FORM 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

or

 

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

For the transition period from             to             

Commission File Number: 000-26481

 

 

 

LOGO

(Exact name of registrant as specified in its charter)

 

 

 

NEW YORK   16-0816610

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

220 LIBERTY STREET, WARSAW, NEW YORK   14569
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (585) 786-1100

 

 

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 regsitrant 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   x
Non-accelerated filer   ¨  (Do not check if a smaller company)    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  x

The registrant had 13,811,691 shares of Common Stock, $0.01 par value, outstanding as of April 30, 2012.

 

 

 


FINANCIAL INSTITUTIONS, INC.

Form 10-Q

For the Quarterly Period Ended March 31, 2012

TABLE OF CONTENTS

 

     PAGE  

PART I. FINANCIAL INFORMATION

  

ITEM 1. Financial Statements

  

Consolidated Statements of Financial Condition - at March 31, 2012 (Unaudited) and December 31, 2011

     3   

Consolidated Statements of Income (Unaudited) - Three months ended March 31, 2012 and 2011

     4   

Consolidated Statements of Comprehensive Income (Unaudited) - Three months ended March 31, 2012 and 2011

     5   

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) - Three months ended March 31, 2012 and 2011

     6   

Consolidated Statements of Cash Flows (Unaudited) - Three months ended March 31, 2012 and 2011

     7   

Notes to Consolidated Financial Statements (Unaudited)

     8   

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     26   

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

     41   

ITEM 4. Controls and Procedures

     41   

PART II. OTHER INFORMATION

  

ITEM 1. Legal Proceedings

     42   

ITEM 1A. Risk Factors

     42   

ITEM 6. Exhibits

     42   

Signatures

     43   

 

- 2 -


PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Financial Condition

 

(Dollars in thousands, except share and per share data)    March 31,
2012
    December 31,
2011
 
     (Unaudited)        

ASSETS

    

Cash and cash equivalents:

    

Cash and due from banks

   $ 76,931      $ 57,489   

Federal funds sold and interest-bearing deposits in other banks

     94        94   
  

 

 

   

 

 

 

Total cash and cash equivalents

     77,025        57,583   

Securities available for sale, at fair value

     699,497        627,518   

Securities held to maturity, at amortized cost (fair value of $24,797 and $23,964, respectively)

     24,196        23,297   

Loans held for sale

     2,053        2,410   

Loans (net of allowance for loan losses of $23,763 and $23,260, respectively)

     1,497,265        1,461,516   

Company owned life insurance

     45,990        45,556   

Premises and equipment, net

     32,831        33,085   

Goodwill

     37,369        37,369   

Other assets

     44,594        48,019   
  

 

 

   

 

 

 

Total assets

   $ 2,460,820      $ 2,336,353   
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Deposits:

    

Noninterest-bearing demand

   $ 404,186      $ 393,421   

Interest-bearing demand

     435,701        362,555   

Savings and money market

     530,754        474,947   

Certificates of deposit

     695,928        700,676   
  

 

 

   

 

 

 

Total deposits

     2,066,569        1,931,599   

Short-term borrowings

     117,347        150,698   

Other liabilities

     36,942        16,862   
  

 

 

   

 

 

 

Total liabilities

     2,220,858        2,099,159   
  

 

 

   

 

 

 

Shareholders’ equity:

    

Series A 3% preferred stock, $100 par value; 1,533 shares authorized and 1,500 shares issued

     150        150   

Series B-1 8.48% preferred stock, $100 par value, 200,000 shares authorized and 173,235 shares issued

     17,323        17,323   
  

 

 

   

 

 

 

Total preferred equity

     17,473        17,473   

Common stock, $0.01 par value, 50,000,000 shares authorized and 14,161,597 shares issued

     142        142   

Additional paid-in capital

     66,793        67,247   

Retained earnings

     162,126        158,079   

Accumulated other comprehensive (loss) income

     (107     945   

Treasury stock, at cost – 349,356 and 358,481 shares, respectively

     (6,465     (6,692
  

 

 

   

 

 

 

Total shareholders’ equity

     239,962        237,194   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 2,460,820      $ 2,336,353   
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

- 3 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

 

(In thousands, except per share amounts)    Three months ended
March 31,
 
     2012     2011  

Interest income:

    

Interest and fees on loans

   $ 19,536      $ 19,035   

Interest and dividends on investment securities

     3,914        4,604   
  

 

 

   

 

 

 

Total interest income

     23,450        23,639   
  

 

 

   

 

 

 

Interest expense:

    

Deposits

     2,398        3,197   

Short-term borrowings

     111        72   

Long-term borrowings

     —          532   
  

 

 

   

 

 

 

Total interest expense

     2,509        3,801   
  

 

 

   

 

 

 

Net interest income

     20,941        19,838   

Provision for loan losses

     1,385        810   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     19,556        19,028   
  

 

 

   

 

 

 

Noninterest income:

    

Service charges on deposits

     1,835        2,105   

ATM and debit card

     1,077        1,016   

Broker-dealer fees and commissions

     587        386   

Company owned life insurance

     426        266   

Net gain on sale of loans held for sale

     333        224   

Net gain on disposal of investment securities

     331        3   

Loan servicing

     94        349   

Impairment charges on investment securities

     (91     —     

Net gain on disposal of other assets

     6        45   

Other

     853        754   
  

 

 

   

 

 

 

Total noninterest income

     5,451        5,148   
  

 

 

   

 

 

 

Noninterest expense:

    

Salaries and employee benefits

     8,931        8,401   

Occupancy and equipment

     2,770        2,843   

Professional services

     711        682   

Computer and data processing

     600        603   

Supplies and postage

     458        452   

FDIC assessments

     297        607   

Advertising and promotions

     101        165   

Other

     1,789        1,597   
  

 

 

   

 

 

 

Total noninterest expense

     15,657        15,350   
  

 

 

   

 

 

 

Income before income taxes

     9,350        8,826   

Income tax expense

     3,154        3,006   
  

 

 

   

 

 

 

Net income

   $ 6,196      $ 5,820   
  

 

 

   

 

 

 

Preferred stock dividends

     369        770   

Accretion of discount on Series A preferred stock

     —          1,305   
  

 

 

   

 

 

 

Net income available to common shareholders

   $ 5,827      $ 3,745   
  

 

 

   

 

 

 

Earnings per common share (Note 2):

    

Basic

   $ 0.43      $ 0.33   

Diluted

   $ 0.42      $ 0.33   

Cash dividends declared per common share

   $ 0.13      $ 0.10   

Weighted average common shares outstanding:

    

Basic

     13,675        11,336   

Diluted

     13,733        11,467   

See accompanying notes to the consolidated financial statements.

 

- 4 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

 

(Dollars in thousands)    Three months ended
March 31,
 
     2012     2011  

Net income

   $ 6,196      $ 5,820   

Other comprehensive (loss) income:

    

Unrealized gains on securities:

    

Change in net unrealized securities gains arising during period

     (1,837     1,255   

Deferred tax benefit (expense)

     728        (497

Reclassification adjustment for gains included in income before income taxes

     (240     (3

Related tax expense

     95        1   
  

 

 

   

 

 

 

Change in net unrealized gains on securities, net of tax

     (1,254     756   

Change in pension and post-retirement obligations:

    

Change in net actuarial gain\loss

     335        145   

Related tax expense

     (133     (58
  

 

 

   

 

 

 

Change in pension and post-retirement obligations, net of tax

     202        87   
  

 

 

   

 

 

 

Other comprehensive (loss) income

     (1,052     843   
  

 

 

   

 

 

 

Comprehensive income

   $ 5,144      $ 6,663   
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

- 5 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

Three months ended March 31, 2012 and 2011

 

(Dollars in thousands,

except per share data)

   Preferred
Equity
    Common
Stock
     Additional
Paid-in
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Treasury
Stock
    Total
Shareholders’
Equity
 

Balance at January 1, 2011

   $ 53,785      $ 113       $ 26,029      $ 144,599      $ (4,722   $ (7,660   $ 212,144   

Comprehensive income:

               

Net income

     —          —           —          5,820        —          —          5,820   

Other comprehensive income, net of tax

     —          —           —          —          843        —          843   
               

 

 

 

Total comprehensive income

                  6,663   

Purchases of common stock for treasury

     —          —           —          —          —          (197     (197

Issuance of common stock

     —          29         43,098        —          —          —          43,127   

Redemption of Series A preferred stock

     (37,515     —           68        —          —          —          (37,447

Share-based compensation plans:

               

Share-based compensation

     —          —           231        —          —          —          231   

Stock options exercised

     —          —           (28     —          —          119        91   

Restricted stock awards issued, net

     —          —           (857     —          —          857        —     

Excess tax benefit on share-based compensation

     —          —           64        —          —          —          64   

Accretion of discount on Series A preferred stock

     1,305        —           —          (1,305     —          —          —     

Cash dividends declared:

               

Series A 3% Preferred-$0.75 per share

     —          —           —          (1     —          —          (1

Series A Preferred-$53.24 per share

     —          —           —          (399     —          —          (399

Series B-1 8.48% Preferred-$2.12 per share

     —          —           —          (370     —          —          (370

Common-$0.10 per share

     —          —           —          (1,083     —          —          (1,083
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2011

   $ 17,575      $ 142       $ 68,605      $ 147,261      $ (3,879   $ (6,881   $ 222,823   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at January 1, 2012

   $ 17,473      $ 142       $ 67,247      $ 158,079      $ 945      $ (6,692   $ 237,194   

Comprehensive income:

               

Net income

     —          —           —          6,196        —          —          6,196   

Other comprehensive loss, net of tax

     —          —           —          —          (1,052     —          (1,052
               

 

 

 

Total comprehensive income

                  5,144   

Purchases of common stock for treasury

     —          —           —          —          —          (525     (525

Share-based compensation plans:

               

Share-based compensation

     —          —           142        —          —          —          142   

Stock options exercised

     —          —           (5     —          —          31        26   

Restricted stock awards issued, net

     —          —           (721     —          —          721        —     

Excess tax benefit on share-based compensation

     —          —           130        —          —          —          130   

Cash dividends declared:

               

Series A 3% Preferred-$0.75 per share

     —          —           —          (1     —          —          (1

Series B-1 8.48% Preferred-$2.12 per share

     —          —           —          (368     —          —          (368

Common-$0.13 per share

     —          —           —          (1,780     —          —          (1,780
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2012

   $
17,473
  
  $ 142       $ 66,793      $ 162,126      $ (107   $ (6,465   $ 239,962   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

- 6 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

 

(Dollars in thousands)    Three months ended
March 31,
 
     2012     2011  

Cash flows from operating activities:

    

Net income

   $ 6,196      $ 5,820   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     874        849   

Net amortization of premiums on securities

     1,300        1,378   

Provision for loan losses

     1,385        810   

Share-based compensation

     142        231   

Deferred income tax expense

     344        876   

Proceeds from sale of loans held for sale

     14,350        10,017   

Originations of loans held for sale

     (13,660     (8,321

Increase in company owned life insurance

     (426     (266

Net gain on sale of loans held for sale

     (333     (224

Net gain on disposal of investment securities

     (331     (3

Impairment charges on investment securities

     91        —     

Net gain on sale and disposal of other assets

     (6     (45

Decrease in other assets

     3,690        1,917   

Decrease in other liabilities

     (1,354     (566
  

 

 

   

 

 

 

Net cash provided by operating activities

     12,262        12,473   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of investment securities:

    

Available for sale

     (99,333     (42,262

Held to maturity

     (3,256     (1,920

Proceeds from principal payments, maturities and calls on investment securities:

    

Available for sale

     44,992        33,990   

Held to maturity

     2,854        5,863   

Proceeds from sales and calls of securities available for sale

     360        —     

Net loan originations

     (37,205     (7,686

Purchases of company owned life insurance

     (8     (7

Proceeds from sales of other assets

     332        110   

Purchases of premises and equipment

     (661     (205
  

 

 

   

 

 

 

Net cash used in investing activities

     (91,925     (12,117
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net increase in deposits

     134,970        86,691   

Net decrease in short-term borrowings

     (33,351     (35,050

Repayments of long-term borrowings

     —          (65

Proceeds from issuance of common stock, net of issuance costs

     —          43,127   

Redemption of Series A preferred stock

     —          (37,447

Purchases of common stock for treasury

     (525     (197

Proceeds from stock options exercised

     26        91   

Excess tax benefit on share-based compensation

     130        64   

Cash dividends paid to preferred shareholders

     (369     (1,010

Cash dividends paid to common shareholders

     (1,776     (1,083
  

 

 

   

 

 

 

Net cash provided by financing activities

     99,105        55,121   
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     19,442        55,477   

Cash and cash equivalents, beginning of period

     57,583        39,058   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 77,025      $ 94,535   
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

- 7 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Financial Institutions, Inc., a financial holding company organized under the laws of New York State (“New York” or “NYS”), and its subsidiaries provide deposit, lending and other financial services to individuals and businesses in Central and Western New York. The Company has also expanded its indirect lending network to include relationships with franchised automobile dealers in the Capital District of New York and Northern Pennsylvania. The Company owns all of the capital stock of Five Star Bank, a New York State chartered bank, and Five Star Investment Services, Inc., a broker-dealer and investment advisor subsidiary offering noninsured investment products. References to “the Company” mean the consolidated reporting entities and references to “the Bank” mean Five Star Bank.

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The accounting and reporting policies conform to U.S. generally accepted accounting principles (“GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in conformity with GAAP have been condensed or omitted pursuant to such rules and regulations. However, in the opinion of management, the accompanying consolidated financial statements reflect all adjustments of a normal and recurring nature necessary to present fairly the consolidated statements of financial condition, income, comprehensive income, shareholders’ equity and cash flows for the periods indicated, and contain adequate disclosure to make the information presented not misleading. Prior years’ consolidated financial statements are re-classified whenever necessary to conform to the current year’s presentation. These consolidated financial statements should be read in conjunction with the Company’s 2011 Annual Report on Form 10-K. The results of operations for any interim periods are not necessarily indicative of the results which may be expected for the entire year.

Subsequent Events

The Company has evaluated events and transactions for potential recognition or disclosure through the day the financial statements were issued.

Use of Estimates

The preparation of these financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates relate to the determination of the allowance for loan losses, assumptions used in the defined benefit pension plan accounting, the carrying value of goodwill and deferred tax assets, and the valuation and other than temporary impairment considerations related to the securities portfolio.

Cash Flow Information

Supplemental cash flow information addressing certain cash payments and noncash investing and financing activities was as follows (in thousands):

 

     Three months ended
March 31,
 
     2012      2011  

Cash payments:

     

Interest

   $ 2,903       $ 4,367   

Income taxes

     60         270   

Noncash investing and financing activities:

     

Real estate and other assets acquired in settlement of loans

   $ 71       $ —     

Accrued and declared unpaid dividends

     2,149         1,454   

Increase in net unsettled security transactions

     21,632         19,360   

Accretion of preferred stock discount

     —           1,305   

 

- 8 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” The provisions of ASU No. 2011-04 result in a consistent definition of fair value and common requirements for the measurement of and disclosure about fair value between U.S. GAAP and International Financial Reporting Standards (“IFRS”). The changes to U.S. GAAP as a result of ASU No. 2011-04 are as follows: (1) The concepts of highest and best use and valuation premise are only relevant when measuring the fair value of nonfinancial assets (that is, it does not apply to financial assets or any liabilities); (2) Extends the prohibition on applying a blockage factor in valuing financial instruments with quoted prices in active markets; (3) Creates an exception to the basic fair value measurement principles for an entity that holds a group of financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk that are managed on the basis of the entity’s net exposure to either of those risks by allowing the entity, if certain criteria are met, to measure the fair value of the net asset or liability position in a manner consistent with how market participants would price the net risk position; (4) Aligns the fair value measurement of instruments classified within an entity’s shareholders’ equity with the guidance for liabilities; and (5) Enhances disclosure requirements for Level 3 fair value measurements to disclose quantitative information about unobservable inputs and assumptions used, to describe the valuation processes used by the entity, and to qualitatively describe the sensitivity of fair value measurements to changes in unobservable inputs and the interrelationships between those inputs. In addition, entities must report the level in the fair value hierarchy of items that are not measured at fair value in the statement of condition but whose fair value must be disclosed. The Company adopted the provisions of ASU No. 2011-04 effective January 1, 2012. The fair value measurement provisions of ASU No. 2011-04 had no impact on the Company’s consolidated financial statements. See Note 9 to the consolidated financial statements for the enhanced disclosures required by ASU No. 2011-04.

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” The provisions of ASU No. 2011-05 allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both options, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. Under either method, entities are required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. ASU No. 2011-05 also eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity but does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU No. 2011-05 was effective for the Company’s interim reporting period beginning on or after January 1, 2012, with retrospective application required. In December 2011, the FASB issued ASU No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” The provisions of ASU No. 2011-12 defer indefinitely the requirement for entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented. ASU No. 2011-12, which shares the same effective date as ASU No. 2011-05, does not defer the requirement for entities to present components of comprehensive income in either a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company adopted the provisions of ASU No. 2011-05 and ASU No. 2011-12 which resulted in a new statement of comprehensive income for the interim period ended March 31, 2012. The adoption of ASU No. 2011-05 and ASU No. 2011-12 had no impact on the Company’s statements of income and financial condition.

 

- 9 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(2.) EARNINGS PER COMMON SHARE (“EPS”)

The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted EPS (in thousands, except per share amounts).

 

     Three months ended
March,
 
     2012     2011  

Net income available to common shareholders

   $ 5,827      $ 3,745   

Less: Earnings allocated to participating securities

     2        10   
  

 

 

   

 

 

 

Net income available to common shareholders for EPS

   $ 5,825      $ 3,735   
  

 

 

   

 

 

 

Weighted average common shares outstanding:

    

Total shares issued

     14,162        11,880   

Unvested restricted stock awards

     (127     (151

Treasury shares

     (360     (393
  

 

 

   

 

 

 

Total basic weighted average common shares outstanding

     13,675        11,336   

Incremental shares from assumed:

    

Exercise of stock options

     3        7   

Vesting of restricted stock awards

     55        49   

Exercise of warrant

     —          75   
  

 

 

   

 

 

 

Total diluted weighted average common shares outstanding

     13,733        11,467   

Basic earnings per common share

   $ 0.43      $ 0.33   
  

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.42      $ 0.33   
  

 

 

   

 

 

 

For each of the periods presented, average shares subject to the following instruments were excluded from the computation of diluted EPS because the effect would be antidilutive:

   

Stock options

     318        352   

Restricted stock awards

     —          27   
  

 

 

   

 

 

 
     318        379   
  

 

 

   

 

 

 

 

- 10 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(3.) INVESTMENT SECURITIES

The amortized cost and fair value of investment securities are summarized below (in thousands):

 

     Amortized      Unrealized      Unrealized      Fair  
     Cost      Gains      Losses      Value  

March 31, 2012

           

Securities available for sale:

           

U.S. Government agencies and government sponsored enterprises

   $ 104,599       $ 2,349       $ 337       $ 106,611   

State and political subdivisions

     141,184         4,221         116         145,289   

Mortgage-backed securities:

           

Federal National Mortgage Association

     94,953         3,090         —           98,043   

Federal Home Loan Mortgage Corporation

     58,911         1,154         —           60,065   

Government National Mortgage Association

     68,746         3,868         —           72,614   

Collateralized mortgage obligations:

           

Federal National Mortgage Association

     56,631         856         31         57,456   

Federal Home Loan Mortgage Corporation

     57,363         591         5         57,949   

Government National Mortgage Association

     96,300         2,284         2         98,582   

Privately issued

     147         1,175         —           1,322   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total collateralized mortgage obligations

     210,441         4,906         38         215,309   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     433,051         13,018         38         446,031   

Asset-backed securities

     267         1,299         —           1,566   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

   $ 679,101       $ 20,887       $ 491       $ 699,497   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

           

State and political subdivisions

   $ 24,196       $ 601       $ —         $ 24,797   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

           

Securities available for sale:

           

U.S. Government agencies and government sponsored enterprises

   $ 94,947       $ 2,770       $ 5       $ 97,712   

State and political subdivisions

     119,099         5,336         11         124,424   

Mortgage-backed securities:

           

Federal National Mortgage Association

     98,679         2,944         —           101,623   

Federal Home Loan Mortgage Corporation

     63,838         1,017         —           64,855   

Government National Mortgage Association

     73,226         3,376         —           76,602   

Collateralized mortgage obligations:

           

Federal National Mortgage Association

     28,339         581         7         28,913   

Federal Home Loan Mortgage Corporation

     22,318         675         1         22,992   

Government National Mortgage Association

     103,975         2,654         18         106,611   

Privately issued

     327         1,762         —           2,089   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total collateralized mortgage obligations

     154,959         5,672         26         160,605   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     390,702         13,009         26         403,685   

Asset-backed securities

     297         1,400         —           1,697   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

   $ 605,045       $ 22,515       $ 42       $ 627,518   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

           

State and political subdivisions

   $ 23,297       $ 667       $ —         $ 23,964   
  

 

 

    

 

 

    

 

 

    

 

 

 

For the three months ended March 31, 2012, proceeds from sales of securities available for sale were $360 thousand and gross realized gains were $331 thousand. There were no sales of available for sale securities during the three months ended March 31, 2011.

 

- 11 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(3.) INVESTMENT SECURITIES (Continued)

 

The scheduled maturities of securities available for sale and securities held to maturity at March 31, 2012 are shown below (in thousands). Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

 

     Amortized      Fair  
     Cost      Value  

Debt securities available for sale:

     

Due in one year or less

   $ 19,166       $ 19,389   

Due from one to five years

     72,353         74,550   

Due after five years through ten years

     226,616         231,886   

Due after ten years

     360,966         373,672   
  

 

 

    

 

 

 
   $ 679,101       $ 699,497   
  

 

 

    

 

 

 

Debt securities held to maturity:

     

Due in one year or less

   $ 18,709       $ 18,823   

Due from one to five years

     4,363         4,638   

Due after five years through ten years

     991         1,161   

Due after ten years

     133         175   
  

 

 

    

 

 

 
   $ 24,196       $ 24,797   
  

 

 

    

 

 

 

There were no unrealized losses in held to maturity securities at March 31, 2012 or December 31, 2011. Unrealized losses on investment securities available for sale and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows (in thousands):

 

     Less than 12 months      12 months or longer      Total  
     Fair      Unrealized      Fair      Unrealized      Fair      Unrealized  
     Value      Losses      Value      Losses      Value      Losses  

March 31, 2012

                 

U.S. Government agencies and government sponsored enterprises

   $ 25,509       $ 332       $ 5,156       $ 5       $ 30,665       $ 337   

State and political subdivisions

     11,189         112         646         4         11,835         116   

Mortgage-backed securities:

                 

Collateralized mortgage obligations:

                 

Federal National Mortgage Association

     12,960         26         1,640         5         14,600         31   

Federal Home Loan Mortgage Corporation

     9,972         5         —           —           9,972         5   

Government National Mortgage Association

     —           —           695         2         695         2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total collateralized mortgage obligations

     22,932         31         2,335         7         25,267         38   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     22,932         31         2,335         7         25,267         38   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total temporarily impaired securities

   $ 59,630       $ 475       $ 8,137       $ 16       $ 67,767       $ 491   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

                 

U.S. Government agencies and government sponsored enterprises

   $ 2,177       $ 1       $ 5,246       $ 4       $ 7,423       $ 5   

State and political subdivisions

     452         2         646         9         1,098         11   

Mortgage-backed securities:

                 

Collateralized mortgage obligations:

                 

Federal National Mortgage Association

     —           —           1,817         7         1,817         7   

Federal Home Loan Mortgage Corporation

     —           —           388         1         388         1   

Government National Mortgage Association

     6,138         18         —           —           6,138      

 

18

  

  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total collateralized mortgage obligations

     6,138         18         2,205         8         8,343         26   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     6,138         18         2,205         8         8,343         26   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total temporarily impaired securities

   $ 8,767       $ 21       $ 8,097       $ 21       $ 16,864       $ 42   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

- 12 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(3.) INVESTMENT SECURITIES (Continued)

 

The total number of security positions in the investment portfolio in an unrealized loss position at March 31, 2012 was 53 compared to 14 at December 31, 2011. At March 31, 2012, the Company had positions in 9 investment securities with an amortized cost of $8.2 million and an unrealized loss of $16 thousand that have been in a continuous unrealized loss position for more than 12 months. There were a total of 44 securities positions in the Company’s investment portfolio, with an amortized cost of $60.1 million and a total unrealized loss of $475 thousand at March 31, 2012, that have been in a continuous unrealized loss position for less than 12 months. The unrealized loss on these investment securities was predominantly caused by changes in market interest rates, average life or credit spreads subsequent to purchase. The fair value of most of the investment securities in the Company’s portfolio fluctuates as market interest rates change.

The Company reviews investment securities on an ongoing basis for the presence of other-than-temporary impairment (“OTTI”) with formal reviews performed quarterly. When evaluating debt securities for OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intention to sell the debt security or whether it is more likely than not that it will be required to sell the debt security before its anticipated recovery. The assessment of whether OTTI exists involves a high degree of subjectivity and judgment and is based on the information available to management.

During the three months ended March 31, 2012, the Company recognized an OTTI charge of $91 thousand related to a privately issued whole loan CMO that was determined to be impaired due to credit quality. No impairment was recorded in the three months ended March 31, 2011.

Based on management’s review and evaluation of the Company’s debt securities as of March 31, 2012, the debt securities with unrealized losses were not considered to be OTTI. As of March 31, 2012, the Company does not intend to sell any debt securities which have an unrealized loss, it is unlikely the Company will be required to sell these securities before recovery and the Company expects to recover the entire amortized cost of these impaired securities. Accordingly, as of March 31, 2012, management has concluded that unrealized losses on its investment securities are temporary and no further impairment loss has been realized in the Company’s consolidated statements of income.

 

- 13 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) LOANS

The Company’s loan portfolio consisted of the following as of the dates indicated (in thousands):

 

     Loans, Gross      Net Deferred
Loan (Fees)
Costs
    Loans, Net  

March 31, 2012

       

Commercial business

   $ 233,690       $ 74      $ 233,764   

Commercial mortgage

     407,293         (772     406,521   

Residential mortgage

     112,096         52        112,148   

Home equity

     232,928         4,091        237,019   

Consumer indirect

     485,244         22,841        508,085   

Other consumer

     23,328         163        23,491   
  

 

 

    

 

 

   

 

 

 

Total

   $ 1,494,579       $ 26,449        1,521,028   
  

 

 

    

 

 

   

Allowance for loan losses

          (23,763
       

 

 

 

Total loans, net

        $ 1,497,265   
       

 

 

 

December 31, 2011

       

Commercial business

   $ 233,727       $ 109      $ 233,836   

Commercial mortgage

     394,034         (790     393,244   

Residential mortgage

     113,865         46        113,911   

Home equity

     227,853         3,913        231,766   

Consumer indirect

     465,807         21,906        487,713   

Other consumer

     24,138         168        24,306   
  

 

 

    

 

 

   

 

 

 

Total

   $ 1,459,424       $ 25,352        1,484,776   
  

 

 

    

 

 

   

Allowance for loan losses

          (23,260
       

 

 

 

Total loans, net

        $ 1,461,516   
       

 

 

 

Loans held for sale (not included above) were comprised entirely of residential real estate mortgages and totaled $2.1 million and $2.4 million as of March 31, 2012 and December 31, 2011, respectively.

 

- 14 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) LOANS (Continued)

 

Past Due Loans Aging

The Company’s recorded investment, by loan class, in current and nonaccrual loans, as well as an analysis of accruing delinquent loans is set forth as of the dates indicated (in thousands):

 

     30-59 Days
Past Due
     60-89 Days
Past Due
     Greater
Than 90
Days
     Total Past
Due
     Nonaccrual      Current      Total
Loans
 

March 31, 2012

                    

Commercial business

   $ 185       $ —         $ —         $ 185       $ 1,863       $ 231,642       $ 233,690   

Commercial mortgage

     236         —           —           236         3,040         404,017         407,293   

Residential mortgage

     379         —           —           379         1,929         109,788         112,096   

Home equity

     250         40         —           290         934         231,704         232,928   

Consumer indirect

     293         119         —           412         444         484,388         485,244   

Other consumer

     69         10         5         84         7         23,237         23,328   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans, gross

   $ 1,412       $ 169       $ 5       $ 1,586       $ 8,217       $ 1,484,776       $ 1,494,579   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

                    

Commercial business

   $ 35       $ —         $ —         $ 35       $ 1,259       $ 232,433       $ 233,727   

Commercial mortgage

     165         —           —           165         2,928         390,941         394,034   

Residential mortgage

     517         —           —           517         1,644         111,704         113,865   

Home equity

     749         68         —           817         682         226,354         227,853   

Consumer indirect

     984         92         —           1,076         558         464,173         465,807   

Other consumer

     106         10         5         121         —           24,017         24,138   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans, gross

   $ 2,556       $ 170       $ 5       $ 2,731       $ 7,071       $ 1,449,622       $ 1,459,424   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

There were no loans past due greater than 90 days and still accruing interest as of March 31, 2012 and December 31, 2011. There were $5 thousand in consumer overdrafts which were past due greater than 90 days as of March 31, 2012 and December 31, 2011. Consumer overdrafts are overdrawn deposit accounts which have been reclassified as loans but by their terms do not accrue interest.

Troubled Debt Restructurings

A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company offers various types of concessions when modifying loans, however, forgiveness of principal is rarely granted. Commercial loans modified in a TDR may involve temporary interest-only payments, term extensions, reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, requesting additional collateral, releasing collateral for consideration, or substituting or adding a new borrower or guarantor.

The following presents, by loan class, information related to loans modified in a TDR during the three months ended March 31, 2012 (dollars in thousands).

 

     Number of
Contracts
     Pre-
Modification
Outstanding
Recorded
Investment
     Post-
Modification
Outstanding
Recorded
Investment
 

Commercial business

     2       $ 433       $ 433   

Commercial mortgage

     1         46         46   
  

 

 

    

 

 

    

 

 

 

Total

     3       $ 479       $ 479   
  

 

 

    

 

 

    

 

 

 

There were no loans modified in a TDR during the three months ended March 31, 2011.

 

- 15 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) LOANS (Continued)

 

All of the loans identified as TDRs by the Company were previously on nonaccrual status and reported as impaired loans prior to restructuring. The modifications primarily related to extending the amortization periods of the loans. All loans restructured during the three months ended March 31, 2012 are on nonaccrual status as of March 31, 2012. Nonaccrual loans that are restructured remain on nonaccrual status, but may move to accrual status after they have performed according to the restructured terms for a period of time. The TDR classification did not have a material impact on the Company’s determination of the allowance for loan losses because the modified loans were impaired and evaluated for a specific reserve both before and after restructuring.

There were no loans modified as a TDR within the previous 12 months that defaulted during the three months ended March 31, 2012 or 2011. For purposes of this disclosure, a loan modified as a TDR is considered to have defaulted when the borrower becomes 90 days past due.

Impaired Loans

Management has determined that specific commercial loans on nonaccrual status and all loans that have had their terms restructured in a troubled debt restructuring are impaired loans. The following table presents the recorded investment, unpaid principal balance and related allowance of impaired loans as of the dates indicated and average recorded investment and interest income recognized of impaired loans for the three months ended on the dates indicated (in thousands):

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

March 31, 2012

              

With no related allowance recorded:

              

Commercial business

   $ 543       $ 1,457       $ —         $ 509       $ —     

Commercial mortgage

     1,260         1,352         —           759         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     1,803         2,809         —           1,268         —     

With an allowance recorded:

              

Commercial business

     1,320         1,320         554         1,010         —     

Commercial mortgage

     1,780         1,780         672         2,171         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     3,100         3,100         1,226         3,181         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 4,903       $ 5,909       $ 1,226       $ 4,449       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

              

With no related allowance recorded:

              

Commercial business

   $ 342       $ 1,266       $ —         $ 361       $ —     

Commercial mortgage

     605         696         —           583         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     947         1,962         —           944         —     

With an allowance recorded:

              

Commercial business

     917         917         436         1,033         —     

Commercial mortgage

     2,323         2,323         644         2,172         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     3,240         3,240         1,080         3,205         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 4,187       $ 5,202       $ 1,080       $ 4,149       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

- 16 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) LOANS (Continued)

 

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors such as the fair value of collateral. The Company analyzes commercial business and commercial mortgage loans individually by classifying the loans as to credit risk. Risk ratings are updated any time the situation warrants. The Company uses the following definitions for risk ratings:

Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as Substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the process described above are considered “Uncriticized” or pass-rated loans and are included in groups of homogeneous loans with similar risk and loss characteristics.

The following table sets forth the Company’s commercial loan portfolio, categorized by internally assigned asset classification, as of the dates indicated (in thousands):

 

     Commercial
Business
     Commercial
Mortgage
 

March 31, 2012

     

Uncriticized

   $ 218,308       $ 395,029   

Special mention

     6,998         2,939   

Substandard

     8,384         9,325   

Doubtful

     —           —     
  

 

 

    

 

 

 

Total

   $ 233,690       $ 407,293   
  

 

 

    

 

 

 

December 31, 2011

     

Uncriticized

   $ 221,477       $ 383,700   

Special mention

     7,445         2,388   

Substandard

     4,805         7,946   

Doubtful

     —           —     
  

 

 

    

 

 

 

Total

   $ 233,727       $ 394,034   
  

 

 

    

 

 

 

The Company utilizes payment status as a means of identifying and reporting problem and potential problem retail loans. The Company considers nonaccrual loans and loans past due greater than 90 days and still accruing interest to be non-performing. The following table sets forth the Company’s retail loan portfolio, categorized by payment status, as of the dates indicated (in thousands):

 

     Residential
Mortgage
     Home
Equity
     Consumer
Indirect
     Other
Consumer
 

March 31, 2012

           

Performing

   $ 110,167       $ 231,994       $ 484,800       $ 23,321   

Non-performing

     1,929         934         444         7   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 112,096       $ 232,928       $ 485,244       $ 23,328   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

           

Performing

   $ 112,221       $ 227,171       $ 465,249       $ 24,138   

Non-performing

     1,644         682         558         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 113,865       $ 227,853       $ 465,807       $ 24,138   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

- 17 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) LOANS (Continued)

 

Allowance for Loan Losses

The following table sets forth the changes in the allowance for loan losses for the three months ended March 31, 2012 and 2011 (in thousands):

 

     Commercial
Business
     Commercial
Mortgage
    Residential
Mortgage
    Home
Equity
     Consumer
Indirect
     Other
Consumer
     Total  

March 31, 2012

                  

Allowance for loan losses:

                  

Beginning balance

   $ 4,036       $ 6,418      $ 858      $ 1,242       $ 10,189       $ 517       $ 23,260   

Charge-offs

     55         120        106        4         1,395         314         1,994   

Recoveries

     77         15        70        9         727         214         1,112   

Provision

     328         475        —          34         478         70         1,385   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance

   $ 4,386       $ 6,788      $ 822      $ 1,281       $ 9,999       $ 487       $ 23,763   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                  

Individually

   $ 554       $ 672      $ —        $ —         $ —         $ —         $ 1,226   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Collectively

   $ 3,832       $ 6,116      $ 822      $ 1,281       $ 9,999       $ 487       $ 22,537   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                  

Ending balance

   $ 233,690       $ 407,293      $ 112,096      $ 232,928       $ 485,244       $ 23,328       $ 1,494,579   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                  

Individually

   $ 1,863       $ 3,040      $ —        $ —         $ —         $ —         $ 4,903   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Collectively

   $ 231,827       $ 404,253      $ 112,096      $ 232,928       $ 485,244       $ 23,328       $ 1,489,676   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

March 31, 2011

                  

Allowance for loan losses:

                  

Beginning balance

   $ 3,712       $ 6,431      $ 1,013      $ 972       $ 7,754       $ 584       $ 20,466   

Charge-offs

     90         344        2        107         1,290         211         2,044   

Recoveries

     154         16        27        10         552         128         887   

Provision (credit)

     245         (195     (22     155         598         29         810   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance

   $ 4,021       $ 5,908      $ 1,016      $ 1,030       $ 7,614       $ 530       $ 20,119   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                  

Individually

   $ 261       $ 522      $ —        $ —         $ —         $ —         $ 783   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Collectively

   $ 3,760       $ 5,386      $ 1,016      $ 1,030       $ 7,614       $ 530       $ 19,336   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                  

Ending balance

   $ 209,259       $ 362,282      $ 123,572      $ 206,608       $ 404,806       $ 24,888       $ 1,331,415   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                  

Individually

   $ 902       $ 2,735      $ —        $ —         $ —         $ —         $ 3,637   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Collectively

   $ 208,357       $ 359,547      $ 123,572      $ 206,608       $ 404,806       $ 24,888       $ 1,327,778   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Risk Characteristics

Commercial business loans primarily consist of loans to small to mid-sized businesses in our market area in a diverse range of industries. These loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. The credit risk related to commercial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations or on the value of underlying collateral, if any.

Commercial mortgage loans generally have larger balances and involve a greater degree of risk than residential mortgage loans, inferring higher potential losses on an individual customer basis. Loan repayment is often dependent on the successful operation and management of the properties, as well as on the collateral securing the loan. Economic events or conditions in the real estate market could have an adverse impact on the cash flows generated by properties securing the Company’s commercial real estate loans and on the value of such properties.

 

- 18 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) LOANS (Continued)

 

Residential mortgage loans and home equities (comprised of home equity loans and home equity lines) are generally made on the basis of the borrower’s ability to make repayment from his or her employment and other income, but are secured by real property whose value tends to be more easily ascertainable. Credit risk for these types of loans is generally influenced by general economic conditions, the characteristics of individual borrowers, and the nature of the loan collateral.

Consumer indirect and other consumer loans may entail greater credit risk than residential mortgage loans and home equities, particularly in the case of other consumer loans which are unsecured or, in the case of indirect consumer loans, secured by depreciable assets, such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, thus are more likely to be affected by adverse personal circumstances such as job loss, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

(5.) SHAREHOLDERS’ EQUITY

Common Stock

The changes in shares of common stock were as follows for three months ended March 31, 2012:

 

     Outstanding     Treasury     Issued  

Shares outstanding at December 31, 2011

     13,803,116        358,481        14,161,597   

Restricted stock awards issued

     48,741        (48,741     —     

Restricted stock awards forfeited

     (9,748     9,748        —     

Stock options exercised

     1,650        (1,650     —     

Treasury stock purchases

     (31,518     31,518        —     
  

 

 

   

 

 

   

 

 

 

Shares outstanding at March 31, 2012

     13,812,241        349,356        14,161,597   
  

 

 

   

 

 

   

 

 

 

 

(6.) SHARE-BASED COMPENSATION PLANS

The Company maintains certain stock-based compensation plans that were approved by the Company’s shareholders and are administered by the Board, or the Management Development and Compensation Committee of the Board. The share-based compensation plans were established to allow for the granting of compensation awards to attract, motivate and retain employees, executive officers and non-employee directors who contribute to the success and profitability of the Company and to give such persons a proprietary interest in the Company, thereby enhancing their personal interest in the Company’s success.

The Company awarded grants of 48,741 restricted shares to certain members of management during the three months ended March 31, 2012. The weighted average market price of the restricted shares on the date of grant was $17.42. Either a service requirement or both service and performance requirements must be satisfied before the participant becomes vested in the shares. Where applicable, the performance period for the awards is the Company’s fiscal year ending December 31, 2012.

The following is a summary of restricted stock award activity for the three months ended March 31, 2012:

 

     Number of
Shares
    Weighted
Average
Market
Price at
Grant Date
 

Outstanding at beginning of year

     166,654      $ 14.34   

Granted

     48,741        17.42   

Vested

     (82,256     12.13   

Forfeited

     (9,748     16.19   
  

 

 

   

Outstanding at end of period

     123,391      $ 16.88   
  

 

 

   

 

- 19 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(6.) SHARE-BASED COMPENSATION PLANS (Continued)

 

The Company amortizes the expense related to restricted stock awards over the vesting period. Share-based compensation expense is included in the consolidated statements of income under salaries and employee benefits for awards granted to management and in other noninterest expense for awards granted to directors. The share-based compensation expense included in the consolidated statements of income is as follows (in thousands):

 

     Three months ended
March 31,
 
     2012      2011  

Stock options:

     

Management Stock Incentive Plan

   $ 4       $ 14   

Director Stock Incentive Plan

     —           10   
  

 

 

    

 

 

 

Total stock option expense

     4         24   

Restricted stock awards:

     

Management Stock Incentive Plan

     123         192   

Director Stock Incentive Plan

     15         15   
  

 

 

    

 

 

 

Total restricted stock award expense

     138         207   
  

 

 

    

 

 

 

Total share-based compensation

   $ 142       $ 231   
  

 

 

    

 

 

 

 

(7.) EMPLOYEE BENEFIT PLANS

Defined Benefit Pension Plan

The Company participates in The New York State Bankers Retirement System (the “System”), a defined benefit pension plan covering substantially all employees, subject to the limitations related to the plan closure effective December 31, 2006. The benefits are based on years of service and the employee’s highest average compensation during five consecutive years of employment. The defined benefit plan was closed to new participants effective December 31, 2006. Only employees hired on or before December 31, 2006 and who met participation requirements on or before January 1, 2008 are eligible to receive benefits.

The components of the Company’s net periodic benefit expense for its pension plan were as follows (in thousands):

 

     Three months ended
March 31,
 
     2012     2011  

Service cost

   $ 509      $ 439   

Interest cost on projected benefit obligation

     504        507   

Expected return on plan assets

     (803     (663

Amortization of unrecognized prior service cost

     5        4   

Amortization of unrecognized loss

     343        152   
  

 

 

   

 

 

 

Net periodic pension cost

   $ 558      $ 439   
  

 

 

   

 

 

 

The Company’s funding policy is to contribute, at a minimum, an actuarially determined amount that will satisfy the minimum funding requirements determined under the appropriate sections of the Internal Revenue Code. The Company satisfied the minimum required contribution to its pension plan of $1.7 million for the 2012 fiscal year by contributing $10.0 million prior to December 31, 2011.

 

- 20 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(8.) COMMITMENTS AND CONTINGENCIES

The Company has financial instruments with off-balance sheet risk established in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk extending beyond amounts recognized in the financial statements.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is essentially the same as that involved with extending loans to customers. The Company uses the same credit underwriting policies in making commitments and conditional obligations as for on-balance sheet instruments.

Off-balance sheet commitments consist of the following (in thousands):

 

     March 31,
2012
     December 31,
2011
 

Commitments to extend credit

   $ 369,991          $ 374,266   

Standby letters of credit

     9,117            8,855   

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. Commitments may expire without being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Standby letters of credit are conditional lending commitments issued by the Company to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support private borrowing arrangements. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers.

The Company also extends rate lock agreements to borrowers related to the origination of residential mortgage loans. To mitigate the interest rate risk inherent in these rate lock agreements when the Company intends to sell the related loan, once originated, as well as closed residential mortgage loans held for sale, the Company enters into forward commitments to sell individual residential mortgages. Rate lock agreements and forward commitments are considered derivatives and are recorded at fair value. The notional value of forward sales commitments totaled $1.9 million and $2.9 million at March 31, 2012 and December 31, 2011, respectively.

 

(9.) FAIR VALUE MEASUREMENTS

Determination of Fair Value — Assets Measured at Fair Value on a Recurring and Nonrecurring Basis

Valuation Hierarchy

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. ASC Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. There have been no changes in the valuation techniques used during the current period. The fair value hierarchy is as follows:

 

   

Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

   

Level 2 - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

   

Level 3 - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Transfers between levels of the fair value hierarchy are recorded as of the end of the reporting period.

 

- 21 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(9.) FAIR VALUE MEASUREMENTS (Continued)

 

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Securities available for sale: Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Loans held for sale: The fair value of loans held for sale is determined using quoted secondary market prices and investor commitments. Loans held for sale are classified as Level 2 in the fair value hierarchy.

Collateral dependent impaired loans: Fair value of impaired loans with specific allocations of the allowance for loan losses is measured based on the value of the collateral securing these loans and is classified as Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable and collateral value is determined based on appraisals performed by qualified licensed appraisers hired by the Company. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Such discounts are typically significant and result in a Level 3 classification of the inputs for determining fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.

Mortgage servicing rights: Mortgage servicing rights do not trade in an active market with readily observable market data. As a result, the Company estimates the fair value of mortgage servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income. The assumptions used in the discounted cash flow model are those that we believe market participants would use in estimating future net servicing income, including estimates of loan prepayment rates, servicing costs, ancillary income, impound account balances, and discount rates. The significant unobservable inputs used in the fair value measurement of the Company’s mortgage servicing rights are the constant prepayment rates and weighted average discount rate. Significant increases (decreases) in any of those inputs in isolation could result in a significantly lower (higher) fair value measurement. Although the constant prepayment rate and the discount rate are not directly interrelated, they will generally move in opposite directions. Mortgage servicing rights are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation.

Other real estate owned (Foreclosed assets): Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. The appraisals are sometimes further discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Such discounts are typically significant and result in a Level 3 classification of the inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

 

- 22 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(9.) FAIR VALUE MEASUREMENTS (Continued)

 

Assets Measured at Fair Value

The following table presents for each of the fair-value hierarchy levels the Company’s assets that are measured at fair value on a recurring and non-recurring basis as of the dates indicated (in thousands).

 

     Quoted Prices in
Active Markets
for Identical
Assets or
Liabilities
     Significant
Other
Observable
Inputs
     Significant
Unobservable
Inputs
        
     (Level 1)      (Level 2)      (Level 3)      Total  

March 31, 2012

           

Measured on a recurring basis:

           

Securities available for sale:

           

U.S. Government agencies and government sponsored enterprises

   $ —         $ 106,611       $ —         $ 106,611   

State and political subdivisions

     —           145,289         —           145,289   

Mortgage-backed securities

     —           446,031         —           446,031   

Asset-backed securities:

           

Trust preferred securities

     —           1,505         —           1,505   

Other

     —           61         —           61   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 699,497       $ —         $ 699,497   
  

 

 

    

 

 

    

 

 

    

 

 

 

Measured on a nonrecurring basis:

           

Loans:

           

Loans held for sale

   $ —         $ 2,053       $ —         $ 2,053   

Collateral dependent impaired loans

     —           —           1,874         1,874   

Other assets:

           

Mortgage servicing rights

     —           —           1,835         1,835   

Other real estate owned

     —           —           258         258   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 2,053       $ 3,967       $ 6,020   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

           

Measured on a recurring basis:

           

Securities available for sale:

           

U.S. Government agencies and government sponsored enterprises

   $ —         $ 97,712       $ —         $ 97,712   

State and political subdivisions

     —           124,424         —           124,424   

Mortgage-backed securities

     —           403,685         —           403,685   

Asset-backed securities:

           

Trust preferred securities

     —           —           1,636         1,636   

Other

     —           61         —           61   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 625,882       $ 1,636       $ 627,518   
  

 

 

    

 

 

    

 

 

    

 

 

 

Measured on a nonrecurring basis:

           

Loans:

           

Loans held for sale

   $ —         $ 2,410       $ —         $ 2,410   

Collateral dependent impaired loans

     —           —           2,160         2,160   

Other assets:

           

Mortgage servicing rights

     —           —           1,973         1,973   

Other real estate owned

     —           —           475         475   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 2,410       $ 4,608       $ 7,018   
  

 

 

    

 

 

    

 

 

    

 

 

 

There were no transfers between level 1 and 2 for the three months ended March 31, 2012. There were no liabilities measured at fair value on a recurring or nonrecurring basis during the three month periods ended March 31, 2012 and 2011.

 

- 23 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(9.) FAIR VALUE MEASUREMENTS (Continued)

 

The following table presents additional quantitative information about assets measured at fair value on a recurring and nonrecurring basis for which the Company has utilized Level 3 inputs to determine fair value (dollars in thousands).

 

Asset

  Fair
Value
   

Valuation Technique

 

Unobservable Input

  Unobservable Input
Value or Range

Collateral dependent impaired loans

  $ 1,874      Appraisal of collateral  (1)   Appraisal adjustments (2)   40% - 100% discount
    Discounted cash flow   Discount rate   5.2% (3)
      Risk premium rate   11.3% (3)

Mortgage servicing rights

    1,835      Discounted cash flow   Discount rate   4.4% (3)
      Constant prepayment rate   30.4% (3)

Other real estate owned

    258      Appraisal of collateral (1)   Appraisal adjustments (2)   25% - 49% discount

 

(1) 

Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable.

(2) 

Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.

(3) 

Weighted averages.

Changes in Level 3 Fair Value Measurements

The reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) is as follows for the periods indicated (in thousands):

 

     Three months ended
March 31,
 
     2012     2011  

Securities available for sale, beginning of period

   $ 1,636      $ 572   

Sales

     (360     —     

Principal paydowns and other

     —          110   

Total gains (losses) realized/unrealized:

    

Included in earnings

     331        —     

Included in other comprehensive income

     (102     (115

Transfers from Level 3 to Level 2

     (1,505     —     
  

 

 

   

 

 

 

Securities available for sale, end of period

   $ —        $ 567   
  

 

 

   

 

 

 

During the three months ended March 31, 2012, the Company transferred $1.5 million of assets out of Level 3, consisting of pooled trust preferred securities. The transfers of the pooled trust preferred securities out of Level 3 was primarily the result of using observable pricing information or a third party pricing quote that appropriately reflects the fair value of those securities, without the need for adjustment based on our own assumptions regarding the characteristics of a specific security or the current liquidity in the market.

 

- 24 -


FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(9.) FAIR VALUE MEASUREMENTS (Continued)

 

Disclosures about Fair Value of Financial Instruments

The assumptions used below are expected to approximate those that market participants would use in valuing these financial instruments.

Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument, including estimates of timing, amount of expected future cash flows and the credit standing of the issuer. Such estimates do not consider the tax impact of the realization of unrealized gains or losses. In some cases, the fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial instrument. Care should be exercised in deriving conclusions about our business, its value or financial position based on the fair value information of financial instruments presented below.

Securities held to maturity: The fair value of the Company’s investment securities held to maturity is primarily measured using information from a third-party pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Loans: The fair value of the Company’s loans was estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made for the same remaining maturities. Loans were first segregated by type such as commercial, residential mortgage, and consumer, and were then further segmented into fixed and variable rate and loan quality categories. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

Time deposits: The fair value of time deposits was estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments. The fair values of the Company’s time deposit liabilities do not take into consideration the value of the Company’s long-term relationships with depositors, which may have significant value.

The following presents (in thousands) the carrying amount, estimated fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of March 31, 2012 and December 31, 2011. This table excludes financial instruments whose fair value was determined utilizing Level 1 inputs and for which the carrying amount approximates fair value. Financial assets for which the fair value approximates carrying value include cash and cash equivalents, FHLB and FRB stock and accrued interest receivable. Financial liabilities for which the fair value approximates carrying value include non-maturity deposits, short-term borrowings and accrued interest payable.

 

                                    
            Estimated      Fair Value Measurements  
     Carrying
Amount
     Fair
Value
     Level 1
Inputs
     Level 2
Inputs
     Level 3
Inputs
 

March 31, 2012

              

Financial assets:

              

Securities held to maturity

   $ 24,196       $ 24,797       $ —         $ 24,797       $ —     

Loans (1)

     1,497,265         1,521,329         —           —           1,521,329   

FHLB and FRB stock

     9,504         9,504         —           9,504         —     

Financial liabilities:

              

Time deposits

     695,928         697,665         —           697,665         —     

December 31, 2011

              

Financial assets:

              

Securities held to maturity

   $ 23,297       $ 23,964       $ —         $ 23,964       $ —     

Loans (1)

     1,461,516         1,493,159         —           —           1,493,159   

FHLB and FRB stock

     10,674         10,674         —           10,674         —     

Financial liabilities:

              

Time deposits

     700,676         702,720         —           702,720         —     

 

(1) 

Comprised of loans (including collateral dependent impaired loans), net of deferred loan costs and the allowance for loan losses.

 

- 25 -


ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD LOOKING INFORMATION

This Quarterly Report on Form 10-Q should be read in conjunction with the more detailed and comprehensive disclosures included in our Annual Report on Form 10-K for the year ended December 31, 2011. In addition, please read this section in conjunction with our Consolidated Financial Statements and Notes to Consolidated Financial Statements contained herein.

Statements and financial analysis contained in this document that are not historical facts are forward looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 (the “Act”). In addition, certain statements may be contained in our future filings with SEC, in press releases, and in oral and written statements made by or with our approval that are not statements of historical fact and constitute forward-looking statement within the meaning of the Act. Forward looking statements describe our future plans, strategies and expectations and are based on certain assumptions. Words such as “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “target,” “projects,” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advise readers that various factors, including those identified under the heading “Risk Factors” in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2011, could affect our financial performance and could cause our actual results or circumstances for future periods to differ materially from those anticipated or projected.

Except as required by law, we do not undertake, and specifically disclaim any obligation to publicly release any revisions to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

GENERAL

Financial Institutions, Inc. is a financial holding company headquartered in New York State, providing banking and nonbanking financial services to individuals and businesses primarily in our Western and Central New York footprint. We have also expanded our indirect lending network to include relationships with franchised automobile dealers in the Capital District of New York and Northern Pennsylvania. Through our wholly-owned banking subsidiary, Five Star Bank, we provide a wide range of services, including business and consumer loan and depository services, as well as other traditional banking services. Through our nonbanking subsidiary, Five Star Investment Services, we provide brokerage and investment advisory services to supplement our banking business.

Our primary sources of revenue, are net interest income (predominantly from interest earned on our loans and securities, net of interest paid on deposits and other funding sources), and noninterest income, particularly fees and other revenue from financial services provided to customers or ancillary services tied to loans and deposits. Business volumes and pricing drive revenue potential, and tend to be influenced by overall economic factors, including market interest rates, business spending, consumer confidence, economic growth, and competitive conditions within the marketplace. We are not able to predict market interest rate fluctuations with certainty and our asset/liability management strategy may not prevent interest rate changes from having a material adverse effect on our results of operations and financial condition.

Our business strategy has been to maintain a community bank philosophy, which consists of focusing on and understanding the individualized banking needs of the businesses, professionals and other residents of the local communities surrounding our banking centers. We believe this focus allows us to be more responsive to our customers’ needs and provide a high level of personal service that differentiates us from larger competitors, resulting in long-standing and broad based banking relationships. Our core customers are primarily comprised of small- to medium-sized businesses, professionals and community organizations who prefer to build a banking relationship with a community bank that offers and combines high quality, competitively-priced banking products and services with personalized service. Because of our identity and origin as a locally operated bank, we believe that our level of personal service provides a competitive advantage over larger banks, which tend to consolidate decision-making authority outside local communities.

A key aspect of our current business strategy is to foster a community-oriented culture where our customers and employees establish long-standing and mutually beneficial relationships. We believe that we are well-positioned to be a strong competitor within our market area because of our focus on community banking needs and customer service, our comprehensive suite of deposit and loan products typically found at larger banks, our highly experienced management team and our strategically located banking centers. A central part of our strategy is generating core deposits to support growth of a diversified and high-quality loan portfolio.

 

- 26 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

BRANCH ACQUISITIONS

On January 19, 2012, Five Star Bank entered into an agreement to acquire four retail banking branches currently owned by First Niagara Bank, N.A located in Medina, Waterloo, Batavia and Brockport, New York and four retail banking branches currently owned by HSBC Bank USA, N.A. located in Elmira, Elmira Heights, Horseheads and Albion, New York. The deposits associated with these branches total approximately $376 million, while loans total approximately $94 million. Subject to customary closing conditions and applicable regulatory approvals, we anticipate the transaction for the First Niagara branches to close during the second quarter of this year, followed by the transaction for the HSBC branches closing during the third quarter.

In anticipation of the branch acquisitions, we have begun and will continue to leverage our balance sheet through the execution of short-term FHLB advances in order to “pre-acquire” investment securities. Our purchase of investment securities will be comprised of mortgage-backed securities, U.S. Government agencies and sponsored enterprise bonds and tax-exempt municipal bonds. The cash received at the time of closing will then be used to pay down the FHLB advances. This strategy will allow us to purchase securities over time and carry out a dollar cost averaging strategy.

RESULTS OF OPERATIONS

Summary of Performance

Net income for the first quarter of 2012 was $6.2 million compared to $5.8 million for the first quarter of 2011. Net income available to common shareholders for the first quarter of 2012 was $5.8 million, or $0.43 and $0.42 earnings per basic and diluted share, respectively. Comparatively, net income available to common shareholders for the first quarter of 2011 was $3.7 million, or $0.33 per basic and diluted share.

Return on average equity was 10.36% and return on average assets was 1.06% for the first quarter of 2012, compared to 10.85% and 1.06%, respectively, for the first quarter of 2011. The net interest margin was 4.05% in both the first quarter of 2012 and 2011.

Net Interest Income and Net Interest Margin

Net interest income is the primary source of our revenue. Net interest income is the difference between interest income on interest-earning assets, such as loans and investment securities, and the interest expense on interest-bearing deposits and other borrowings used to fund interest-earning and other assets or activities. Net interest income is affected by changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, as well as the sensitivity of the balance sheet to changes in interest rates, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities and repricing frequencies.

Interest rate spread and net interest margin are utilized to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on earning assets and the rate paid for interest-bearing liabilities that fund those assets. The net interest margin is expressed as the percentage of net interest income to average earning assets. The net interest margin exceeds the interest rate spread because noninterest-bearing sources of funds (“net free funds”), principally noninterest-bearing demand deposits and stockholders’ equity, also support earning assets. To compare tax-exempt asset yields to taxable yields, the yield on tax-exempt investment securities is computed on a taxable equivalent basis. Net interest income, interest rate spread, and net interest margin are discussed on a taxable equivalent basis.

The following table reconciles interest income per the consolidated statements of income to interest income adjusted to a fully taxable equivalent basis (dollars in thousands):

 

     Three months ended
March 31,
 
     2012      2011  

Interest income per consolidated statements of income

   $ 23,450       $ 23,639   

Adjustment to fully taxable equivalent basis

     507         514   
  

 

 

    

 

 

 

Interest income adjusted to a fully taxable equivalent basis

     23,957         24,153   

Interest expense per consolidated statements of income

     2,509         3,801   
  

 

 

    

 

 

 

Net interest income on a taxable equivalent basis

   $ 21,448       $ 20,352   
  

 

 

    

 

 

 

Net interest income on a taxable equivalent basis for the three months ended March 31, 2012, was $21.4 million, an increase of $1.1 million or 5% versus the comparable quarter last year. The increase in taxable equivalent net interest income was primarily attributable to favorable volume variances (as changes in the balances and mix of earning assets and interest-bearing liabilities added $1.9 million to taxable equivalent net interest income), partly offset by unfavorable rate variances (as the impact of changes in the interest rate environment and product pricing reduced taxable equivalent net interest income by $841 thousand).

 

- 27 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The net interest margin for the first three months of 2012 was 4.05%, unchanged from the same period in 2011. The interest rate spread was 3.94% during the first quarter of 2012 compared to 3.86% during the first quarter of 2011. This 8 basis point increase was offset by an 8 basis point decrease in the contribution from net free funds (due principally to lower rates on interest-bearing liabilities reducing the value of noninterest-bearing deposits and other net free funds). The higher interest rate spread was a net result of a 27 basis point decrease in the yield on earning assets and a 35 basis point decrease in the cost of interest-bearing liabilities.

The Federal Reserve left the Federal funds rate unchanged at 0.25% during 2010, 2011 and thus far in 2012. During 2011, the Federal Reserve disclosed that short-term interest rates would be held near zero through at least the middle of 2013, in anticipation of low growth and little risk of inflation. In April 2012, the Federal Reserve further announced that interest rates will likely need to remain at exceptionally low levels through late 2014.

For the first quarter of 2012, the yield on average earning assets of 4.53% was 27 basis points lower than the first quarter of 2011. Loan yields decreased 47 basis points to 5.24%. Commercial mortgage and consumer indirect loans in particular, down 37 and 92 basis points, respectively, experienced lower yields given the competitive pricing pressures in a low interest rate environment. The yield on investment securities dropped 17 basis points to 2.83%, also impacted by the lower interest rate environment and prepayments of mortgage-related investment securities. Overall, earning asset rate changes reduced interest income by $1.9 million during the first quarter of 2012.

The cost of average interest-bearing liabilities of 0.59% in the first quarter of 2012 was 35 basis points lower than the first quarter of 2011. The average cost of interest-bearing deposits was 0.60% in 2012, 23 basis points lower than 2011, reflecting the lower rate environment, mitigated by a focus on product pricing to retain balances. The cost of short-term funding decreased 11 basis points to 0.46% for the first quarter of 2012. The interest-bearing liability rate changes resulted in $1.0 million of lower interest expense.

Average interest-earning assets were $2.125 billion for first quarter 2012, an increase of $93.9 million or 5% from the comparable quarter last year, with average loans up $150.8 million and average securities down $56.7 million. The growth in average loans was comprised of increases in consumer loans (up $100.2 million, primarily indirect loans) and commercial loans (up $65.0 million), while residential mortgages declined (down $14.4 million).

Average interest-bearing liabilities of $1.700 billion in first quarter of 2012 were $59.7 million or 4% higher than the first quarter of 2011. On average, interest-bearing deposits grew $40.5 million (primarily attributable to a $37.9 million increase on average municipal deposits), while noninterest-bearing demand deposits (a principal component of net free funds) were up $37.1 million. Average borrowings increased $19.2 million between the first quarter periods, with short-term borrowings higher by $46.0 million, offset by a decrease in long-term funding. There was no long-term debt outstanding during the first quarter of 2012. During the third quarter of 2011 we repaid all of our outstanding long-term debt, including our 10.20% junior subordinated debentures.

 

- 28 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The following tables sets forth certain information relating to the consolidated balance sheets and reflects the average yields earned on interest-earning assets, as well as the average rates paid on interest-bearing liabilities for the periods indicated (in thousands).

 

     Three months ended March 31,  
     2012     2011  
     Average
Balance
    Interest      Average
Rate
    Average
Balance
    Interest      Average
Rate
 

Interest-earning assets:

              

Federal funds sold and interest-earning deposits

   $ 94      $ —           0.29   $ 258      $ —           0.21

Investment securities (1):

              

Taxable

     479,563        2,972         2.48        545,079        3,649         2.68   

Tax-exempt (2)

     145,320        1,449         3.99        136,525        1,469         4.30   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total investment securities

     624,883        4,421         2.83        681,604        5,118         3.00   

Loans:

              

Commercial business

     231,865        2,727         4.73        207,669        2,473         4.83   

Commercial mortgage

     402,007        5,502         5.50        361,228        5,231         5.87   

Residential mortgage

     114,166        1,547         5.42        128,567        1,835         5.71   

Home equity

     233,550        2,495         4.30        208,656        2,323         4.51   

Consumer indirect

     494,861        6,650         5.41        417,833        6,525         6.33   

Other consumer

     23,554        615         10.50        25,226        648         10.41   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total loans

     1,500,003        19,536         5.24        1,349,179        19,035         5.71   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

     2,124,980        23,957         4.53        2,031,041        24,153         4.80   
    

 

 

    

 

 

     

 

 

    

 

 

 

Allowance for loan losses

     (23,836          (20,876     

Other noninterest-earning assets

     241,586             211,613        
  

 

 

        

 

 

      

Total assets

   $ 2,342,730           $ 2,221,778        
  

 

 

        

 

 

      

Interest-bearing liabilities:

              

Deposits:

              

Interest-bearing demand

   $ 392,353      $ 146         0.15   $ 395,807      $ 162         0.17

Savings and money market

     507,543        283         0.22        434,579        262         0.24   

Certificates of deposit

     703,372        1,969         1.13        732,414        2,773         1.54   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing deposits

     1,603,268        2,398         0.60        1,562,800        3,197         0.83   

Short-term borrowings

     97,093        111         0.46        51,127        72         0.57   

Long-term borrowings

     —          —           —          26,743        532         7.98   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total borrowings

     97,093        111         0.46        77,870        604         3.12   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     1,700,361        2,509         0.59        1,640,670        3,801         0.94   
    

 

 

    

 

 

     

 

 

    

 

 

 

Noninterest-bearing demand deposits

     387,153             350,032        

Other noninterest-bearing liabilities

     14,703             13,548        

Shareholders’ equity

     240,513             217,528        
  

 

 

        

 

 

      

Total liabilities and shareholders’ equity

   $ 2,342,730           $ 2,221,778        
  

 

 

        

 

 

      

Net interest income (tax-equivalent)

     $ 21,448           $ 20,352      
    

 

 

        

 

 

    

Interest rate spread

          3.94          3.86
       

 

 

        

 

 

 

Net earning assets

   $ 424,619           $ 390,371        
  

 

 

        

 

 

      

Net interest margin (tax-equivalent)

          4.05          4.05
       

 

 

        

 

 

 

Ratio of average interest-earning assets to average interest-bearing liabilities

          124.97          123.79
       

 

 

        

 

 

 

 

(1) 

Investment securities are shown at amortized cost and include non-performing securities.

(2) 

The interest on tax-exempt securities is calculated on a tax equivalent basis assuming a Federal tax rate of 35%.

 

- 29 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The following table presents, on a tax equivalent basis, the relative contribution of changes in volumes and changes in rates to changes in net interest income for the periods indicated. The change in interest not solely due to changes in volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each (in thousands):

 

     Three months ended
March 31, 2012 vs. 2011
 
Increase (decrease) in:    Volume     Rate     Total  

Interest income:

      

Federal funds sold and interest-earning deposits

   $ —        $ —        $ —     

Investment securities:

      

Taxable

     (419     (258     (677

Tax-exempt

     92        (112     (20
  

 

 

   

 

 

   

 

 

 

Total investment securities

     (327     (370     (697

Loans:

      

Commercial business

     285        (31     254   

Commercial mortgage

     569        (298     271   

Residential mortgage

     (198     (90     (288

Home equity

     269        (97     172   

Consumer indirect

     1,107        (982     125   

Other consumer

     (44     11        (33
  

 

 

   

 

 

   

 

 

 

Total loans

     1,988        (1,487     501   
  

 

 

   

 

 

   

 

 

 

Total interest income

     1,661        (1,857     (196
  

 

 

   

 

 

   

 

 

 

Interest expense:

      

Deposits:

      

Interest-bearing demand

     (1     (15     (16

Savings and money market

     42        (21     21   

Certificates of deposit

     (106     (698     (804
  

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

     (65     (734     (799

Short-term borrowings

     55        (16     39   

Long-term borrowings

     (266     (266     (532
  

 

 

   

 

 

   

 

 

 

Total borrowings

     (211     (282     (493
  

 

 

   

 

 

   

 

 

 

Total interest expense

     (276     (1,016     (1,292
  

 

 

   

 

 

   

 

 

 

Net interest income

   $ 1,937      $ (841   $ 1,096   
  

 

 

   

 

 

   

 

 

 

Provision for Loan Losses

The provision for loan losses is based upon credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimate of losses inherent in the current loan portfolio. The provision for loan losses for the first quarter of 2012 was $1.4 million, compared to $810 thousand for the same period in 2011. See “Allowance for Loan Losses” under the section titled “Lending Activities” included herein for additional information.

 

- 30 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Noninterest Income

The following table details the major categories of noninterest income for the periods presented (in thousands):

 

     Three months ended
March 31,
 
     2012     2011  

Service charges on deposits

   $ 1,835      $ 2,105   

ATM and debit card

     1,077        1,016   

Broker-dealer fees and commissions

     587        386   

Company owned life insurance

     426        266   

Net gain on sale of loans held for sale

     333        224   

Net gain on disposal of investment securities

     331        3   

Loan servicing

     94        349   

Impairment charges on investment securities

     (91     —     

Net gain on sale and disposal of other assets

     6        45   

Other

     853        754   
  

 

 

   

 

 

 

Total noninterest income

   $ 5,451      $ 5,148   
  

 

 

   

 

 

 

The components of noninterest income fluctuated as discussed below.

Service charges on deposit accounts were down $270 thousand in the first quarter primarily due to changes in customer behavior and recent regulatory changes that include requirements for customers to opt in for overdraft coverage for certain types of electronic banking activities.

Broker-dealer fees and commissions were up $201 thousand or 52% for the first quarter of 2012 compared to 2011. Broker-dealer fees and commissions fluctuate mainly due to sales volume, which increased during 2012 as a result of improving market and economic conditions and our renewed focus on this line of business.

During the third quarter of 2011 we purchased an additional $18.0 million of company owned life insurance. The increased amount of insurance was largely responsible for the $160 thousand increase in company owned life insurance income.

Gains from the sale of loans held for sale were $109 thousand higher than in the first quarter of 2011 due to increased origination volume.

We recognized a $331 thousand pre-tax gain from the sale of a pooled trust-preferred security that had been written down in prior periods and included in non-performing assets. We continue to monitor the market for the trust-preferred securities and evaluate the potential for future dispositions. The amount and timing of our sale of investments securities is dependent on a number of factors, including our prudent efforts to realize gains while managing duration, premium and credit risk.

Loan servicing income represents fees earned for servicing mortgage and indirect auto loans sold to third parties, net of amortization expense and impairment losses, if any, associated with capitalized loan servicing assets. Loan servicing income was down $255 thousand for the three months ended March 31, 2012 compared to 2011. Loan servicing income decreased as a result of more rapid amortization of servicing rights due to loans paying off, lower fees collected due to a decrease in the sold and serviced portfolio and write-downs on capitalized mortgage servicing assets.

During the first quarter of 2012 we recognized an OTTI charge of $91 thousand related to a privately issued whole loan CMO that was determined to be impaired due to credit quality.

 

- 31 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Noninterest Expense

The following table details the major categories of noninterest expense for the periods presented (in thousands):

 

     Three months ended
March 31,
 
     2012      2011  

Salaries and employee benefits

   $ 8,931       $ 8,401   

Occupancy and equipment

     2,770         2,843   

Professional services

     711         682   

Computer and data processing

     600         603   

Supplies and postage

     458         452   

FDIC assessments

     297         607   

Advertising and promotions

     101         165   

Other

     1,789         1,597   
  

 

 

    

 

 

 

Total noninterest expense

   $ 15,657       $ 15,350   
  

 

 

    

 

 

 

The components of noninterest expense fluctuated as discussed below.

Salaries and employee benefits (which includes salary-related expenses and fringe benefit expenses) was $8.9 million for 2012, up $530 thousand or 6% from 2011. Average full-time equivalent employees (“FTEs”) were 574 for 2012, about the same as 576 for last year. Salary-related expenses increased $326 thousand or 5% for the three months ended March 31, 2012, compared to 2011, reflecting annual merit increases, as well as an increase in estimated incentive compensation, which was previously limited under the TARP Capital Purchase Program. Fringe benefit expenses increased $204 thousand or 10%, primarily attributable to higher pension expense.

Other noninterest expense was $1.8 million for the first quarter of 2012, an increase of $192 thousand or 12% from the first quarter of 2011. Other noninterest expense for the first quarter of 2012 included $125 thousand of severance expense associated with workforce realignment in a continued effort to reduce future costs.

FDIC assessments decreased $310 thousand for the three months ended March 31, 2012, compared to 2011, primarily a result of changes implemented by the FDIC in the method of calculating assessment rates which became effective in the second quarter of 2011.

The efficiency ratio for the first quarter of 2012 was 58.59% compared with 59.97% for the first quarter of 2011. See “Use of Non-GAAP Financial Measures” on page 40 for further discussion of the efficiency ratio.

Income Taxes

For the three months ended March 31, 2012, we recorded income tax expense of $3.2 million, versus $3.0 million a year ago. The change in income tax was primarily due to higher pre-tax income during the first quarter of 2012. The effective tax rates for the first quarter of 2012 and 2011 were 33.7% and 34.1%, respectively. Effective tax rates are impacted by items of income and expense that are not subject to federal or state taxation. Our effective tax rates reflect the impact of these items, which include, but are not limited to, interest income from tax-exempt and tax-preferred securities and earnings on company owned life insurance.

 

- 32 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

ANALYSIS OF FINANCIAL CONDITION

INVESTING ACTIVITIES

Investment Securities

The following table sets forth selected information regarding the composition our investment securities portfolio as of the dates indicated (in thousands):

 

     Investment Securities Portfolio Composition  
     March 31, 2012      December 31, 2011  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

Securities available for sale:

           

U.S. Government agency and government-sponsored enterprise securities

   $ 104,599       $ 106,611       $ 94,947       $ 97,712   

State and political subdivisions

     141,184         145,289         119,099         124,424   

Mortgage-backed securities:

           

Agency mortgage-backed securities

     432,904         444,709         390,375         401,596   

Non-Agency mortgage-backed securities

     147         1,322         327         2,089   

Asset-backed securities (1)

     267         1,566         297         1,697   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

     679,101         699,497         605,045         627,518   

Securities held to maturity:

           

State and political subdivisions

     24,196         24,797         23,297         23,964   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 703,297       $ 724,294       $ 628,342       $ 651,482   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Includes non-performing investment securities. See “Non-Performing Assets and Potential Problem Loans” under the section titled “Lending Activities” included herein for additional information.

Investment securities available for sale increased $72.0 million or 11%, from $627.5 million at December 31, 2011 to $699.5 million at March 31, 2012, as we invested excess liquidity into this investment category.

Impairment Assessment

We review investment securities on an ongoing basis for the presence of other-than-temporary impairment (“OTTI”) with formal reviews performed quarterly. When evaluating debt securities for OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intention to sell the debt security or whether it is more likely than not that it will be required to sell the debt security before its anticipated recovery. The assessment of whether OTTI exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

Securities Deemed to be Other-Than-Temporarily Impaired

Through the impairment assessment process, we determined that a privately issued whole loan CMO was other-than-temporarily impaired due to credit quality at March 31, 2012. We recognized an OTTI charge of $91 thousand related to that security for the three months ended March 31, 2012. No impairment was recorded in the three months ended March 31, 2011.

 

- 33 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

LENDING ACTIVITIES

The following table sets forth selected information regarding the composition of the Company’s loan portfolio as of the dates indicated (in thousands).

 

     Loan Portfolio Composition  
     March 31, 2012     December 31, 2011  
     Amount      % of
Total
    Amount      % of
Total
 

Commercial business

   $ 233,764         15.4   $ 233,836         15.7

Commercial mortgage

     406,521         26.7        393,244         26.5   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial

     640,285         42.1        627,080         42.2   

Residential mortgage

     112,148         7.4        113,911         7.7   

Home equity

     237,019         15.6        231,766         15.6   

Consumer indirect

     508,085         33.4        487,713         32.9   

Other consumer

     23,491         1.5        24,306         1.6   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer

     768,595         50.5        743,785         50.1   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

     1,521,028         100.0     1,484,776         100.0
     

 

 

      

 

 

 

Allowance for loan losses

     23,763           23,260      
  

 

 

      

 

 

    

Total loans, net

   $ 1,497,265         $ 1,461,516      
  

 

 

      

 

 

    

Total loans increased $36.3 million to $1.521 billion as of March 31, 2012 from $1.485 billion as of December 31, 2011.

Commercial loans increased $13.2 million and represented 42.1% of total loans as of March 31, 2012, a result of our continued commercial business development efforts.

Residential mortgage loans decreased $1.8 million to $112.1 million as of March 31, 2012 in comparison to $113.9 million as of December 31, 2011. This category of loans decreased as the majority of newly originated and refinanced residential mortgages were sold to the secondary market rather than being added to our portfolio.

Our home equity portfolio, which consists of home equity loans and lines, totaled $237.0 million as of March 31, 2012, up $5.3 million or 2% compared to December 31, 2011. As of March 31, 2012, approximately 70% of the loans in the home equity portfolio were first lien positions.

The consumer indirect portfolio increased $20.4 million to $508.1 million as of March 31, 2012, from $487.7 million as of December 31, 2011. During the first quarter of 2012, we originated $72.3 million in indirect auto loans with a mix of approximately 46% new auto and 54% used auto. This compares with $45.6 million in indirect loan auto originations with a mix of approximately 41% new auto and 59% used auto for the same period in 2011.

Loans Held for Sale and Mortgage Servicing Rights

Loans held for sale (not included in the loan portfolio composition table) totaled $2.1 million and $2.4 million as of March 31, 2012 and December 31, 2011, respectively, all of which were residential real estate loans.

We sell certain qualifying newly originated or refinanced residential real estate mortgages on the secondary market. Residential real estate mortgages serviced for others, which are not included in the consolidated statements of financial condition, amounted to $292.9 million as of March 31, 2012 and $297.8 million as of December 31, 2011.

 

- 34 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Allowance for Loan Losses

The following table sets forth an analysis of the activity in the allowance for loan losses for the periods indicated (in thousands).

 

     Loan Loss Analysis  
     Three months ended March 31,  
     2012     2011  

Balance as of beginning of period

   $ 23,260      $ 20,466   

Charge-offs:

    

Commercial business

     55        90   

Commercial mortgage

     120        344   

Residential mortgage

     106        2   

Home equity

     4        107   

Consumer indirect

     1,395        1,290   

Other consumer

     314        211   
  

 

 

   

 

 

 

Total charge-offs

     1,994        2,044   

Recoveries:

    

Commercial business

     77        154   

Commercial mortgage

     15        16   

Residential mortgage

     70        27   

Home equity

     9        10   

Consumer indirect

     727        552   

Other consumer

     214        128   
  

 

 

   

 

 

 

Total recoveries

     1,112        887   
  

 

 

   

 

 

 

Net charge-offs

     882        1,157   

Provision for loan losses

     1,385        810   
  

 

 

   

 

 

 

Balance at end of period

   $ 23,763      $ 20,119   
  

 

 

   

 

 

 

Net loan charge-offs to average loans (annualized)

     0.24     0.35

Allowance for loan losses to total loans

     1.56     1.49

Allowance for loan losses to non-performing loans

     289     275

The allowance for loan losses represents the estimated amount of probable credit losses inherent in our loan portfolio. We perform periodic, systematic reviews of the loan portfolio to estimate probable losses in the respective loan portfolios. In addition, we regularly evaluate prevailing economic and business conditions, industry concentrations, changes in the size and characteristics of the portfolio and other pertinent factors. The process we use to determine the overall allowance for loan losses is based on this analysis. Based on this analysis, we believe the allowance for loan losses is adequate as of March 31, 2012.

Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based upon management’s evaluation of the amounts required to meet estimated charge-offs in the loan portfolio after weighing a variety of factors, including the risk-profile of our loan products and customers. We do not engage in sub-prime or other high-risk residential mortgage lending as a line-of-business. We primarily originate fixed and variable rate one-to-four family residential mortgages collateralized by owner-occupied properties located within our central and western New York marketplace, which has been relatively stable in recent years. Residential mortgages collateralized by one-to-four family residential real estate generally have been originated in amounts of no more than 85% of appraised value or have mortgage insurance.

The adequacy of the allowance for loan losses is subject to ongoing management review. While management evaluates currently available information in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution’s allowance for loan losses. Such agencies may require the financial institution to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

Net charge-offs of $882 thousand in the first quarter of 2012 represented 0.24% of average loans on an annualized basis compared to $1.2 million or 0.35% in the first quarter of 2011. The provision for loan losses totaled $1.4 million in the first quarter of 2012, exceeding charge-offs by $503 thousand, as we continue to maintain the allowance for loan losses consistent with the growth in our loan portfolio and trends in asset quality. The allowance equaled 289% of non-performing loans and 1.56% of total loans as of March 31, 2012.

 

- 35 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Non-Performing Assets and Potential Problem Loans

The table below sets forth the amounts and categories of the Company’s non-performing assets at the dates indicated (in thousands).

 

     Non-Performing Assets  
     March 31,     December 31,     March 31,  
     2012     2011     2011  

Nonaccrual loans:

      

Commercial business

   $ 1,863      $ 1,259      $ 901   

Commercial mortgage

     3,040        2,928        2,736   

Residential mortgage

     1,929        1,644        2,192   

Home equity

     934        682        835   

Consumer indirect

     444        558        639   

Other consumer

     7        —          12   
  

 

 

   

 

 

   

 

 

 

Total nonaccrual loans

     8,217        7,071        7,315   

Accruing loans 90 days or more delinquent

     5        5        3   
  

 

 

   

 

 

   

 

 

 

Total non-performing loans

     8,222        7,076        7,318   

Foreclosed assets

     258        475        568   

Non-performing investment securities

     1,505        1,636        567   
  

 

 

   

 

 

   

 

 

 

Total non-performing assets

   $ 9,985      $ 9,187      $ 8,453   
  

 

 

   

 

 

   

 

 

 

Non-performing loans to total loans

     0.54     0.48     0.54

Non-performing assets to total assets

     0.41     0.39     0.37

Information regarding the activity in nonaccrual loans for the three months ended March 31, 2012 is as follows (in thousands).

 

Nonaccrual loans, beginning of year

   $ 7,071   

Additions

     4,454   

Payments

     (1,301

Charge-offs

     (1,794

Returned to accruing status

     (142

Transferred to other real estate or repossessed assets

     (71
  

 

 

 

Nonaccrual loans, end of period

   $ 8,217   
  

 

 

 

Non-performing assets include non-performing loans, foreclosed assets and non-performing investment securities. Non-performing assets at March 31, 2012 were $10.0 million, an increase of $798 thousand from the $9.2 million balance at December 31, 2011. The primary component of non-performing assets is non-performing loans, which were $8.2 million at March 31, 2012, an increase of $1.1 million from the $7.1 million balance at December 31, 2011.

The ratio of non-performing loans to total loans was 0.54% at March 31, 2012, compared to 0.48% at December 31, 2011. The average of our peer group was 2.95% of total loans at December 31, 2011, the most recent period for which information is available (Source: Federal Financial Institutions Examination Council — Bank Holding Company Performance Report as of December 31, 2011 — Top-tier bank holding companies having consolidated assets between $1 billion and $3 billion).

Foreclosed assets consist of real property formerly pledged as collateral to loans, which we have acquired through foreclosure proceedings or acceptance of a deed in lieu of foreclosure. Foreclosed asset holdings represented 5 properties totaling $258 thousand at March 31, 2012 and 8 properties totaling $475 thousand at December 31, 2011.

As of March 31, 2012, non-performing investment securities for which we have stopped accruing interest consists of 9 securities with a total fair value of $1.5 million, compared to 10 securities with a fair value of $1.6 million at December 31, 2011. The non-performing investment securities are pooled trust preferred securities included in non-performing assets at fair value. During the first quarter of 2012 we recognized a $331 thousand pre-tax gain from the sale of one security that had been written down in prior periods and classified as non-performing at December 31, 2011. The security had a fair value of $125 thousand at December 31, 2011.

Potential problem loans are loans that are currently performing, but information known about possible credit problems of the borrowers causes management to have concern as to the ability of such borrowers to comply with the present loan payment terms and may result in disclosure of such loans as nonperforming at some time in the future. These loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and/or personal or government guarantees. Management considers loans classified as substandard, which continue to accrue interest, to be potential problem loans. We identified $12.8 million and $8.6 million in loans that continued to accrue interest which were classified as substandard as of March 31, 2012 and December 31, 2011, respectively.

 

- 36 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

FUNDING ACTIVITIES

Deposits

The following table summarizes the composition of our deposits at the dates indicated (dollars in thousands).

 

     Deposit Composition  
     March 31, 2012     December 31, 2011  
     Amount      % of
Total
    Amount      % of
Total
 

Noninterest-bearing demand

   $ 404,186         19.5   $ 393,421         20.3

Interest-bearing demand

     435,701         21.1        362,555         18.8   

Savings and money market

     530,754         25.7        474,947         24.6   

Certificates of deposit < $100,000

     469,862         22.8        486,496         25.2   

Certificates of deposit of $100,000 or more

     226,066         10.9        214,180         11.1   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total deposits

   $ 2,066,569         100.0   $ 1,931,599         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

We offer a variety of deposit products designed to attract and retain customers, with the primary focus on building and expanding long-term relationships. As of March 31, 2012, total deposits were $2.067 billion, an increase of $135.0 million in comparison to $1.932 billion as of December 31, 2011. Certificates of deposit were approximately 34% and 36% of total deposits at March 31, 2012 and December 31, 2011, respectively. Depositors remain hesitant to invest in certificates of deposit for long periods due to the low rate environment and, as a result, reduced both the amount they placed in time deposits and the maturity terms.

Nonpublic deposits represent the largest component of our funding. Total nonpublic deposits were $1.533 billion and $1.541 billion as of March 31, 2012 and December 31, 2011, respectively. We continue to manage this segment of funding through a strategy of competitive pricing and relationship-based sales and marketing that minimizes the number of customer relationships that have only a single high-cost deposit account.

As an additional source of funding, we offer a variety of public deposit products to the many towns, villages, counties and school districts within our market. Public deposits generally range from 20 to 25% of our total deposits. As of March 31, 2012, total public deposits were $533.3 million in comparison to $390.2 million as of December 31, 2011. There is a high degree of seasonality in this component of funding, as the level of deposits varies with the seasonal cash flows for these public customers. We maintain the necessary levels of short-term liquid assets to accommodate the seasonality associated with public deposits.

Borrowings

The following table summarizes our borrowings as of the dates indicated (in thousands):

 

     March 31,      December 31,  
     2012      2011  

Short-term borrowings:

     

Federal funds purchased

   $ —         $ 11,597   

Repurchase agreements

     40,547         36,301   

Short-term FHLB borrowings

     76,800         102,800   
  

 

 

    

 

 

 

Total short-term borrowings

   $ 117,347       $ 150,698   
  

 

 

    

 

 

 

We classify borrowings as short-term or long-term in accordance with the original terms of the agreement. There were no long-term borrowings outstanding as of March 31, 2012 or December 31, 2011.

We have credit capacity with the FHLB and can borrow through facilities that include amortizing and term advances or repurchase agreements. We had approximately $38 million of immediate credit capacity with FHLB as of March 31, 2012. We had approximately $392 million in secured borrowing capacity at the Federal Reserve Bank (“FRB”) Discount Window, none of which was outstanding at March 31, 2012. The FHLB and FRB credit capacity are collateralized by securities from our investment portfolio and certain qualifying loans. We had approximately $114 million of credit available under unsecured federal funds purchased lines with various banks as of March 31, 2012.

 

- 37 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Funds are borrowed on an overnight basis through retail repurchase agreements with bank customers and federal funds purchased from other financial institutions. Retail repurchase agreement borrowings are collateralized by securities of U.S. Government agencies. Federal funds purchased are short-term borrowings that typically mature within one to ninety days. There were no Federal funds purchased at March 31, 2012. Federal funds purchased totaled $11.6 million at December 31, 2011. Repurchase agreements are secured overnight borrowings with customers. These short-term repurchase agreements amounted to $40.5 million and $36.3 million as of March 31, 2012 and December 31, 2011, respectively. Short-term FHLB borrowings have original maturities of less than one year and include overnight borrowings which we typically utilizes to address short term funding needs as they arise. Short-term FHLB borrowings of $76.8 million and $102.8 million at March 31, 2012 and December 31, 2011, respectively, consisted of short-term advances.

Shareholders’ Equity

Shareholders’ equity was $240.0 million at March 31, 2012, an increase of $2.8 million from $237.2 million at December 31, 2011. Net income for the quarter increased shareholders’ equity by $6.2 million, which was partially offset by common and preferred stock dividends of $2.1 million. Accumulated other comprehensive income included in shareholders’ equity decreased $1.1 million during the first quarter due primarily to lower net unrealized gains on securities available for sale.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

The objective of maintaining adequate liquidity is to assure the ability of the Company to meet its financial obligations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the servicing and repayment of debt and preferred equity obligations, the ability to fund new and existing loan commitments, to take advantage of new business opportunities and to satisfy other operating requirements. The Company achieves liquidity by maintaining a strong base of core customer funds, maturing short-term assets, its ability to sell securities, lines of credit, and access to the financial and capital markets.

Liquidity for the Bank is managed through the monitoring of anticipated changes in loans, the investment portfolio, core deposits and wholesale funds, as well as the results of its operations and capital expenditures. The strength of the Bank’s liquidity position is a result of its base of core customer deposits. These core deposits are supplemented by wholesale funding sources that include credit lines with the other banking institutions, the FHLB and the FRB.

The primary sources of liquidity for the parent company are dividends from the Bank and access to financial and capital markets. Dividends from the Bank are limited by various regulatory requirements related to capital adequacy and earnings trends. The Bank relies on cash flows from operations, core deposits, borrowings and short-term liquid assets. Five Star Investment Services relies on cash flows from operations and funds from the parent company when necessary.

The Company’s cash and cash equivalents were $77.0 million as of March 31, 2012, up $19.4 million from $57.6 million as of December 31, 2011. Net cash provided by operating activities totaled $12.3 million and the principal source of operating activity cash flow was net income adjusted for noncash income and expense items. Net cash used in investing activities totaled $91.9 million, which included cash outflows of $37.2 million for net loan originations and $54.4 million from investment securities transactions. Net cash provided by financing activities of $99.1 million was attributed to a $135.0 million increase in deposits, partly offset by a $33.4 million increase in short-term borrowings and $2.1 million in dividend payments.

Capital Resources

Banks and financial holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material impact on the Company’s consolidated financial statements. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by 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 and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets (all as defined in the regulations). These minimum amounts and ratios are included in the table below.

 

- 38 -


MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The Company’s and the Bank’s Tier 1 capital consists of shareholders’ equity excluding unrealized gains and losses on securities available for sale (except for unrealized losses which have been determined to be other than temporary and recognized as expense in the consolidated statements of income), goodwill and other intangible assets and disallowed portions of deferred tax assets. Tier 1 capital for the Company includes, subject to limitation, $17.5 million of preferred stock. The Company and the Bank’s total capital are comprised of Tier 1 capital for each entity plus a permissible portion of the allowance for loan losses.

The Tier 1 and total capital ratios are calculated by dividing the respective capital amounts by risk-weighted assets. Risk-weighted assets are calculated based on regulatory requirements and include total assets, excluding goodwill and other intangible assets and disallowed portions of deferred tax assets, allocated by risk weight category and certain off-balance-sheet items (primarily loan commitments and securities more than one level below investment grade that are subject to the low level exposure rules). The leverage ratio is calculated by dividing Tier 1 capital by adjusted quarterly average total assets, which exclude goodwill and other intangible assets and disallowed portions of deferred tax assets.

The following table reflects the ratios and their components (dollars in thousands).

 

     March 31,     December 31,  
     2012     2011  

Total shareholders’ equity

   $ 239,962      $ 237,194   

Less: Unrealized gain on securities available for sale, net of tax

     12,316        13,570   

Unrecognized net periodic pension & postretirement benefits (costs), net of tax

     (12,423     (12,625

Disallowed goodwill and other intangible assets

     37,369        37,369   

Disallowed deferred tax assets

     —          1,794   
  

 

 

   

 

 

 

Tier 1 capital

   $ 202,700      $ 197,086   
  

 

 

   

 

 

 

Adjusted average total assets (for leverage capital purposes)

   $ 2,304,029      $ 2,282,755   
  

 

 

   

 

 

 

Tier 1 leverage ratio (Tier 1 capital to adjusted average total assets)

     8.80     8.63

Total Tier 1 capital

   $ 202,700      $ 197,086   

Plus: Qualifying allowance for loan losses

     20,774        20,239   
  

 

 

   

 

 

 

Total risk-based capital

   $ 223,474      $ 217,325   
  

 

 

   

 

 

 

Net risk-weighted assets

   $ 1,658,969      $ 1,616,119   
  

 

 

   

 

 

 

Tier 1 capital ratio (Tier 1 capital to net risk-weighted assets)

     12.22     12.20

Total risk-based capital ratio (Total risk-based capital to net risk-weighted assets)

     13.47     13.45

The Company’s and the Bank’s actual and required regulatory capital ratios were as follows (dollars in thousands):

 

                      For Capital               
         Actual     Adequacy Purposes     Well Capitalized  
         Amount      Ratio     Amount      Ratio     Amount      Ratio  

March 31, 2012

                 

Tier 1 leverage:

  Company    $ 202,700         8.80   $ 92,161         4.00   $ 115,201         5.00
 

Bank

     191,030         8.31        91,961         4.00        114,951         5.00   

Tier 1 capital:

  Company      202,700         12.22        66,359         4.00        99,538         6.00   
 

Bank

     191,030         11.54        66,221         4.00        99,331         6.00   

Total risk-based capital:

  Company      223,474         13.47        132,718         8.00        165,897         10.00   
 

Bank

     211,762         12.79        132,442         8.00        165,552         10.00   

December 31, 2011

                 

Tier 1 leverage:

  Company    $ 197,086         8.63   $ 91,310         4.00   $ 114,138         5.00
 

Bank

     184,639         8.10        91,192         4.00        113,990         5.00   

Tier 1 capital:

  Company      197,086         12.20        64,645         4.00        96,967         6.00   
 

Bank

     184,639         11.46        64,445         4.00        96,667         6.00   

Total risk-based capital:

  Company      217,325         13.45        129,290         8.00        161,612         10.00   
 

Bank

     204,817         12.71        128,890         8.00        161,112         10.00   

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Dividend Restrictions

In the ordinary course of business the Company is dependent upon dividends from Five Star Bank to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years.

USE OF NON-GAAP FINANCIAL MEASURES

In addition to results presented in accordance with U.S. GAAP, this report includes the non-GAAP financial measure “efficiency ratio”. We believe this non-GAAP financial measure provides a meaningful base for period-to-period comparisons and will assist investors in analyzing our operating results and facilitating performance comparisons with others in the banking industry. Non-GAAP measures have inherent limitations, are not required to be uniformly applied and are not audited. Readers should be aware of these limitations and should be cautious in their use of such measures. To mitigate these limitations, we have procedures in place to ensure that these measures are calculated using the appropriate GAAP or regulatory components in their entirety and to ensure that its performance is properly reflected to facilitate consistent period-to-period comparisons. Although we believe the efficiency ratio enhance investors’ understanding of our business and performance, this non-GAAP measure should not be considered in isolation, or as a substitute for GAAP basis financial measures. Investors should consider our performance and financial condition as reported under GAAP and all other relevant information when assessing our performance or financial condition.

The efficiency ratio measures the amount of revenue (defined as the sum of tax-equivalent net interest income and noninterest income before net gains and impairment charges on investment securities) needed to cover noninterest expenses. In accordance with industry standards, we believe that presenting net interest margin on a taxable equivalent basis, using a 35% effective federal tax rate, allows comparability of net interest margin with industry peers by eliminating the effect of the differences in portfolios attributable to the proportion represented by both taxable and tax-exempt investments. A reconciliation of interest income to interest income on a fully taxable equivalent basis and net interest income on a taxable equivalent basis is presented in the table under “Net Interest Income and Net Interest Margin.”

The following table provides: (i) a reconciliation of noninterest expense (GAAP) to adjusted noninterest expense (non-GAAP); (ii) a reconciliation of noninterest income (GAAP) to adjusted noninterest income (non-GAAP); (iii) a computation of adjusted total revenue (non-GAAP); and (iv) a computation of the efficiency ratio (non-GAAP) (dollars in thousands).

 

          Three months ended  
          March 31,  
          2012     2011  

Noninterest expense

      $ 15,657      $ 15,350   

Significant items:

       

Other real estate owned expense

        (37     (59
     

 

 

   

 

 

 

Adjusted noninterest expense (non-GAAP)

   A    $ 15,620      $ 15,291   
     

 

 

   

 

 

 

Net interest income on a taxable equivalent basis

      $ 21,448      $ 20,352   

Noninterest income

        5,451        5,148   

Significant items:

       

Net gain on disposal of investment securities

        (331     (3

Impairment charges on investment securities

        91        —     
     

 

 

   

 

 

 

Adjusted noninterest expense (non-GAAP)

   B    $ 26,659      $ 25,497   
     

 

 

   

 

 

 

Efficiency ratio (non-GAAP)

   A/B      58.59     59.97

 

- 40 -


ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Our primary market risk is interest rate risk, which is defined as the potential variability of our earnings that arises from changes in market interest rates and the magnitude of the change at varying points along the yield curve. Changes in market interest rates, whether they are increases or decreases, can trigger repricings and changes in the pace of payments for both assets and liabilities, which individually or in combination may affect our net income, net interest income and net interest margin, either positively or negatively.

The principal objective of the Company’s interest rate risk management is to evaluate the interest rate risk inherent in certain assets and liabilities, determine the appropriate level of risk to the Company given its business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with the guidelines approved by the Company’s Board of Directors. The Company’s management is responsible for reviewing with the Board its activities and strategies, the effect of those strategies on the net interest margin, the fair value of the portfolio and the effect that changes in interest rates will have on the portfolio and exposure limits. Management develops an Asset-Liability Policy that meets strategic objectives and regularly reviews the activities of the Bank.

The primary tool the Company uses to manage interest rate risk is a “rate shock” simulation to measure the rate sensitivity of the balance sheet. Rate shock simulation is a modeling technique used to estimate the impact of changes in rates on net interest income and economic value of equity. The Company measures net interest income at risk by estimating the changes in net interest income resulting from instantaneous and sustained parallel shifts in interest rates of different magnitudes over a period of twelve and twenty four months. This simulation is based on management’s assumption as to the effect of interest rate changes on assets and liabilities and assumes a parallel shift of the yield curve. It also includes certain assumptions about the future pricing of loans and deposits in response to changes in interest rates. Further, it assumes that delinquency rates would not change as a result of changes in interest rates, although there can be no assurance that this will be the case. While this simulation is a useful measure as to net interest income at risk due to a change in interest rates, it is not a forecast of the future results and is based on many assumptions that, if changed, could cause a different outcome.

In addition to the changes in interest rate scenarios listed above, the Company typically runs other scenarios to measure interest rate risk, which vary depending on the economic and interest rate environments.

The Company has experienced no significant changes in market risk due to changes in interest rates since the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, dated March  9, 2012, as filed with the Securities and Exchange Commission.

ITEM 4. Controls and Procedures

Evaluation of disclosure controls and procedures

As of March 31, 2012, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b), as adopted by the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (“Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

41


PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

The Company has experienced no material developments in its legal proceedings from the disclosure included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, dated March 9, 2012, as filed with the Securities and Exchange Commission.

ITEM 1A. Risk Factors

The Company has experienced no material changes in its risk factors from the disclosure included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, dated March 9, 2012, as filed with the Securities and Exchange Commission.

ITEM 6. Exhibits

 

  (a) The following is a list of all exhibits filed or incorporated by reference as part of this Report.

 

Exhibit
Number

  

Description

   Location  
31.1    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Principal Executive Officer      Filed Herewith   
31.2    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Principal Financial Officer      Filed Herewith   
32    Certification pursuant to18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002      Filed Herewith   
*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   

 

* Pursuant to Rule 406T of Regulation S-T, the information in this exhibit shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be incorporated by reference into any registration statement, prospectus or other document filed under the Securities Act of 1933, or the Securities Exchange Act of 1934, except as shall be expressly set forth by specific reference in such filings.

 

42


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.

 

FINANCIAL INSTITUTIONS, INC.    
/s/ Peter G. Humphrey   ,   May 8, 2012
Peter G. Humphrey    
President and Chief Executive Officer    
(Principal Executive Officer)    
/s/ Karl F. Krebs   ,   May 8, 2012
Karl F. Krebs    
Executive Vice President and Chief Financial Officer    
(Principal Financial and Principal Accounting Officer)    

 

43