CHEMUNG FINANCIAL CORP - FORM 10-Q

Attached files

file	filename
EX-32.2 - EXHIBIT 32.2 - CHEMUNG FINANCIAL CORP	chmg10q09302017exh32-2.htm
EX-32.1 - EXHIBIT 32.1 - CHEMUNG FINANCIAL CORP	chmg10q09302017exh32-1.htm
EX-31.2 - EXHIBIT 31.2 - CHEMUNG FINANCIAL CORP	chmg10q09302017exh31-2.htm
EX-31.1 - EXHIBIT 31.1 - CHEMUNG FINANCIAL CORP	chmg10q09302017exh31-1.htm



UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 FORM 10-Q
[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarterly period ended September 30, 2017



Or
[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. 000-13888



CHEMUNG FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)

New York			16-1237038
(State or other jurisdiction of incorporation or organization)			I.R.S. Employer Identification No.

One Chemung Canal Plaza, Elmira, NY			14901
(Address of principal executive offices)			(Zip Code)

(607) 737-3711 or (800) 836-3711
(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: X 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: X NO:____

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer	[ ]	Non-accelerated filer	[ ]
Accelerated filer	[X]	Smaller reporting company	[ ]
		Emerging growth company	[ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
YES: NO: X

The number of shares of the registrant's common stock, $.01 par value, outstanding on October 31, 2017 was 4,740,401.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

INDEX



		PAGES
	Glossary of Abbreviations and Terms	3

PART I.	FINANCIAL INFORMATION

Item 1:	Financial Statements – Unaudited

	Consolidated Balance Sheets	6
	Consolidated Statements of Income	7
	Consolidated Statements of Comprehensive Income	8
	Consolidated Statements of Shareholders’ Equity	9
	Consolidated Statements of Cash Flows	10

	Notes to Unaudited Consolidated Financial Statements	12

Item 2:	Management's Discussion and Analysis of Financial Condition and Results of Operations	44

Item 3:	Quantitative and Qualitative Disclosures About Market Risk	74

Item 4:	Controls and Procedures	75

PART II.	OTHER INFORMATION

Item 1:	Legal Proceedings	76

Item 1A:	Risk Factors	76

Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	76

Item 3:	Defaults Upon Senior Securities	76

Item 4:	Mine Safety Disclosures	76

Item 5:	Other Information	76

Item 6:	Exhibits	77

SIGNATURES		78

EXHIBIT INDEX

GLOSSARY OF ABBREVIATIONS AND TERMS

To assist the reader the Corporation has provided the following list of commonly used abbreviations and terms included in the Notes to the Unaudited Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Abbreviations



ALCO	Asset-Liability Committee
ASU	Accounting Standards Update
Bank	Chemung Canal Trust Company
Basel III	The Third Basel Accord of the Basel Committee on Banking Supervision
Board of Directors	Board of Directors of Chemung Financial Corporation
CDARS	Certificate of Deposit Account Registry Service
CDO	Collateralized Debt Obligation
CECL	Current expected credit loss
CFS	CFS Group, Inc.
Corporation	Chemung Financial Corporation
CRM	Chemung Risk Management, Inc.
Dodd-Frank Act	The Dodd-Frank Wall Street Reform and Consumer Protection Act
EPS	Earnings per share
Exchange Act	Securities Exchange Act of 1934
FASB	Financial Accounting Standards Board
FDIC	Federal Deposit Insurance Corporation
FHLBNY	Federal Home Loan Bank of New York
FRB	Board of Governors of the Federal Reserve System
FRBNY	Federal Reserve Bank of New York
Freddie Mac	Federal Home Loan Mortgage Corporation
GAAP	U.S. Generally Accepted Accounting Principles
ICS	Insured Cash Sweep Service
IFRS	International Financial Reporting Standards
MD&A	Management’s Discussion and Analysis of Financial Condition and Results of Operations
NAICS	North American Industry Classification System
N/M	Not meaningful
OPEB	Other postemployment benefits
OREO	Other real estate owned
OTTI	Other-than-temporary impairment
PCI	Purchased credit impaired
ROA	Return on average assets
ROE	Return on average equity
RWA	Risk-weighted assets
SBA	Small Business Administration
SEC	Securities and Exchange Commission
Securities Act	Securities Act of 1933
TDRs	Troubled debt restructurings
WMG	Wealth Management Group

Terms



Allowance for loan losses to total loans	Represents period-end allowance for loan losses divided by retained loans.



Assets under administration	Represents assets that are beneficially owned by clients and all investment decisions pertaining to these assets are also made by clients.
Assets under management	Represents assets that are managed on behalf of clients.
Basel III	A comprehensive set of reform measures designed to improve the regulation, supervision, and risk management within the banking sector. The reforms require banks to maintain proper leverage ratios and meet certain capital requirements.
Benefit obligation	Refers to the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for OPEB plans.
Capital Bank	Division of Chemung Canal Trust Company located in the “Capital Region” of New York State and includes the counties of Albany and Saratoga.
CDARS	Product involving a network of financial institutions that exchange certificates of deposits among members in order to ensure FDIC insurance coverage on customer deposits above the single institution limit. Using a sophisticated matching system, funds are exchanged on a dollar-for-dollar basis, so that the equivalent of an original deposit comes back to the originating institution.
Captive insurance company	A company that provides risk-mitigation services for its parent company.
Collateralized debt obligation	A structured financial product that pools together cash flow-generating assets, such as mortgages, bonds, and loans.
Collateralized mortgage obligations	A type of mortgage-backed security with principal repayments organized according to their maturities and into different classes based on risk. The mortgages serve as collateral and are organized into classes based on their risk profile.
Dodd-Frank Act	The Dodd-Frank Act was enacted on July 21, 2010 and significantly changed the bank regulatory landscape and has impacted and will continue to impact the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare various studies and reports for Congress.
Fully taxable equivalent basis	Income from tax-exempt loans and investment securities that have been increased by an amount equivalent to the taxes that would have been paid if this income were taxable at statutory rates; the corresponding income tax impact related to tax-exempt items is recorded within income tax expense.
GAAP	Accounting principles generally accepted in the United States of America.
Holding company	Consists of the operations for Chemung Financial Corporation (parent only).
ICS	Product involving a network of financial institutions that exchange interest-bearing money market deposits among members in order to ensure FDIC insurance coverage on customer deposits above the single institution limit. Using a sophisticated matching system, funds are exchanged on a dollar-for-dollar basis, so that the equivalent of an original deposit comes back to the originating institution.
Loans held for sale	Residential real estate loans originated for sale on the secondary market with maturities from 15-30 years.
Long term lease obligation	An obligation extending beyond the current year, which is related to a long term capital lease that is considered to have the economic characteristics of asset ownership.
Mortgage-backed securities	A type of asset-backed security that is secured by a collection of mortgages.
Municipal clients	A political unit, such as a city, town, or village, incorporated for local self-government.
N/A	Data is not applicable or available for the period presented.
N/M	Not meaningful.
Non-GAAP	A calculation not made according to GAAP.
Obligations of state and political subdivisions	An obligation that is guaranteed by the full faith and credit of a state or political subdivision that has the power to tax.
Obligations of U.S. Government	A federally guaranteed obligation backed by the full power of the U.S. government, including Treasury bills, Treasury notes and Treasury bonds.
Obligations of U.S. Government sponsored enterprise obligations	Obligations of agencies originally established or chartered by the U.S. government to serve public purposes as specified by the U.S. Congress; these obligations are not explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the U.S. government.



OREO	Represents real property owned by the Corporation, which is not directly related to its business and is most frequently the result of a foreclosure on real property.
OTTI	Impairment charge taken on a security whose fair value has fallen below the carrying value on the balance sheet and whose value is not expected to recover through the holding period of the security.
PCI loans	Represents loans that were acquired in the Fort Orange Financial Corp. transaction and deemed to be credit-impaired on the acquisition date in accordance with the guidance of FASB.
Political subdivision	A county, city, town, or other municipal corporation, a public authority, or a publicly-owned entity that is an instrumentality of a state or a municipal corporation.
Pre-provision profit/(loss)	Represents total net revenue less noninterest expense, before income tax expense (benefit). The Corporation believes that this financial measure is useful in assessing the ability of a bank to generate income in excess of its provision for credit losses.
RWA	Risk-weighted assets consist of on- and off-balance sheet assets that are assigned to one of several broad risk categories and weighted by factors representing their risk and potential for default. On-balance sheet assets are risk-weighted based on the perceived credit risk associated with the obligor or counterparty, the nature of any collateral, and the guarantor, if any. Off-balance sheet assets such as lending-related commitments, guarantees, derivatives and other applicable off-balance sheet positions are risk-weighted by multiplying the contractual amount by the appropriate credit conversion factor to determine the on-balance sheet credit equivalent amount, which is then risk-weighted based on the same factors used for on-balance sheet assets. Risk-weighted assets also incorporate a measure for market risk related to applicable trading assets-debt and equity instruments. The resulting risk-weighted values for each of the risk categories are then aggregated to determine total risk-weighted assets.
SBA loan pools	Business loans partially guaranteed by the SBA.
Securities sold under agreements to repurchase	Sale of securities together with an agreement for the seller to buy back the securities at a later date.
TDR	A TDR is deemed to occur when the Corporation modifies the original terms of a loan agreement by granting a concession to a borrower that is experiencing financial difficulty.
Trust preferred securities	A hybrid security with characteristics of both subordinated debt and preferred stock which allows for early redemption by the issuer, makes fixed or variable payments, and matures at face value.
Unaudited	Financial statements and information that have not been subjected to auditing procedures sufficient to permit an independent certified public accountant to express an opinion.
WMG	Provides services as executor and trustee under wills and agreements, and guardian, custodian, trustee and agent for pension, profit-sharing and other employee benefit trusts, as well as various investment, financial planning, pension, estate planning and employee benefit administration services.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)



(in thousands, except share and per share data)	September 30, 2017			December 31, 2016
ASSETS
Cash and due from financial institutions	$	34,572		$	28,205
Interest-bearing deposits in other financial institutions	21,806			45,957
Total cash and cash equivalents	56,378			74,162

Trading assets, at fair value	909			774

Securities available for sale, at estimated fair value	312,226			303,402
Securities held to maturity, estimated fair value of $3,861 at September 30, 2017 and $4,912 at December 31, 2016	3,865			4,705
FHLBNY and FRBNY Stock, at cost	3,497			4,041

Loans, net of deferred loan fees	1,288,813			1,200,290
Allowance for loan losses	(15,694		)	(14,253		)
Loans, net	1,273,119			1,186,037

Loans held for sale	1,246			412
Premises and equipment, net	27,366			28,923
Goodwill	21,824			21,824
Other intangible assets, net	2,292			2,945
Bank-owned life insurance	2,964			2,912
Accrued interest receivable and other assets	25,996			27,042

Total assets	$	1,731,682		$	1,657,179

LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest-bearing	$	449,841		$	417,812
Interest-bearing	1,087,177			1,038,531
Total deposits	1,537,018			1,456,343

Securities sold under agreements to repurchase	10,000			27,606
FHLBNY term advances	9,009			9,093
Long term capital lease obligation	4,568			4,722
Dividends payable	1,232			1,225
Accrued interest payable and other liabilities	15,578			14,442
Total liabilities	1,577,405			1,513,431

Shareholders' equity:
Common stock, $0.01 par value per share, 10,000,000 shares authorized; 5,310,076 issued at September 30, 2017 and December 31, 2016	53			53
Additional paid-in capital	46,089			45,603
Retained earnings	130,006			124,111
Treasury stock, at cost; 571,115 shares at September 30, 2017 and 597,843 shares at December 31, 2016	(14,596		)	(15,265		)
Accumulated other comprehensive loss	(7,275		)	(10,754		)
Total shareholders' equity	154,277			143,748

Total liabilities and shareholders' equity	$	1,731,682		$	1,657,179

See accompanying notes to unaudited consolidated financial statements.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)



	Three Months Ended September 30,				Nine Months Ended September 30,
(in thousands, except per share data)	2017		2016		2017		2016
Interest and dividend income:
Loans, including fees	$	13,709	$	12,487	$	39,025	$	37,054
Taxable securities	1,369		1,225		4,189		3,943
Tax exempt securities	322		228		836		722
Interest-bearing deposits	97		85		445		180
Total interest and dividend income	15,497		14,025		44,495		41,899
Interest expense:
Deposits	545		561		1,632		1,607
Securities sold under agreements to repurchase	95		214		383		636
Borrowed funds	94		210		273		623
Total interest expense	734		985		2,288		2,866
Net interest income	14,763		13,040		42,207		39,033
Provision for loan losses	1,289		1,050		2,750		2,033
Net interest income after provision for loan losses	13,474		11,990		39,457		37,000

Non-interest income:
WMG fee income	2,147		2,027		6,525		6,240
Service charges on deposit accounts	1,269		1,361		3,678		3,781
Interchange revenue from debit card transactions	925		1,203		2,809		3,035
Net gains on securities transactions	—		75		12		983
Net gains on sales of loans held for sale	71		115		193		273
Net gains (losses) on sales of other real estate owned	30		10		38		(6		)
Income from bank-owned life insurance	17		19		52		55
Other	707		625		1,728		1,891
Total non-interest income	5,166		5,435		15,035		16,252

Non-interest expenses:
Salaries and wages	5,480		5,355		16,177		15,720
Pension and other employee benefits	992		1,573		3,417		4,894
Net occupancy expenses	1,476		1,503		4,784		5,287
Furniture and equipment expenses	657		685		2,119		2,286
Data processing expense	1,667		1,624		4,858		5,058
Professional services	452		502		1,169		1,418
Legal accruals and settlements	—		—		850		1,200
Amortization of intangible assets	214		245		653		748
Marketing and advertising expenses	213		101		580		648
Other real estate owned expenses	4		41		35		150
FDIC insurance	312		324		946		895
Loan expense	165		162		447		462
Other	1,644		1,356		4,618		4,283
Total non-interest expenses	13,276		13,471		40,653		43,049
Income before income tax expense	5,364		3,954		13,839		10,203
Income tax expense	1,710		1,209		4,250		3,130
Net income	$	3,654	$	2,745	9,589		$	7,073

Weighted average shares outstanding	4,802		4,765		4,796		4,758
Basic and diluted earnings per share	$	0.76	$	0.58	$	2.00	$	1.49

See accompanying notes to unaudited consolidated financial statements.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)



	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands)	2017			2016			2017			2016
Net income	$	3,654		$	2,745		$	9,589		$	7,073
Other comprehensive income (loss):
Unrealized holding gains (losses) on securities available for sale	(522		)	(733		)	5,498			4,899
Reclassification adjustment for gains realized in net income	—			(75		)	(12		)	(983		)
Net unrealized gains (losses)	(522		)	(808		)	5,486			3,916
Tax effect	(198		)	(305		)	2,069			1,477
Net of tax amount	(324		)	(503		)	3,417			2,439

Change in funded status of defined benefit pension plan and other benefit plans:
Reclassification adjustment for amortization of prior service costs	(55		)	(22		)	(165		)	(67		)
Reclassification adjustment for amortization of net actuarial loss	88			396			264			1,188
Total before tax effect	33			374			99			1,121
Tax effect	12			141			37			423
Net of tax amount	21			233			62			698

Total other comprehensive income (loss)	(303		)	(270		)	3,479			3,137

Comprehensive income	$	3,351		$	2,475		$	13,068		$	10,210

See accompanying notes to unaudited consolidated financial statements.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(UNAUDITED)



(in thousands, except share and per share data)	Common Stock		Additional Paid-in Capital			Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Loss			Total
Balances at January 1, 2016	$	53	$	45,537		$	118,973		$	(16,379	)	$	(10,942	)	$	137,242
Net income	—		—			7,073			—			—			7,073
Other comprehensive income	—		—			—			—			3,137			3,137
Restricted stock awards	—		145			—			—			—			145
Restricted stock units for directors' deferred compensation plan	—		72			—			—			—			72
Cash dividends declared ($0.78 per share)	—		—			(3,664		)	—			—			(3,664		)
Distribution of 9,532 shares of treasury stock for directors' compensation	—		19			—			243			—			262
Distribution of 7,661 shares of treasury stock for employee compensation	—		15			—			195			—			210
Distribution of 3,740 shares of treasury stock for deferred directors’ compensation	—		(92		)	—			95			—			3
Sale of 11,857 shares of treasury stock (a)	—		28			—			304			—			332
Balances at September 30, 2016	$	53	$	45,724		$	122,382		$	(15,542	)	$	(7,805	)	$	144,812


Balances at January 1, 2017	$	53	$	45,603		$	124,111		$	(15,265	)	$	(10,754	)	$	143,748
Net income	—		—			9,589			—			—			9,589
Other comprehensive income	—		—			—			—			3,479			3,479
Restricted stock awards	—		162			—			—			—			162
Restricted stock units for directors' deferred compensation plan	—		72			—			—			—			72
Cash dividends declared ($0.78 per share)	—		—			(3,694		)	—			—			(3,694		)
Distribution of 7,880 shares of treasury stock for directors' compensation	—		68			—			201			—			269
Distribution of 5,861 shares of treasury stock for employee compensation	—		50			—			150			—			200
Distribution of 2,438 shares of treasury stock for deferred directors’ compensation	—		(51		)	—			62			—			11
Sale of 11,688 shares of treasury stock (a)	—		142			—			299			—			441
Forfeiture of 1,139 shares of restricted stock awards	—		43			—			(43		)	—			—
Balances at September 30, 2017	$	53	$	46,089		$	130,006		$	(14,596	)	$	(7,275	)	$	154,277

(a) All treasury stock sales were completed at the prevailing market price with the Chemung Canal Trust Company Profit Sharing, Savings, and Investment Plan which is a defined contribution plan sponsored by the Bank.

See accompanying notes to unaudited consolidated financial statements.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)



(in thousands)	Nine Months Ended September 30,
CASH FLOWS FROM OPERATING ACTIVITIES:	2017			2016
Net income	$	9,589		$	7,073
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of intangible assets	653			748
Provision for loan losses	2,750			2,033
Net losses on disposal of fixed assets	15			—
Depreciation and amortization of fixed assets	2,820			3,285
Amortization of premiums on securities, net	1,098			1,365
Gains on sales of loans held for sale, net	(193		)	(273		)
Proceeds from sales of loans held for sale	9,655			12,854
Loans originated and held for sale	(10,296		)	(11,624		)
Net gains on trading assets	(96		)	(53		)
Proceeds from sales of trading assets	20			99
Net gains on securities transactions	(12		)	(983		)
Net (gains) losses on sales of other real estate owned	(38		)	6
Purchase of trading assets	(59		)	(65		)
Expense related to restricted stock units for directors' deferred compensation plan	72			72
Expense related to employee stock compensation	200			210
Expense related to employee restricted stock awards	162			145
Income from bank-owned life insurance	(52		)	(55		)
Decrease in other assets and accrued interest receivable	888			2,250
Decrease in accrued interest payable	(26		)	(8		)
Increase (decrease) in other liabilities	(565		)	2,702
Net cash provided by operating activities	16,585			19,781

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales and calls of securities available for sale	1,620			36,130
Proceeds from maturities and principal collected on securities available for sale	35,262			56,661
Proceeds from maturities and principal collected on securities held to maturity	2,807			2,797
Purchases of securities available for sale	(41,306		)	(47,696		)
Purchases of securities held to maturity	(1,967		)	(2,735		)
Purchase of FHLBNY and FRBNY stock	(1,708		)	(5,458		)
Redemption of FHLBNY and FRBNY stock	2,252			5,764
Proceeds from sale of equipment	16			—
Purchases of premises and equipment	(1,294		)	(937		)
Proceeds from sales of other real estate owned	383			1,499
Net increase in loans	(90,019		)	(49,243		)
Net cash (used in) provided by investing activities	(93,954		)	(3,218		)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits, interest-bearing demand accounts, savings accounts, and insured money market accounts	98,599			126,309
Net decrease in time deposits	(17,924		)	(17,660		)
Net increase (decrease) in securities sold under agreements to repurchase	(17,606		)	1,549
Net change in FHLBNY overnight advances, net	—			(13,900		)
Repayments of FHLBNY long term advances	(84		)	(82		)
Payments made on capital leases	(154		)	(136		)
Sale of treasury stock	441			332
Cash dividends paid	(3,687		)	(3,656		)
Net cash provided by financing activities	59,585			92,756
Net increase (decrease) in cash and cash equivalents	(17,784		)	109,319
Cash and cash equivalents, beginning of period	74,162			26,185
Cash and cash equivalents, end of period	$	56,378		$	135,504
(continued)

See accompanying notes to unaudited consolidated financial statements.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED

(UNAUDITED)



(in thousands)	Nine Months Ended September 30,
Supplemental disclosure of cash flow information:	2017		2016
Cash paid for:
Interest	$	2,314	$	2,874
Income taxes	$	4,050	$	2,680
Supplemental disclosure of non-cash activity:
Transfer of loans to other real estate owned	$	187	$	342
Dividends declared, not yet paid	$	1,232	$	1,222
Distribution of treasury stock for directors' compensation	$	269	$	262
Distribution of treasury stock for deferred directors' compensation	$	11	$	3
Assets acquired through long term capital lease obligations	$	—	$	2,035

See accompanying notes to unaudited consolidated financial statements.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

The Corporation, through its wholly-owned subsidiaries, the Bank and CFS, provides a wide range of banking, financing, fiduciary and other financial services to its clients. The Corporation and the Bank are subject to the regulations of certain federal and state agencies and undergo periodic examinations by those regulatory authorities.

CRM, a wholly-owned subsidiary of the Corporation, which was formed and began operations on May 31, 2016, is a Nevada-based captive insurance company which insures against certain risks unique to the operations of the Corporation and its subsidiaries and for which insurance may not be currently available or economically feasible in today's insurance marketplace. CRM pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves. CRM is subject to regulations of the State of Nevada and undergoes periodic examinations by the Nevada Division of Insurance.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with GAAP for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X of the Exchange Act. These financial statements include the accounts of the Corporation and its subsidiaries, and all significant intercompany balances and transactions are eliminated in consolidation. Amounts in the prior periods' consolidated financial statements are reclassified whenever necessary to conform to the current period's presentation.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and disclosures provided, and actual results could differ. In the opinion of management, all adjustments (consisting of normal recurring adjustments) and disclosures necessary for the fair presentation of the accompanying consolidated financial statements have been included. The unconsolidated financial statements should be read in conjunction with the Corporation's 2016 Annual Report on Form 10-K for the year ended December 31, 2016. The results of operations for any interim periods are not necessarily indicative of the results which may be expected for the entire year.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, an amendment to Revenue from Contracts with Customers (Topic 606). The objective of this amendment is to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRS. This update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets unless those contracts are in the scope of other standards. In August 2015, the FASB issued ASU 2015-14 to defer for one year the effective date of the new revenue standard. The requirements are effective for annual periods and interim periods within fiscal years beginning after December 15, 2017. During 2016, the FASB issued further implementation guidance regarding revenue recognition. This additional guidance included clarification on certain principal versus agent considerations within the implementation of the guidance as well as clarification related to identifying performance obligations and licensing, assessing collectability, presenting sales taxes, measuring non-cash consideration, and certain transition matters. The Corporation intends to adopt the new revenue guidance as of January 1, 2018 and does not expect a significant change upon adoption of the standard, as the new standard will not materially change the way the Corporation currently records revenue for its WMG and fee income from mortgage servicing fees, financial guarantees, and deposit related fees.

In January 2016, the FASB issued ASU 2016-01, an amendment to Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10). The objectives of the ASU are to (1) require equity investments to be measured at fair value, with changes in fair value recognized in net income, (2) simplify the impairment assessment of equity investments without readily determinable fair values, (3) eliminate the requirement to disclose methods and significant assumptions used to estimate fair value for financial instruments measured at amortized cost on the balance sheet, (4) require the use of the exit price notion when measuring the fair value of financial instruments, and (5) clarify the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The Corporation intends to adopt the new guidance as of January 1, 2018 and believes the ASU will not have a material impact on its consolidated financial statements, as the Corporation's equity investment portfolio is less than $1.0 million as of September 30, 2017.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 requires companies that lease valuable assets to recognize on their balance sheets the assets and liabilities generated by contracts longer than a year. The amendments in this update are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018, though early adoption is permitted. The Corporation intends to adopt the new lease guidance as of January 1, 2019 and is currently evaluating the impact that adoption of these updates will have on its consolidated financial statements. Currently, the Corporation believes the implementation of this ASU will create a right of use asset of less than $8.0 million for the Corporation's 15 leased facilities and a related capital obligation of the same amount as of January 1, 2019.

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The objectives of the ASU are to simplify accounting for a stock payment's tax consequences and amend how excess tax benefits and a business's payments to cover the tax bills for the shares' recipients should be classified. The amendments allow companies to estimate the number of stock awards they expect to vest, and they revise the withholding requirements for classifying stock awards as equity. The amendments in this ASU became effective for public companies for fiscal years beginning after December 15, 2016, though early adoption was permitted. The adoption of ASU 2016-09 did not have a significant impact on the Corporation's consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The objective of the ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date by replacing the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to form credit loss estimates. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2019, though entities may adopt the amendments earlier for fiscal year beginning after December 15, 2018. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements. The Corporation anticipates that the adoption of the CECL model will result in an increase to the Corporation's allowance for loan losses. The Corporation has established a committee to oversee the implementation of CECL. This committee is currently assessing the data and system requirements necessary for adoption. The Corporation plans to run its current incurred loss model and a CECL model concurrently for 12 months prior to the adoption of this guidance on January 1, 2020.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The objective of the ASU is to reduce the existing diversity in practice relating to eight specific cash flow issues: (1) debt prepayment or debt extinguishment costs, (2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, (3) contingent consideration payments made after a business combination, (4) proceeds from the settlement of insurance claims, (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, (6) distributions received from equity method investees, (7) beneficial interests in securitization transactions, and (8) separately identifiable cash flows and application of the predominance principal. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, though early adoption is permitted. The adoption of the ASU is not expected to have a significant impact on the Corporation's consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The objective of the ASU is to simplify the manner in which an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Additionally, the ASU removes the requirement for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to perform Step 2 of the goodwill impairment test. The amendments in this ASU are effective for annual, or any interim, goodwill impairment tests in fiscal years beginning after December 15, 2019. The adoption of the ASU is not expected to have a significant impact on the Corporation's consolidated financial statements.

In March 2017, the FASB issued ASU 2017-07, Compensation - Retirement Benefits (Topic 715) - Improving the Presentation of Net Periodic Cost and Net Periodic Postretirement Benefit Cost. The objective of the ASU is to improve guidance related to the presentation of defined benefit costs in the income statement. Specifically, the ASU requires that an employer report the service cost component in the same line item(s) as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. Additionally, the ASU allows only the service cost component to be eligible for capitalization, when applicable. The amendments in this ASU are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The adoption of the ASU is not expected to have a significant impact on the Corporation's consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The objective of the ASU is to align the amortization period of premiums and discounts to expectations incorporated in market pricing on the underlying securities. The amendment requires that the premium be amortized to the earliest call date, but does not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The amendments in this ASU are effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2018. The adoption of the ASU is not expected to have a significant impact on the Corporation's consolidated financial statements.

NOTE 2 EARNING PER COMMON SHARE (shares in thousands)

Basic earnings per share is net income divided by the weighted average number of common shares outstanding during the period. Issuable shares, including those related to directors’ restricted stock units and directors’ stock compensation, are considered outstanding and are included in the computation of basic earnings per share. All outstanding unvested share based payment awards that contain rights to non-forfeitable dividends are considered participating securities for this calculation. Restricted stock awards are grants of participating securities and are considered outstanding at grant date. Earnings per share information is adjusted to present comparative results for stock splits and stock dividends that occur. Earnings per share were computed by dividing net income by 4,802 and 4,765 weighted average shares outstanding for the three-month periods ended September 30, 2017 and 2016, respectively. Earnings per share were computed by dividing net income by 4,796 and 4,758 weighted average shares outstanding for the nine-month periods ended September 30, 2017 and 2016, respectively. There were no common stock equivalents during the three and nine-month periods ended September 30, 2017 or 2016.

NOTE 3 SECURITIES

Amortized cost and estimated fair value of securities available for sale are as follows (in thousands):



	September 30, 2017
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	15,494	$	90	$	—	$	15,584
Mortgage-backed securities, residential	239,074		480		2,893		236,661
Obligations of states and political subdivisions	54,144		612		28		54,728
Corporate bonds and notes	249		—		7		242
SBA loan pools	4,513		2		30		4,485
Corporate stocks	265		261		—		526
Total	$	313,739	$	1,445	$	2,958	$	312,226



	December 31, 2016
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	17,300	$	155	$	—	$	17,455
Mortgage-backed securities, residential	253,156		202		7,492		245,866
Obligations of states and political subdivisions	38,843		209		312		38,740
Corporate bonds and notes	249		1		—		250
SBA loan pools	568		3		1		570
Corporate stocks	285		236		—		521
Total	$	310,401	$	806	$	7,805	$	303,402

Amortized cost and estimated fair value of securities held to maturity are as follows (in thousands):



	September 30, 2017
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
Obligations of states and political subdivisions	$	2,030	$	—	$	—	$	2,030
Time deposits with other financial institutions	1,835		1		5		1,831
Total	$	3,865	$	1	$	5	$	3,861



	December 31, 2016
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
Obligations of states and political subdivisions	$	3,725	$	206	$	—	$	3,931
Time deposits with other financial institutions	980		1		—		981
Total	$	4,705	$	207	$	—	$	4,912

The amortized cost and estimated fair value of debt securities are shown below by expected maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately (in thousands):



	September 30, 2017
	Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Within one year	$	13,067	$	13,135	$	753	$	751
After one, but within five years	26,063		26,328		2,841		2,839
After five, but within ten years	29,621		29,944		271		271
After ten years	1,136		1,147		—		—
	69,887		70,554		3,865		3,861
Mortgage-backed securities, residential	239,074		236,661		—		—
SBA loan pools	4,513		4,485		—		—
Total	$	313,474	$	311,700	$	3,865	$	3,861

The proceeds from sales and calls of securities resulting in gains or losses for the three months ended September 30, 2017 and 2016 are listed below (in thousands):



	2017		2016
Proceeds	$	545	$	20,709
Gross gains	—		75
Tax expense	—		28

The proceeds from sales and calls of securities resulting in gains or losses for the nine months ended September 30, 2017 and 2016 are listed below (in thousands):



	2017		2016
Proceeds	$	1,620	$	36,130
Gross gains	12		983
Tax expense	4		371

The following tables summarize the investment securities available for sale with unrealized losses at September 30, 2017 and December 31, 2016 by aggregated major security type and length of time in a continuous unrealized loss position (in thousands):



	Less than 12 months				12 months or longer				Total
September 30, 2017	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities, residential	$	121,345	$	1,022	$	57,638	$	1,871	$	178,983	$	2,893
Obligations of states and political subdivisions	4,080		19		281		9		4,361		28
Corporate bonds and notes	242		7		—		—		242		7
SBA loan pools	3,970		30		—		—		3,970		30
Total temporarily impaired securities	$	129,637	$	1,078	$	57,919	$	1,880	$	187,556	$	2,958



	Less than 12 months				12 months or longer				Total
December 31, 2016	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities, residential	$	233,843	$	7,492	$	—	$	—	$	233,843	$	7,492
Obligations of states and political subdivisions	25,724		312		—		—		25,724		312
SBA loan pools	—		—		225		1		225		1
Total temporarily impaired securities	$	259,567	$	7,804	$	225	$	1	$	259,792	$	7,805

Other-Than-Temporary Impairment

As of September 30, 2017, the majority of the Corporation’s unrealized losses in the investment securities portfolio related to mortgage-backed securities. At September 30, 2017, all of the unrealized losses related to mortgage-backed securities were issued by U.S. government sponsored entities, Fannie Mae and Freddie Mac. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because it is not likely that the Corporation will be required to sell these securities before their anticipated recovery, the Corporation does not consider these securities to be other-than-temporarily impaired at September 30, 2017.

NOTE 4 LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of the loan portfolio, net of deferred origination fees and costs, is summarized as follows (in thousands):



	September 30, 2017		December 31, 2016
Commercial and agricultural:
Commercial and industrial	$	188,341	$	176,201
Agricultural	448		360
Commercial mortgages:
Construction	57,704		46,387
Commercial mortgages, other	580,061		522,269
Residential mortgages	197,210		198,493
Consumer loans:
Credit cards	1,444		1,476
Home equity lines and loans	98,492		98,590
Indirect consumer loans	147,426		139,572
Direct consumer loans	17,687		16,942
Total loans, net of deferred origination fees and costs	$	1,288,813	$	1,200,290
Interest receivable on loans	3,448		3,192
Total recorded investment in loans	$	1,292,261	$	1,203,482

The Corporation's concentrations of credit risk by loan type are reflected in the preceding table. The concentrations of credit risk with standby letters of credit, committed lines of credit and commitments to originate new loans generally follow the loan classifications in the table above.

The following tables present the activity in the allowance for loan losses by portfolio segment for the three and nine-month periods ended September 30, 2017 and 2016 (in thousands):



	Three Months Ended September 30, 2017
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Total
Beginning balance	$	1,883		$	7,778		$	1,517		$	3,926		$	15,104
Charge-offs	(89		)	(154		)	(133		)	(440		)	(816		)
Recoveries	34			1			—			82			117
Net recoveries (charge-offs)	(55		)	(153		)	(133		)	(358		)	(699		)
Provision	99			758			12			420			1,289
Ending balance	$	1,927		$	8,383		$	1,396		$	3,988		$	15,694



	Three Months Ended September 30, 2016
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Total
Beginning balance	$	1,771		$	7,754		$	1,504		$	3,639		$	14,668
Charge-offs	(104		)	(52		)	(7		)	(280		)	(443		)
Recoveries	15			1			—			34			50
Net recoveries (charge-offs)	(89		)	(51		)	(7		)	(246		)	(393		)
Provision	101			520			50			379			1,050
Ending balance	$	1,783		$	8,223		$	1,547		$	3,772		$	15,325



	Nine Months Ended September 30, 2017
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Total
Beginning balance:	$	1,589		$	7,270		$	1,523		$	3,871		$	14,253
Charge-offs:	(96		)	(154		)	(193		)	(1,265		)	(1,708		)
Recoveries:	95			4			30			270			399
Net recoveries (charge-offs)	(1		)	(150		)	(163		)	(995		)	(1,309		)
Provision	339			1,263			36			1,112			2,750
Ending balance	$	1,927		$	8,383		$	1,396		$	3,988		$	15,694



	Nine Months Ended September 30, 2016
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Total
Beginning balance:	$	1,831		$	7,112		$	1,464		$	3,853		$	14,260
Charge-offs:	(121		)	(52		)	(65		)	(995		)	(1,233		)
Recoveries:	65			10			—			190			265
Net recoveries (charge-offs)	(56		)	(42		)	(65		)	(805		)	(968		)
Provision	8			1,153			148			724			2,033
Ending balance	$	1,783		$	8,223		$	1,547		$	3,772		$	15,325

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of September 30, 2017 and December 31, 2016 (in thousands):



	September 30, 2017
Allowance for loan losses:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	159	$	1,009	$	—	$	—	$	1,168
Collectively evaluated for impairment	1,768		7,345		1,396		3,988		14,497
Loans acquired with deteriorated credit quality	—		29		—		—		29
Total ending allowance balance	$	1,927	$	8,383	$	1,396	$	3,988	$	15,694



	December 31, 2016
Allowance for loan losses:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	735	$	—	$	141	$	876
Collectively evaluated for impairment	1,589		6,476		1,498		3,730		13,293
Loans acquired with deteriorated credit quality	—		59		25		—		84
Total ending allowance balance	$	1,589	$	7,270	$	1,523	$	3,871	$	14,253



	September 30, 2017
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	1,133	$	9,458	$	434	$	67	$	11,092
Loans collectively evaluated for impairment	188,170		629,211		197,267		265,689		1,280,337
Loans acquired with deteriorated credit quality	—		832		—		—		832
Total ending loans balance	$	189,303	$	639,501	$	197,701	$	265,756	$	1,292,261



	December 31, 2016
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	693	$	10,382	$	396	$	455	$	11,926
Loans collectively evaluated for impairment	176,334		558,451		198,474

CHEMUNG FINANCIAL CORP - FORM 10-Q - November 1, 2017

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