1,043
     
0.61
     
228,885
     
1,004
     
0.59
 
Total savings and time deposits
   
937,997
     
1,949
     
0.28
     
893,271
     
1,874
     
0.28
 
Borrowings
   
78,464
     
310
     
0.53
     
2,619
     
7
     
0.36
 
Total interest-bearing liabilities
   
1,016,461
     
2,259
     
0.30
     
895,890
     
1,881
     
0.28
 
Demand deposits
   
723,650
                     
644,042
                 
Other liabilities
   
23,451
                     
17,592
                 
Total liabilities
   
1,763,562
                     
1,557,524
                 
Stockholders' equity
   
188,708
                     
176,464
                 
Total liabilities and stockholders' equity
 
$
1,952,270
                   
$
1,733,988
                 
Total cost of funds
                   
0.17
%
                   
0.16
%
Net interest rate spread
                   
3.89
%
                   
3.99
%
Net interest income/margin
           
54,475
     
4.02
%
           
49,310
     
4.11
%
Less tax-equivalent basis adjustment
           
(2,759
)
                   
(2,921
)
       
Net interest income
         
$
51,716
                   
$
46,389
         

(1) Interest on securities includes the effects of tax-equivalent basis adjustments of $2,327 and $2,573 in 2015 and 2014, respectively.
(2) Interest on loans includes the effects of tax-equivalent basis adjustments of $432 and $348 in 2015 and 2014, respectively.

Due to a combination of improved credit metrics coupled with $515 thousand in 2015 year-to-date net recoveries, the Company’s provision for loan losses declined by $150 thousand during the first nine months of 2015 versus the comparable 2014 period.

Non-interest income declined by $1.8 million or 21.1% in the September 2015 year-to-date period when compared to 2014.  This reduction was due to several factors, most notably reductions in net gain on sale of premises and equipment (down $752 thousand), fiduciary fees (down $824 thousand), service charges on deposit accounts (down $515 thousand) and other service charges, commissions and fees (down $317 thousand). The reduction in net gain on the sale of premises and equipment resulted from gains recorded in 2014 on the sale of two bank properties. Fiduciary fees declined as a result of the Company’s sale of its wealth management business in late 2014. Deposit service charges declined principally due to a reduction in overdraft and demand deposit account analysis fees in 2015. Other service charges, commissions and fees were lower than the comparable 2014 period primarily as the result of a reduction in income from the sale of investment products through the Company’s branch network. Partially offsetting the foregoing reductions in non-interest income were increases in net gain on the sale of securities available for sale (up $331 thousand) and net gain on the sale of portfolio loans (up $351 thousand).
 
Total operating expenses declined by $747 thousand in the first nine months of 2015 versus 2014 as the result of reductions in several categories, most notably employee compensation and benefits (down $875 thousand) and consulting and professional services (down $392 thousand). Excluding a $449 thousand branch consolidation expense credit recorded in the 2014 year-to-date period, total operating expenses would have declined by $1.2 million or 3.0% in 2015 when compared to 2014. The Company’s core operating efficiency ratio improved to 64.8% in the first nine months of 2015 from 70.8% a year ago. (See also Non-GAAP Disclosure contained herein.)

The Company recorded income tax expense of $4.7 million in the year-to-date September 2015 period resulting in an effective tax rate of 25.0% versus an income tax expense of $3.0 million and an effective tax rate of 21.3% in the comparable period a year ago. The increase in the 2015 effective tax rate resulted from growth in pre-tax income taxed at the 35% federal rate, coupled with a reduction in tax-exempt income versus the comparable 2014 period.

Asset Quality - Non-accrual loans totaled $7.5 million or 0.48% of loans outstanding at September 30, 2015 versus $13.0 million or 0.96% of total loans outstanding at December 31, 2014 and $14.7 million or 1.16% of loans outstanding at September 30, 2014. The allowance for loan losses as a percentage of total non-accrual loans amounted to 271%, 148% and 128% at September 30, 2015, December 31, 2014 and September 30, 2014, respectively.
 

The Company had no loans 90 days or more past due and still accruing at any of the reported dates. Total loans 30 - 89 days past due and accruing amounted to $1 million or 0.06% of loans outstanding at September 30, 2015 as compared to $1 million or 0.10% of loans outstanding at December 31, 2014 and $3 million or 0.25% of loans outstanding at September 30, 2014. The Company held no OREO during any of the reported periods.

Total criticized and classified loans were $29 million at September 30, 2015 versus $40 million at December 31, 2014 and September 30, 2014. Criticized loans are those loans that are not classified but require some degree of heightened monitoring. Classified loans were $15 million at September 30, 2015 as compared to $30 million at December 31, 2014 and September 30, 2014. The allowance for loan losses as a percentage of total classified loans was 133%, 64% and 62%, respectively, at the same dates.

At September 30, 2015, the Company had $13 million in TDRs, primarily consisting of commercial and industrial loans, commercial real estate loans and residential mortgages totaling $1 million, $5 million and $5 million, respectively. The Company had TDRs amounting to $20 million at December 31, 2014 and September 30, 2014.

The Company recorded net loan charge-offs of $86 thousand in the third quarter of 2015 versus net loan recoveries of $726 thousand in the second quarter of 2015 and net loan recoveries of $72 thousand in the third quarter of 2014. As a percentage of average total loans outstanding, these net amounts represented, on an annualized basis, 0.02% for the third quarter of 2015, (0.21%) for the second quarter of 2015 and (0.02%) for the third quarter of 2014.
 
At September 30, 2015, the Company’s allowance for loan losses amounted to $20.3 million or 1.30% of period-end loans outstanding. The allowance as a percentage of loans outstanding was 1.42% and 1.49% at December 31, 2014 and September 30, 2014, respectively.
 

As a result of continued growth in the loan portfolio, the Company recorded a $350 thousand provision for loan losses during the third quarter of 2015. The Company recorded a provision for loan losses of $250 thousand in the third quarter of 2014.

For the three months ended September 30, 2015, the ending balance of the Company’s allowance for loan losses increased by $264 thousand when compared to June 30, 2015. During the third quarter of 2015, the Company increased its allowance for loan losses allocated to commercial real estate (“CRE”) and multifamily loans by $430 thousand and $252 thousand, respectively, and decreased its allowance for loan losses allocated to commercial and industrial (“C&I”) loans by $176 thousand.

The increases in the allowance for loan losses allocated to CRE and multifamily loans during the third quarter of 2015 largely reflected increases of $49 million and $32 million, respectively, in unimpaired pass rated CRE and multifamily loans. The decrease in the allowance for loan losses allocated to C&I loans was primarily due to a decrease of $12 million in unimpaired pass rated C&I loans, partially offset by a 0.08% increase versus June 30, 2015 in the average combined historical loss and environmental factors rates on such unimpaired pass rated loans.

The loss factors rates incorporate a rolling twelve quarter look back period used in calculating historical losses for each loan segment. In an effort to more accurately represent the Company’s incurred and probable losses by individual loan segment, a twelve quarter period is used to improve the granularity of individual loan segment charge-off history and reduce the volatility associated with improperly weighting short-term trends in the calculation.

At September 30, 2015, the Company’s allowance for loan losses included an unallocated portion totaling $3.1 million. For the three months ended September 30, 2015, the ending balance of the Company’s unallocated portion of the allowance for loan losses decreased $482 thousand versus June 30, 2015. Loan portfolio growth was 5.6% during the third quarter of 2015, primarily in multifamily and CRE loans. Loan growth, including multifamily loans, is expected to continue throughout 2015. An unallocated portion of the reserve is considered a prudent strategy until these loans to new borrowers establish longer-term payment patterns.

Management has determined that the current level of the allowance for loan losses is adequate in relation to the probable inherent losses present in the portfolio. Management considers many factors in this analysis, among them credit risk grades, delinquency trends, concentrations within segments of the loan portfolio, recent charge-off experience, local and national economic conditions, current real estate market conditions in geographic areas where the Company’s loans are located, changes in the trend of non-performing loans, changes in interest rates and loan portfolio growth. Changes in one or a combination of these factors may adversely affect the Company’s loan portfolio resulting in increased delinquencies, loan losses and future levels of loan loss provisions. Due to these uncertainties, management expects to record loan charge-offs in future periods. (See also Critical Accounting Policies, Judgments and Estimates contained herein.)
 

ANALYSIS OF NON-PERFORMING ASSETS
AND THE ALLOWANCE FOR LOAN LOSSES
September 30, 2015 versus December 31, 2014 and September 30, 2014
(dollars in thousands)

NON-PERFORMING ASSETS BY TYPE:

   
At
 
   
9/30/2015
   
12/31/2014
   
9/30/2014
 
Non-accrual loans
 
$
7,501
   
$
12,981
   
$
14,654
 
Non-accrual loans held for sale
   
-
     
-
     
-
 
Loans 90 days or more past due and still accruing
   
-
     
-
     
-
 
OREO
   
-
     
-
     
-
 
Total non-performing assets
 
$
7,501
   
$
12,981
   
$
14,654
 
                         
Gross loans outstanding
 
$
1,559,520
   
$
1,355,427
   
$
1,262,061
 
Total loans held for sale
 
$
745
   
$
26,495
   
$
-
 
                         
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES:
 
   
Quarter Ended
 
   
9/30/2015
   
12/31/2014
   
9/30/2014
 
Beginning balance
 
$
20,051
   
$
18,800
   
$
18,478
 
Provision
   
350
     
250
     
250
 
Charge-offs
   
(253
)
   
(22
)
   
(119
)
Recoveries
   
167
     
172
     
191
 
Ending balance
 
$
20,315
   
$
19,200
   
$
18,800
 
                         
KEY RATIOS:
 
   
At
 
   
9/30/2015
   
12/31/2014
   
9/30/2014
 
Allowance as a % of total loans (1)
   
1.30
%
   
1.42
%
   
1.49
%
                         
Non-accrual loans as a % of total loans (1)
   
0.48
%
   
0.96
%
   
1.16
%
                         
Non-performing assets as a % of total loans, loans held for sale and OREO
   
0.48
%
   
0.94
%
   
1.16
%
                         
Allowance for loan losses as a % of non-accrual loans (1)
   
271
%
   
148
%
   
128
%
                         
Allowance for loan losses as a % of non-accrual loans and loans 90 days or more past due and still accruing (1)
   
271
%
   
148
%
   
128
%

(1) Excludes loans held for sale.

ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company originates and invests in interest-earning assets and solicits interest-bearing deposit accounts. The Company’s operations are subject to market risk resulting from fluctuations in interest rates to the extent that there is a difference between the amounts of interest-earning assets and interest-bearing liabilities that are prepaid, withdrawn, mature, or repriced in any given period of time. The Company’s earnings or the net value of its portfolio will change under different interest rate scenarios. The principal objective of the Company’s asset/liability management program is to maximize net interest income within an acceptable range of overall risk, including both the effect of changes in interest rates and liquidity risk. The Company’s assessment of market risk at September 30, 2015 indicated there were no material changes in the quantitative and qualitative disclosures from those in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.
 
ITEM 4. – CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of its principal executive officer and principal financial officer, of the effectiveness of the design and operation of its disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”), as of the end of the period covered by this report.

Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that, as of September 30, 2015, the Company’s disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) accumulated and communicated to the Company’s management, including the Company’s principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. There have been no changes in the Company’s internal controls or in other factors that have materially affected, or are reasonably likely to materially affect, internal controls subsequent to the date the Company carried out its evaluation.

Changes in Internal Control Over Financial Reporting

There were no changes to the Company’s internal control over financial reporting as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act that occurred in the third quarter of 2015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating the disclosure controls and procedures, the Company’s management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that the Company’s management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

PART II

ITEM 1. - LEGAL PROCEEDINGS
 
See the information set forth in Note 10—Legal Proceedings in the Notes to Unaudited Condensed Consolidated Financial Statements under Part I, Item I, which information is incorporated by reference in response to this item.

ITEM 1A. – RISK FACTORS

There are no material changes from the risks disclosed in the Risk Factors section of our Annual Report on Form 10-K for the year ended December 31, 2014, except as discussed below.

The Company’s loan portfolio has a high concentration of commercial real estate loans (exclusive of multifamily and mixed use commercial loans) and its business may be adversely affected by credit risk associated with commercial real estate and a decline in property values.

At September 30, 2015, $648 million, or 42% of the Company’s total gross loan portfolio, was comprised of commercial real estate (exclusive of multifamily and mixed use commercial loans). This type of lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. Although real estate prices have shown signs of improvement, a decline in real estate values may reduce the value of the real estate collateral securing these types of loans and increase the risk that the Company would incur losses if borrowers default on their loans.
 
ITEM 2. – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. – DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. – MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. – OTHER INFORMATION

Not applicable.

ITEM 6. – EXHIBITS

31.1
Certification of principal executive officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
31.2
Certification of principal financial officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act
of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
32.1
Certification of principal executive officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   
32.2
Certification of principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   
101.INS
XBRL Instance Document
   
101.SCH
XBRL Taxonomy Extension Schema Document
   
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
   
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
   
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
   
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
 
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

SUFFOLK BANCORP

Date: October 30, 2015
/s/ Howard C. Bluver
 
Howard C. Bluver
 
President & Chief Executive Officer
 
(principal executive officer)
   
Date: October 30, 2015
/s/ Brian K. Finneran
 
Brian K. Finneran
 
Executive Vice President & Chief Financial Officer
 
(principal financial and accounting officer)
 
EXHIBIT INDEX

Exhibit
Number
 
Description
   
Certification of principal executive officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
Certification of principal financial officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act
of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
Certification of principal executive officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   
Certification of principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   
101.INS
XBRL Instance Document
   
101.SCH
XBRL Taxonomy Extension Schema Document
   
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
   
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
   
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
   
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
 
 
46